Could the US become a "Banana Republic"?

WASHINGTON (CNN) – A leading fiscal mind on Capitol Hill and a one-time Obama Cabinet pick sounded the alarm Sunday over the projected long-term financial challenges the country faces. “This deficit is driven by us,” New Hampshire Republican Sen. Judd Gregg candidly said Sunday on CNN’s State of the Union when asked about the federal government’s projected $1.42 trillion operating deficit for the 2009 fiscal year. “You talk about systemic risk. The systemic risk today is the Congress of the United States,“ the Ranking Republican on the Senate Budget Committee told CNN Chief National Correspondent John King, “that we’re creating these massive debts which we’re passing on to our children. We’re going to undermine fundamentally the quality of life for our children by doing this.” “Now you can’t blame that on [former President] George [W.] Bush,” Greg said, noting that using the Obama administration’s projections the budget deficit for the next ten years is $1 trillion per year. And Gregg said that during the same ten-year period, public debt as a percentage of gross domestic product would increase from 40 percent - which Gregg called “tolerable but still too high” - up to 80 percent. The figures, Gregg told King, “mean we’re basically on the path to a banana-republic-type of financial situation in this country. And you just can’t do that. You can’t keep running these [federal] programs out [into the future] and not paying for them. And you can’t keep throwing debt on top of debt.” “Standards of living will drop if we keep this up,” Gregg also said.After repeated promises from the White House that the final health care reform bill will be deficit neutral, Gregg said a Democratic plan to avoid otherwise automatic Medicare cuts without having a funding source for the projected expense of $250 billion over the next decade was “gamesmanship.” Asked about criticism leveled Sunday by former Republican-turned-Democrat Sen. Arlen Specter of Pennsylvania that Republicans were being obstructionist in the health care reform debate, Gregg replied, “Well, I suppose he has to call us something now that he’s left the party.” Responding to the Democratic charge that the GOP is “the party of ‘no,’” Gregg pointed to Republican health care reform proposals including his own and another co-sponsored by Republican Sens. Tom Coburn and Sen. Richard Burr, as well as a bipartisan proposal put forward by Sens. Ron Wyden (D-OR) and Robert Bennett (R-UT).” Gregg said the versions of health care reform voted out of the Senate Finance Committee and the Senate Health, Education, Labor and Pensions Committee would amount to “a huge expansion of government.”
“You’re talking about taking the government and increasing it by $1-$2 trillion over the next ten years,” Gregg said. He added that he thought growing government at that rate would have a “very debilitating effect” on the overall economy and the ability of Americans to get health care in the future. At one point earlier this year, Gregg, who is not seeking re-election to his Senate seat in 2010, was President Obama’s choice to head the Commerce Department. But the fiscal hawk removed himself from consideration because of differences with the new administration on several policy issues.

