US: US DOLLAR and World Economy

Jon Kofas writes: As investors celebrate today the anniversary of the NASDAQ’s peak five years ago, they are facing the bad news from Japan that it plans to diversify its reserve holdings. The announcement comes just a few weeks after South Korea hinted the same thing, sending the dollar’s value down against foreign currencies. Because foreign central banks hold 64% of their reserves in dollars, there is a lot of concern in the U.S. about the continued decline of the dollar, if other countries diversify. Because the EU has been lobbying China to support the dollar as a reserve currency so that European exporters do not suffer further losses, and given that 64% of foreign central banks’ reserves are in dollars, the U.S. currency has remained artificially high against the reality of a combined budgetary and trade deficit that will exceed $1 trillion, or about 8.5% of GDP in 2005. Informed observers can draw their own conclusions on how we arrived here. The more serious question is whether living standards in the U.S. will not continue to decline in the next 10 years as a result of this situation to which there is no end in sight. Bush administration policies designed to cut social programs, prevent the minimum wage from rising more than a $1, continue to raise defense to astronomical levels, and provide more tax breaks for the top 10% of income earners will further weaken the U.S. economy for the next ten years, and beyond, depending on the next administration’s policies. The relative weakening of the U.S. dollar and economy which helps strengthen China will pose geopolitical balance of power problems for the U.S. in the future. This, in part, explains the nervousness of Japan and South Korea about the U.S. dollar and their move to diversify.       

Christopher Jones says: While I agree with everything Jon Kofas says, the question is what is the alternative to the dollar?  The Euro is itself artificially high and the stability pack has been practically abolished; the Swiss franc does have a significant portion backed in gold but it too its flirting with new territory; so my best guess is that these thrifty foreigners will start rebuying just what debt-guru Greenspan was set to malign, slander and destroy in order to construct his perverse financial world based on debt: gold.  RH: Is this a fair summary of Greenspan's ideas?

Jon Kofas says:Just a quick reply to both Randy Black's and Christopher Jones' comments. First, I agree with Chris that the alternative to the dollar is a huge challenge, and that is why a transition toward the currently highly-valued EURO will take many years. This is also why it is in the interest of all countries to keep supporting the weak dollar, to their own detriment. Regarding Randy's comments, he is of course correct that the U.S. has no poor people, no elitism, the best social programs in the world, the most affordable and universal  medical care system in the world, and the most fair income distribution system in the world. In all seriousness,  do not fault Randy for choosing to see statistics from a rosy perspective, because the U.S. has historically and to this day been a society of very high socoeconomic mobility, an open society, a welcoming society for immigrants, and one that allows more opportunities and the realization of an individual's potential than any other in the world. While all of us must acknowledge these realities, do we turn a blind eye to social justice issues which have clearly not been a priority under the Republicans?  To deny that the U.S. has been somehow transformed into a Shangri-la society with no socioeconomic ills, or even into Sweden and Norway where social justice is a priority, is to deny reality.

Cameron Sawyer said: Trade deficits are self-regulating and relatively harmless -- a trade deficit is really nothing more than a surplus of incoming investment.  Bob Gard disagrees: Trade deficits are "harmless" only if nations who run a trade surplus with us are willing to invest the surplus in the US. Many analysts believe it unlikely that we can continue with impunity to run annual deficits on current account at the current rate of  $600 billion.  

Jon Kofas replies to Cameron Sawyer:Not to belabor the matter, but if I could possibly answer Cameron point-by-point, especially today upon the announcement that the EU will proceed with plans to lift the weapon's ban to China, despite U.S. objections.
1. Adjusted for monetary inflation, and taking into account that the level of personal debt is at an all time high, U.S.  living standards are not at an all-time high. Moreover, "average incomes" are deceptive, because billionaires are counted along with 36-38 million Americans who live below the poverty line, and another 47 million who have no health care. It is true that the EU economy in terms of GDP growth  are not doing as well as the U.S., China, or India, but the fact is that the EU has a much stronger social welfare system which provides a better safety net for the lower classes than what we have in the U.S.

