IN OCTOBER 1987 James Baker, secretary of the US Treasury in the Reagan administration, wandered out onto the White House lawn and gave the impression that he and his colleagues would not be unduly concerned about a weaker dollar.
What he failed t
o appreciate was that while he and his boss might apparently not be worried about the fall in the international value of the greenback, those foreign investors who were pouring money into US Treasury bills, vital in the funding of the country's enormous deficits, might have other ideas. They did, and while it is rarely mentioned as the catalyst, this was the trigger for the October 1987 worldwide stock market debacle.
Could it happen again? Certainly the figures involved are mind-boggling. The US Federal deficit was at an all-time high of $311 billion for the first half of this budget year, with some forecasts suggesting a full-year total of $500bn, about 36.8 per cent of GDP. Again, this is being funded by overseas buying of US bills and similar instruments.
Indeed, it is something of an irony that a proportion of this inflow is coming out of Opec, so it could be argued that at least some of the Arab states are actually financing the US's presence in Iraq.
Be that as it may, the dollar has continued to plunge, now down 45 per cent against the euro since 2002 and recently breaking through the $2 barrier against the pound for the first time since 1992.
Of course, the weak dollar has cushioned us all to an extent from the effects of rocketing commodity prices. Even after its stratospheric increase, the cost of oil is still, in real terms, below the level hit during the oil crisis in 1973. However, there are other dimensions that are less appealing.
A strong pound relative to the US currency makes UK exports much more expensive, while for companies earning appreciable proportions of their revenue from dollar denominated regions, there are substantial conversion losses when repatriating sales back to the UK.
To some extent the weakness in the dollar is something of a deliberate US Federal Reserve policy, although, unlike Baker, the current Fed chairman, Ben Bernanke, is hardly likely to admit it in public. Today his biggest fear is recession, perhaps even depression if some of the wilder suggestions on the prospects for the US housing market are confirmed.
If we get a spiral of repossessions coming onto an already depressed housing market, consumer spending will collapse, the US industry will rein back its investment programmes and the 1930s dust bowl years will return. Of course, a government can simply print paper money to fund a deficit but if confidence in the currency collapses one can get hyper-inflation.
The other doomsday scenario is if the continuing devaluation of the US currency finally exasperates overseas investors and they pull the plug. There would then be the real possibility of a US default, with catastrophic consequences for the global financial edifice.
But will this happen? I doubt it, simply because few economies would be insulated against such a cataclysmic event.
However, there is another side to this coin. China, India, Russia and the oil-revenue rich countries of Opec may well demand a quid pro quo for continuing to fund the US economy's financial abysses. In the UK in 1974, the then chancellor of the exchequer, Denis Healey, was obliged to go cap in hand to the International Monetary Fund to bail out the crippled British economy. The IMF obliged, but if the US found itself in the same position I doubt whether Russia, China – or, indeed, any Arab state, including Saudi Arabia – would be quite so generous.
Mind you, the US is not alone. According to the latest official figures the UK had a national debt of £536.5bn by the end of December last year.
Fortunately, this was still within Gordon Brown's 40 per cent rule on borrowing and spending, although he has a habit of not just moving the goalposts but carrying them out of the stadium and down the road.
As many are finding to their cost today, debt is not a gift, and papering over the cracks by printing more money is a poor substitute for responsible expenditure. We must all hope that the bloated debt pachyderm will be kept acquiescent across the Atlantic by ingesting copious bales of foreign funds. If not, the global economic structure could be flattened by his subsequent rage.
? Bryan Johnston is a director of Bell Lawrie in Edinburgh
The full article contains 768 words and appears in The Scotsman newspaper.