Dollar's Slide Gives Rise to Calls for New Reserve

By Frank Ahrens
Washington Post
Wednesday, October 7, 2009
The U.S. dollar continued its six-month slide Tuesday amid a growing international chorus that wants the dollar replaced -- or at least supplemented -- as the world's reserve currency, a move that would end the greenback's six decades of global dominance. The dollar has come under attack from abroad as the economic crisis has played out, thanks to the Federal Reserve's decision to flood a seized-up financial system with liquidity last fall. The central bank's moves likely staved off deflation, but the massive influx of new dollars has devalued existing ones. Foreign nations are worried that the massive U.S. national debt and rising deficits are not being addressed. And though inflation is not yet a concern in the United States, a prolonged slide in the dollar's value could lead to higher prices for consumers. Further, large emerging economies -- such as China, Russia, Brazil and India -- are tired of kow-towing to the American buck, and sense an opportunity to knock a weakened dollar off its imperial perch. "The U.S. dollar is headed for also-ran status, and it will continue to lose its value against many other currencies and assets," Miller Tabak equity strategist Peter Boockvar said. "The rest of the world wants the U.S. dollar to lose influence, but no one wants it to be abrupt, as it's in no one's interest. An evolutionary process is what is wanted." The question is: When will that happen? "In the next two to three years, it is highly unlikely to see the dollar replaced," said Eswar Prasad, an economics professor at Cornell University and a senior fellow at the Brookings Institution in Washington. "Over the next decade, though, we would expect to see other currencies play a much more significant role." The dollar fell to nearly its lowest point of the year against the yen and euro on Tuesday, which sent the price of gold surging to a record intraday high above $1,045 per ounce, as investors sought a hedge against inflation and foreign nations continued to stockpile the precious metal. For the American consumer, a falling dollar means U.S. exports sell better overseas, which can lead to more jobs here. But it also means imports costs more, which means higher prices at U.S. stores. "For the average Joe, the implications of a crisis of confidence in the dollar could end up in higher borrowing costs, lower government expenditures -- so that means reduced services -- and higher taxes," Prasad said. "Most likely, some combination of all of the above." Stocks, which typically move opposite of the dollar, staged a strong rally on Tuesday, continuing their fast Monday start. The Dow Jones industrial average and the broader Standard & Poor's 500-stock index both gained 1.4 percent, while the tech-heavy Nasdaq surged 1.7 percent. The U.S. dollar has been the world's reserve currency since World War II. Central banks and financial institutions in other nations hold dollars to pay off foreign obligations, or to influence their currency's exchange rate. Commodities, such as oil, are priced in dollars, which spreads the dollar's influence around the world. But the dollar's dominance is being challenged, thanks to the crisis. China was the first major power to attack the greenback, calling in March for the dollar to be replaced as the world's reserve currency. China holds more U.S. debt than any other country -- about $800 billion -- and the further the dollar drops, the less the value of the U.S. debt owed to China.
Other nations have followed China's criticism. In March, Kazakhstan criticized the dollar and called for the creation of a new currency it calls the "acmetal" (a coinage combining "acme" and "capital"). Last month, Iran shifted its reserve currency from the dollar to the euro, a move that is likely more political than economic and a response to harsh U.S. criticism of Iran's nuclear moves. But major powers have spoken against the dollar, as well. In September, Russia said it remains satisfied with the dollar as a reserve currency but said others are also needed. At an international investment summit last month, Russian Prime Minister Vladimir Putin criticized the United States -- and implicitly, Federal Reserve Chairman Ben S. Bernanke, who controls the money supply -- for "uncontrolled issue of dollars." Both China and Russia have called for a new "global supercurrency," similar but larger in scale to the euro, that would replace the dollar. Even the world's big financial institutions are piling on. "The United States would be mistaken to take for granted the dollar's place as the world's predominant reserve currency," World Bank President Robert Zoellick said in a speech last week.

The end of the dollar spells the rise of a new order

October 6, 2009
The Independent

Last autumn's global financial crisis set off an economic earthquake. And we are still feeling the tremors. The latest sign of the ground shifting beneath our feet is our report today of plans by Gulf states, China, Russia, France and Japan to end their practice of conducting oil deals in US dollars, switching instead to a diverse basket of currencies. It is not hard to see the motivation for oil exporters to move away from the dollar. The value of the US currency has fallen sharply since last year's meltdown. And fears are growing, in the light of a spiralling US government deficit, that a further depreciation is likely. They do not want to sell their wares in return for a currency with an uncertain future. It is also easy to see why China would like a world trading system that is underpinned by other currencies as well as the dollar. For the past decade Beijing has been recycling the proceeds of its giant national trade surplus into purchases of US government bonds and other dollar-denominated assets. China too stands to make a significant loss if the value of the dollar falls. For China, however, the timing is much more sensitive. Beijing needs to reduce its dollar holdings, but if it does so too quickly it will bring about the very devaluation it fears. This explains why Chinese officials appear to want this transition to take place gradually over the next decade. But the significance of this development goes much further. Since the end of the Second World War the dollar has been the bedrock of world trade. The pre-eminence of the American currency flowed naturally from the economic dominance of the US. Virtually everyone traded with America so it made sense to use their currency. But the US is not the dominant power that it once was. The financial crisis has left it hobbled with significant government and household debts and sharply reduced prospects for growth. Developing nations such as China, Brazil and India, on the other hand, have weathered the economic storm significantly better. So while this latest proposal is born of financial calculation, it is also a reflection of a new economic world order. We should not be sentimental for the dollar. It makes economic sense for world trade to be conducted in a variety of currencies. Relying on one only has the advantage of clarity, but it also creates instability if the economy that underpins it faces uncertain prospects. Yet we need to understand that exchange rate volatility is a symptom, rather than a cause, of what truly ails the world economy. The biggest driver of global economic instability in recent years has been the determination of China to boost its export sector at all costs. Beijing's persistently large trade surpluses and manipulation to prevent its own currency from appreciating have effectively forced Western nations into running persistently large trade deficits. It was this pressure that blew up various asset bubbles that burst with such disastrous effect last year. A gradual move away from the dollar makes sense. But without a commitment from world governments - both in the rich and developing world - to reduce these destabilising global trade imbalances we will enter an uncertain new era; and one that could yet make us pine for the days of the dominant greenback.