2. China does benefit from the weak dollar, and the proof of that is that it is using the surplus dollars, partly at the urging of the EU and Japan, to finance the U.S. debt by purchasing bonds. Though the rate of return on the long-bond is low, the Chinese and all long-term bond investors are betting on slow U.S. long-term growth. Though it has been the policy of the U.S. since the Carter administration to strengthen the Chinese economy, the EU is now countering by lifting the ban on sales of weapons' sales, partly as a means to make up the gap that the U.S.-China trade has created in EU losses because of the weak dollar. The U.S. has been vehemently opposed to the lifting of the EU ban, and has threatened to retaliate, but we'll have to see what is worked out in a compromise. The EU has no problem lifting the weapons ban, because the U.S. has no problem strengthening China by the economic integration it has forged in the past 25 years.

3. Though the geopolitical balance shift in China's favor is largely due to the country's own policies, resources, and expanding domestic marker, it is undeniable that the U.S. government and the U.S. private sector have played a role in lifting China to its current status as an economic power-house. All of this started with the deliberate U.S. plan to weaken the USSR and use China as a counter-weight since the 1970s. (This is confirmed by the NSC archival papers at the Carter and Reagan Libraries).

4. Budget and trade deficits do drive the currency down under the current economic and fiscal climate, because the U.S. economy is not expected to grow sufficiently to cover the estimated deficit (trade and budget) of about 4% of the total GDP. The expanding defense spending, combined with the tax breaks to the wealthiest income earners entails growing chronic deficits. That is why Bush is trying to have Social Security "reform", namely shift the burden to the workers and middle income groups, to pay these enormous deficits.

5. The idea that minimum wage is unrelated to living standards is debatable at the very least. Minimum wage has been used as the criterion to determine wages for the vast majority of the unskilled and semi-skilled labor force. This has been the case ever since David Ricardo, in Principles of Political Economy (1817), forged the "subsistence wage theory" or "iron law of wages." Today we need to ask why is it that for the past forty years  companies have been relocating from the high-wage areas (G-7) to the low-wage markets? 

RH:In this regard, there was an excellent German documentary on General Motors.  Flint, once an importing manufacturing tow, became almost as ghost town when General Motors shut down its plant there.  Now General Motors is thinking of moving its Opel plant in Bochum, Germany, to Poland and similar places.  This has greatly increased labor unrest in Germany.