The demise of the dollar

In a graphic illustration of the new world order, Arab states have launched secret moves with China, Russia and France to stop using the US currency for oil trading

By Robert Fisk
Tuesday, 6 October 2009

In the most profound financial change in recent Middle East history, Gulf Arabs are planning – along with China, Russia, Japan and France – to end dollar dealings for oil, moving instead to a basket of currencies including the Japanese yen and Chinese yuan, the euro, gold and a new, unified currency planned for nations in the Gulf Co-operation Council, including Saudi Arabia, Abu Dhabi, Kuwait and Qatar. Secret meetings have already been held by finance ministers and central bank governors in Russia, China, Japan and Brazil to work on the scheme, which will mean that oil will no longer be priced in dollars. The plans, confirmed to The Independent by both Gulf Arab and Chinese banking sources in Hong Kong, may help to explain the sudden rise in gold prices, but it also augurs an extraordinary transition from dollar markets within nine years. The Americans, who are aware the meetings have taken place – although they have not discovered the details – are sure to fight this international cabal which will include hitherto loyal allies Japan and the Gulf Arabs. Against the background to these currency meetings, Sun Bigan, China's former special envoy to the Middle East, has warned there is a risk of deepening divisions between China and the US over influence and oil in the Middle East. "Bilateral quarrels and clashes are unavoidable," he told the Asia and Africa Review. "We cannot lower vigilance against hostility in the Middle East over energy interests and security." This sounds like a dangerous prediction of a future economic war between the US and China over Middle East oil – yet again turning the region's conflicts into a battle for great power supremacy. China uses more oil incrementally than the US because its growth is less energy efficient. The transitional currency in the move away from dollars, according to Chinese banking sources, may well be gold. An indication of the huge amounts involved can be gained from the wealth of Abu Dhabi, Saudi Arabia, Kuwait and Qatar who together hold an estimated $2.1 trillion in dollar reserves. The decline of American economic power linked to the current global recession was implicitly acknowledged by the World Bank president Robert Zoellick. "One of the legacies of this crisis may be a recognition of changed economic power relations," he said in Istanbul ahead of meetings this week of the IMF and World Bank. But it is China's extraordinary new financial power – along with past anger among oil-producing and oil-consuming nations at America's power to interfere in the international financial system – which has prompted the latest discussions involving the Gulf states. Brazil has shown interest in collaborating in non-dollar oil payments, along with India. Indeed, China appears to be the most enthusiastic of all the financial powers involved, not least because of its enormous trade with the Middle East. China imports 60 per cent of its oil, much of it from the Middle East and Russia. The Chinese have oil production concessions in Iraq – blocked by the US until this year – and since 2008 have held an $8bn agreement with Iran to develop refining capacity and gas resources. China has oil deals in Sudan (where it has substituted for US interests) and has been negotiating for oil concessions with Libya, where all such contracts are joint ventures. Furthermore, Chinese exports to the region now account for no fewer than 10 per cent of the imports of every country in the Middle East, including a huge range of products from cars to weapon systems, food, clothes, even dolls. In a clear sign of China's growing financial muscle, the president of the European Central Bank, Jean-Claude Trichet, yesterday pleaded with Beijing to let the yuan appreciate against a sliding dollar and, by extension, loosen China's reliance on US monetary policy, to help rebalance the world economy and ease upward pressure on the euro. Ever since the Bretton Woods agreements – the accords after the Second World War which bequeathed the architecture for the modern international financial system – America's trading partners have been left to cope with the impact of Washington's control and, in more recent years, the hegemony of the dollar as the dominant global reserve currency. The Chinese believe, for example, that the Americans persuaded Britain to stay out of the euro in order to prevent an earlier move away from the dollar. But Chinese banking sources say their discussions have gone too far to be blocked now. "The Russians will eventually bring in the rouble to the basket of currencies," a prominent Hong Kong broker told The Independent. "The Brits are stuck in the middle and will come into the euro. They have no choice because they won't be able to use the US dollar." Chinese financial sources believe President Barack Obama is too busy fixing the US economy to concentrate on the extraordinary implications of the transition from the dollar in nine years' time. The current deadline for the currency transition is 2018. The US discussed the trend briefly at the G20 summit in Pittsburgh; the Chinese Central Bank governor and other officials have been worrying aloud about the dollar for years. Their problem is that much of their national wealth is tied up in dollar assets. "These plans will change the face of international financial transactions," one Chinese banker said. "America and Britain must be very worried. You will know how worried by the thunder of denials this news will generate." Iran announced late last month that its foreign currency reserves would henceforth be held in euros rather than dollars. Bankers remember, of course, what happened to the last Middle East oil producer to sell its oil in euros rather than dollars. A few months after Saddam Hussein trumpeted his decision, the Americans and British invaded Iraq.