Bob Gard said: "Trade deficits are 'harmless' only if nations who run a trade surplus with us are willing to invest the surplus in the US." From Moscow, Cameron Sawyer replies: Of course!  But why "only" if they are willing to invest?  If they don't invest, we can't buy their stuff, and trade deficits disappear.  Our currency loses its value against theirs as a direct function of any imbalance between incoming and outgoing flows of capital.  It is completely self-regulating.  Remember, trade deficits are a result of international markets of goods, services, and investments.  They are not the result of government spending or policies unless we're talking about a centrally planned economy where goods are purchased not by private businesses and individuals, but by the state.  That is why it is complete nonsense to lump trade deficits and budget deficits in one category.
As to Jon Kofas' theses:
1.  By any measure, U.S. living standards are the highest of any large nation and are higher than they were 10, 20, or 30 years ago, and are improving faster than in Europe.  A widespread social safety net and large numbers of people on public relief, as in Western Europe, are not signs of high living standards, but quite the opposite -- they are signs of failure of those economies to produce enough wealth for everyone to have a chance to prosper. 
2.  A weak or weakening dollar works against anyone investing in the U.S. as well as anyone selling goods to the U.S.  Why would Chinese investors want their investments to be devalued (by the way, most of these investments go into equities, not bonds).  The only beneficiary of a weak or weakening dollar is U.S. exporters, who gain price advantage.  This is part of the self-regulating mechanism of trade deficits.
2.a.  The EU is making weapons sales to China because it wants to earn money on those sales, period.  The EU desperately needs that boost to its aerospace and military industries.  It has decided that it just doesn't give a damn about the security threat.  And in fairness, the Chinese are getting extremely good weapons from Russia, and are developing their own.  If they're going to have sophisticated weapons anyway, why not make some money off it?  Maybe they're right, but it's a dangerous game.
2.b.  If Carter thinks he built up the Chinese economy, then he is a fool.  U.S.--Chinese trade is mutually beneficial, and we needed it as badly as they did.  The Chinese invented their own economy, not even using our methods, and their successes are 100% their own.   By the same token, proposed EU weapons sales have nothing to do with U.S.-Chinese trade, which has nothing to do with the EU whatsoever (Chinese goods do not compete with European goods). 
3.  Maybe the U.S. government, at some point, wanted China to get stronger, to be a counterweight to the USSR, but wanting it, and doing it are completely different things.  It was never in our power to make the Chinese economy stronger or weaker; the very idea is a sign of the same kind of megalomania which has gotten us in over our heads in the Middle East these days.
4.  Budget and trade deficits, once again, have nothing whatsoever to do with each other.  A growing economy is not needed to balance a trade deficit; trade deficits balance themselves out no matter what the economy does.  Other than erecting trade barriers (not practiced much these days because science now knows that these do vastly more harm than good), there is nothing the government can do about a trade deficit.  Budget deficits, on the other hand, can be covered only if capital markets will buy the deficit-spending governments scrip, and only if the economy continues to produce enough output to cover the debt service payments and, best of all, if the economy grows enough to swallow the previous deficits.  Budget deficits increase demand for capital, and tend to drive up the value of currency (not down, as in the case of a trade deficit), at least until the state's credit rating starts to slip.  We saw this in Russia in 1997-1998, where the state was running huge budget deficits, but fairly large trade surpluses, and the ruble in real terms appreciated continuously, and the market for Russian state bonds (GKO's) turned into a kind of pyramid scheme which collapsed one black Monday in August, 1998.
5.  How can the minimum wage affect living standards?  Just because you outlaw work below a certain wage level does not mean that other jobs at a higher wage level magically appear.  A higher minimum wage simply outlaws that work which willing buyers and sellers of labor would otherwise contract for at a lower price, and that work, naturally enough, moves to poorer countries.  Minimum wages are properly used to prohibit sweatshop work in countries which can afford to do without sweatshop-type jobs.  However, this benefit is not without a cost -- namely, unemployment.  A higher minimum wage merely makes some workers unemployed -- those who cannot sell their labor on the market for as much as the minimum wage.  This requires higher degrees of public spending on social programs.  In moderation, there is nothing wrong with this.  If employed to an unreasonable degree, however, such as in France, and all the more in conjunction with restrictive employment legislation, it creates mass unemployment.  But between the U.S., with reasonable minimum wage laws, and developing countries, it works perfectly well -- low value added production moves to countries which need such jobs, and this movement gets an extra push from minimum wage laws, and Americans move up the food chain, doing higher and higher value added work.   There are no "subsistence wages" in the U.S. a la Ricardo.  And we do not have structural unemployment in the U.S., while the Europeans do.  See the excellent discussion of minimum wages at
On this general subject, I would like to add one comment concerning a remark of mine some time ago which Ronald misunderstood -- namely concerning Europe and whether or not it is heading towards becoming a big museum with no economic significance.  I did not mean that Europe is good for nothing but being a big museum.  In fact, I am a European resident by choice, having lived most of my adult life here.  I adore Europe and plan to spend the rest of my life here.  And I do not think that Europe's future is so bleak.  I merely meant that if economic policies continue without reform, that such a result is possible.  I think that there will be reform.  I was reading Der Spiegel last week on the TGV between Nice and Paris, a large part of which was devoted to Schroeder's economic policies and promises to reduce unemployment, and the contrast between these promises and the actual results (an enormous increase in unemployment, to levels which Germany will not be able to withstand for long).   Der Spiegel, for those who don't read German journals, is the backbone of the serious left-liberal German press.  The editors of Der Spiegel themselves are beginning to understand the failure of European socialism,  which is evident in their merciless dissection of the German economy, and damning critique of Schroeder's economic policies in last week's issue.   When even the left establishment starts to see this, then a consensus in favor of reform starts to become possible.  Russia's successful economic reforms were possible only because Communism underwent a fatal crisis.  The crisis of European socialism is also coming, perhaps not as dramatic as the crisis which ended the Soviet Union, but a crisis nevertheless.  And this crisis itself creates the possibility of meaningful reform.

From France, Christopher Jones writes: Bob Gard brings up an interesting point that I have tried to make more than once; the US is dependent on foreign money to keep it going.  This situation has a historical and uncomfortable precedent:  during the late 1780s, the Kingdom of France found itself more and more dependent on "hot" money from thrifty foreigners to finance the state debt.  When the crown's ability to finance this dried up, the carpet was pulled and the French Revolution took place.  When the imported goods are strengthening the long term economic structure of the country, a trade deficit may be a sign of healthy long term investment. However, in the case of the US, this has long ceased to be the case.  A massive debt to finance military prowess sounds a little reminiscent of the policies of the late Shah of Iran.

From Denmark. Holger Terp writes: No wonder that the US deficts are high, considering the money spent on new weapons. This are examples:

                                      AIR FORCE

 Arctic Pipe and Materials LLC, Colorado Springs, Colo. and TDF Construction Joint Venture, Colorado Springs, Colo., are being awarded a $150,000,000 indefinite delivery/indefinite quantity contract to provide for the Simplified Acquisition of Base Engineering Requirements (SABER) construction contract for Peterson Air Force Base (AFB), Ft. Carson Post and Pinon Canyon, Cheyenne Mountain Air Force Station, Colo.  The work performed is construction services, which includes maintenance, repair and minimal design.  The Air Force can
issue delivery orders totaling up to the maximum amount indicated above, although actual requirements may necessitate less than the amount above.  At this time, $100,000 of the funds has been obligated.  Future funds will be obligated as individual delivery orders are issued.   This work will be complete November 2005. Solicitation began August 2004 and negotiations were complete January 2005.  The 21st Space Wing, Peterson AFB, Colo., is the contracting activity (FA2517-05-D-5001 and FA2517-05-D-5002).


Lockheed Martin Corp., Lockheed Martin Aeronautics Co., Palmdale, Calif., is being awarded a $10,641,888 increment of a $55,186,452 modification to a previously awarded other transaction for prototypes agreement that exercises the option for Phase Iib of Task 2 (Hypersonic Technology Vehicle) of the DARPA/Air Force Falcon program.  Work will be performed in Palmdale, Calif. (41.5%) and King of Prussia, Penn. (58.5 percent) and will be completed in December 2005.  A portion of the funds ($3,063,958) will expire at the end of this fiscal year.  The Defense Advanced Research Projects Agency is the contracting activity (HR0011-04-9-0010, P00006).


BAE Systems Technologies Inc., Rockville, Md., is being awarded a $6,687,077 modification to a previously awarded cost-plus-fixed-fee contract (N00421-01-C-0192) to exercise an option for engineering and technical support for Air Traffic Control and Landing Systems.  Work will be performed in St. Inigoes, Md. (88.5 percent) and San Diego, Calif. (11.5 percent), and is expected to be completed in March 2006.  Contract funds in the amount of $501,530 will expire at the end of the current fiscal year.  The Naval Air Systems Command Aircraft
Division, St. Inigoes, Md., is the contracting activity.

Sierra Nevada Corp., Sparks, Nev., is being awarded a $5,015,460 modification to a previously awarded firm-fixed-price, indefinite delivery, indefinite quantity contract (N00421-05-D-0010) to exercise an option for the procurement of 42 radio beacon sets for the AN/SPN245 Radar System.  Work will be performed in Lancaster, Pa., and is expected to be completed in December 2005. Contract funds will not expire at the end of the current fiscal year.  The Naval Air Warfare Center Aircraft Division, Patuxent River, Md., is the contracting activity.