Gold hits record high on 'plan' to ditch dollar

LONDON (AFP) – The price of gold struck an all-time high at 1,038.65 dollars an ounce here on Tuesday as the dollar fell on a reported plan by Gulf states to stop using the greenback for oil trading. Gold reached the level in late afternoon trade on the London Bullion Market, beating the previous record high of 1,032.70 dollars an ounce struck in March, 2008. "Gold prices hit an all-time high as the dollar weakens," said Barclays Capital precious metals analyst Suki Cooper. "The dollar weakness appears to be related to ... (reported) secret talks about oil being priced in a basket of currencies including gold rather than the dollar, which has added to concerns about the future role of the dollar in international financial markets." The dollar's future as the world's top currency was thrown into doubt on Tuesday as a report said Arab states had launched secret moves with China and Russia to stop using the greenback for oil trading. Arab states have launched steps with China, Russia, Japan and France to stop using the dollar for oil trades, British daily The Independent reported on Tuesday, but the report was denied by Kuwait and Qatar and reportedly by other nations. The United Nations meanwhile on Tuesday called for a new global reserve currency to end dollar supremacy, which has allowed the United States the "privilege" of building a huge trade deficit. The Independent's Middle East correspondent Robert Fisk wrote in his paper: "In the most profound financial change in recent Middle East history, Gulf Arabs are planning -- along with China, Russia, Japan and France -- to end dollar dealings for oil." They would instead switch "to a basket of currencies including the Japanese yen and Chinese yuan, the euro, gold and a new, unified currency planned for nations in the Gulf Co-operation Council (GCC), including Saudi Arabia, Abu Dhabi, Kuwait and Qatar," added Fisk. Gold, viewed as a safe-haven investment, has won back favour in recent months as the global economy struggles out of its worst slump in decades. The run-up in gold has been largely driven by weakness in the dollar, which makes dollar-priced commodities cheaper for holders of stronger currencies, boosting demand. Gold also wins support from fears about higher inflation because the metal is widely regarded by investors as a safe store of value. Precious metals consultancy GFMS last month warned that the current upward trend in gold may not be sustainable should global stimulus packages fail to boost flagging demand in the battered world economy and inflation fall as a result. The Group of 20 leaders of emerging and developed nations recently agreed at a summit in Pittsburgh not to roll back massive stimulus measures that helped contain a severe global recession.

World Bank could 'run out of money' within 12 months

The World Bank is close to running out of money, its president, Robert Zoellick, has disclosed.