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Robert Gard writes: Nations running a trade surplus with us do have an option other than investing in US securities. There's an international market in currencies; they can sell the dollars for Euros, for example. In fact, two foreign finance ministers recently suggested that they are considering diversifying from dollar financial instruments. Doing so would have nothing to do with the US consumer appetite for their goods, but it would
reduce the value of the dollar relative to currencies being purchased with dollars. 

From France, Christopher Jones writes: I would like to carry Robert Gard's post on to its ultimate, lethal conclusion.  As those thrifty foreigners sell dollars for Euros, Yen, Swissie or whatever, because of the trade deficit, [exacerbated in part by outsourcing and general globalization] those imported goods will increase in price, fuelling inflation.  The knock on effect would be higher interest rates inside the US, very probabaly when it cannot afford them.  Higher rates will make servicing the debt more difficult, entailing even higher rates:  As the economy stalls because of the upward pressure on the cost of money, the bond market could easily collapse, scaring off hot foreign money, that will be waiting for even higher returns.  [So and so, the stock market has been moving sideways for years now, with corporate indebtedness running at an all time high, higher rates will drive the stocks market down too -- as usual] That will put even further pressure on interest rates.  The stage has been set the scenery in place for the beginning of the second American revolution.  Any buying strike by foreigners (Chinese --we'll buy your bonds if you let us attack Taiwan? Japanese, Germans etc.) and or a terror attack against the mainland US could bring the whole edifice, based on debt, crashing down.

Robert Gard wrote: Nations running a trade surplus with us do have an option other than investing in US securities. There's an international market in currencies; they can sell the dollars for Euros, for example.
Robert Whealey comments: This is exactly what Europe did from 1965 to 1975 during the Vietnam War. They also bought gold. What the U.S. Civil War, World War I, the Spanish Civil War, World War II, Korea and Vietnam all prove is that countries that go to war loose money.  The Swiss and Swedes have proven over and over again it that peace pays. Every day that the Afghan and Iraq wars, and the Arab Israeli crisis continues costs the U.S. public money. Special interests make money.  DuPont in World War I,  Dow Chemical in Vietnam,  Japan in Korea,  and Haliburton in the Middle East have made money today at the tax payers' expense.

Robert Gard wrote: Nations running a trade surplus with us do have an option other than investing in US securities. There's an international market in currencies; they can sell the dollars for Euros, for example. Robert Whealey commented: This is exactly what Europe did from 1965 to 1975 during the Vietnam War. They also bought gold. What the U.S. Civil War, World War I, the Spanish Civil War, World War II, Korea and Vietnam all prove is that countries that go to war loose money.  The Swiss and Swedes have proven over and over again it that peace pays. Every day that the Afghan and Iraq wars, and the Arab Israeli crisis continues costs the U.S. public money. CAmeron Sawyer says: Sure, but it doesn't make any difference.  If the dollars which come in from export sales to the U.S. don't get back into the U.S. as either trade or investment, the dollar falls, and the export sales dry up.  As to war-making countries losing money, this is a different subject, but I agree with Robert Whealey.  War is an economically destructive activity, contrary to what many believe.  Human lives and treasure are spent for non-economic purposes, therefore, war does not only kill, it impoverishes as well.

Randy Black writes: I am never really surprised when Jon Kofas passes along opinions on US economic policies. On the surface, Mr. Kofas’ positions read well and are interesting, until one exams easily accessible sources. Contrary to the positions Mr. Kofas elaborated in his post:
1)      US living standards have not/will not ‘continue’ their decline. Factually, American household wealth is at an all time high.
2)      Social programs continue to increase their spending rate at significant levels, year over year. All a person has to do is read the line items in the national budget as approved by Congress, from year to year dating from 1990 to present. Contrary to Mr. Kofas’ position, new and existing social programs are expanding and eating up increasing percentages of the national budget, year over year. Factually, a study of social programs such as Medicare, Medicaid, Children’s and Maternal Health spending, VA spending, Public Health and Indian Health Budgets, along with about 15 other social spending programs prove that spending increased in every year over the past 15, except for two years during the Clinton Administration (1995-1996). (See item: for downloading for the actual budget spent.)
3)      Mr. Kofas complains that the Bush Administration prevent(ed) the minimum wage from increasing; yet the vote has not yet taken place. Is Mr. Kofas thus predicting the future? Does Mr. Kofas know who minimum wage earners are and what percentage of the workforce they represent? On that topic, is Mr. Kofas referring to the Federal minimum wage or that of the ten states that have raised the minimum wage to higher levels locally going back years? Note: Less than 2 percent of workers over age 25 earn minimum wage in the U.S. One fourth of minimum wage workers are age 16-19.
4)      Mr. Kofas complains that tax rates for the top 10% of income earners is lower (that it once was) when the opposite is true. While historically speaking, the top tax rates are lower today than they once were 45 years ago when John Kennedy was elected President, is Mr. Kofas indicating that we should return to the days of John F. Kennedy when the top tax rate was 91 percent? JFK concluded that the rates were too high then, thus he encouraged Congress to lower the top rate to 70 percent. The result contributed to an economy that boomed.
Note: According to Article I, Section 9 of the Constitution, "No money shall be drawn from the treasury, but in consequence of appropriations made by law." Ultimately, then, the executive branch cannot spend a dime that has not been voted on by the U.S. Congress. Source: Annelise Anderson, Senior Research Fellow, The Hoover Institution.
Facts that Mr. Kofas ignores: The top 1 percent pay 29 percent of the taxes paid in the United States. The top 10 percent of income earners in the United States pay 65 percent of all income taxes, up from 63 percent five years ago. The bottom 50 percent of all US wage earners pay about only 4 percent of the taxes. The bottom 20 percent pay nothing.  Thus, Mr. Kofas’ position is based on misinformation, likely from the Ted Kennedy types in the Senate and Congress.
I surmise that Mr. Kofas is ‘anti-rich’ in that he opposes wealth. Just who are the so-called rich guys who pay the top tax rates? According to a Tax Foundation analysis of Internal Revenue Service (IRS) data, the cutoff point for the top 20 percent of tax returns is $56,262. Thus, if you earned more than $56,262, you are in the top 20 percent of wage earners in the United States. Doesn’t sound so rich does it?
The empirical evidence shows that the wealthiest citizens are also paying an ever-increasing proportion of all taxes collected by the federal government. Data from the Congressional Budget Office show not only that taxes on the wealthy have risen over time but that the 2001 Bush tax cut barely kept their share of the tax burden from rising further.

Cameron Sawyer disagrees with Jon Kofas. He says: A few points in no particular order:
1.  U.S. living standards are rising continuously, not declining, and are presently at their all time highest point.  The gap between the U.S. and European living standards widens continuously because the U.S. economy, while growing sluggishly, is still much more dynamic than the really sluggish European economy.
2.  China does not benefit from a weak dollar.  On the contrary, the U.S. is China's biggest trading partner, and the export of manufactured goods is the engine of the Chinese economy.
3.  The geopolitical balance is changing in favor of China with or without us.  That is because the Chinese economy is built for speed and is growing at long-term rates of nearly 10%.
4.  Budget and trade deficits do not necessarily drive a currency down.  Budget deficits, leading to demand for capital and increased interest rates, often tend to strengthen a currency.
5.  The level of the minimum wage has almost nothing to do with living standards except in countries with very high unemployment, where high minimum wages (or other restrictive employment laws) eliminate some jobs.
All that being said, our budget deficits are truly horrible and will sink us if we don't cut spending.  The war, of course, is the biggest single culprit, but that is no comfort.  Speaking of "combined trade and budget deficits" is nonsensical.  The two things have nothing to do with one another.  Trade deficits are self-regulating and relatively harmless -- a trade deficit is really nothing more than a surplus of incoming investment.  Budget deficits are neither self-regulating nor harmless.






Ronald Hilton 2005


last updated: April 12, 2005