By Edmund Conway, Economics Editor in Istanbul
02 Oct 2009
REUTERS

The Bank, whose job it is to support low-income countries, has had to hand out so much cash in the wake of the financial crisis that its resources could run dry within 12 months. “By the middle of next year we will face serious constraints,” said its president Robert Zoellick, as he launched a major campaign to persuade rich nations to pour more money into the Washington-based institution. He conceded that such a task was likely to be extremely difficult, given the difficulties facing countries in the wake of the developed world’s biggest recession since the Second World War. However, Mr Zoellick, speaking at the opening of the IMF and World Bank annual meetings in Istanbul, said the Bank needed a capital increase of as much as $11.1bn (£6.9bn) to keep functioning. He said he hoped that its shareholders, including the UK and other leading nations, would decide on resources before its spring meeting next April. The money would be shared between the International Bank for Reconstruction and Development – the key part of the bank, which lends to poor nations – and the International Financial Corporation (IFC), which lends to companies. Mr Zoellick said: “We recognise that all countries are under budgetary strain and it is not an easy time to be asking for these things”. He said that a shortfall of cash for the IFC was a cause for particular concern, Mr Zoellick added, “because one of the issues in this recovery is the hand-off from government stimulus programs to private-sector development.” The Bank has had to lend significantly more cash than the three-year $100bn programme it committed to last year because of the virulence of the financial and economic crisis. The majority of the money has been spent ensuring the survival of the most vulnerable nations.

Roubini Says Stocks Have Risen ‘Too Much, Too Soon, Too Fast’

By Shamim Adam and Francine Lacqua
Oct. 5 (Bloomberg) -- New York University Professor Nouriel Roubini, who predicted the financial crisis, said stock and commodity markets may drop in coming months as the gradual pace of the economic recovery disappoints investors.
“Markets have gone up too much, too soon, too fast,” Roubini said in an interview in Istanbul on Oct. 3. “I see the risk of a correction, especially when the markets now realize that the recovery is not rapid and V-shaped, but more like U- shaped. That might be in the fourth quarter or the first quarter of next year.” Stocks have surged around the world in the past six months as evidence mounts that the economy is emerging from its deepest recession since the 1930s. The Standard & Poor’s 500 Index has soared 51 percent from a 12-year low in March while Europe’s Dow Jones Stoxx 600 is up 48 percent. The euphoria contrasts with the cautious tone of Group of Seven policy makers, who said after meeting in Istanbul over the weekend that prospects for growth “remain fragile.”
“The real economy is barely recovering while markets are going this way,” Roubini said. If growth doesn’t rebound rapidly, “eventually markets are going to flatten out and correct to valuations that are justified. I see a growing gap between what markets are doing and the weaker real economic activities.”

‘Anemic’ Recovery

The International Monetary Fund predicts the global economy will expand 3.1 percent in 2010, led by growth in Asia, after a 1.1 percent contraction this year. That is still “anemic” and “very weak,” Roubini said. U.S. stocks fell last week after manufacturing expanded less than anticipated and unemployment climbed to a 26-year high, fueling concern the economy is rebounding more slowly than forecast.
Gains in the S&P 500 have pushed valuations in the index to more than 19 times reported operating profits from the past year, data compiled by Bloomberg show. That’s near the most expensive level since 2004. The performance of the U.S. economy is probably more sluggish than reflected in stock markets, risking a correction in equities, Nobel Prize-winning economist Michael Spence said last month. U.S. stock-market investors have “over processed” the stabilization of growth in the world’s largest economy, Spence said.

Creating Bubbles

The global equity rally has added about $20.1 trillion to the value of stocks worldwide since this year’s low on March 9. Governments have poured about $2 trillion of stimulus into the global economy while central banks have cut interest rates to close to zero in efforts to revive growth. “In the short run we need monetary and fiscal stimulus to avoid another tipping point and to avoid deflation, but now this easy money has already started to create asset bubbles in equities, commodities, credit and emerging markets,” Roubini said. “For the sake of achieving growth stability again and avoiding deflation, we may be planting the seeds of the next cycle of financial instability.”

To contact the reporters on this story: Shamim Adam in Istanbul at sadam2@bloomberg.net; Francine Lacqua in Istanbul at flacqua@bloomberg.net