Executive Intelligence Review
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This article appears in the February 7, 2003 issue of Executive Intelligence Review.

First Casualty of an Iraq War
Will Be the U.S. Dollar

by Edward Spannaus

While President George W. Bush thinks he's going to war in the Middle East, he's being warned that the U.S. economy may not come back. U.S. forces may return, but the dollar won't. This is the admonition that has been directed at the United States from a number of sources recently.

The threat to the dollar results, of course, from a long-term process, reflecting what Lyndon LaRouche has identified as the 35-year transformation of the United States from a producer society to a consumer society. The dollar's decline has accelerated in recent months, and it is now in its worst fall against European currencies since 1987. The point that is being made to the President, is that if he marches off to war in defiance of the rest of the world, he will face a sharply-increased capital flight out of U.S. markets, and should not expect much help in bailing out the dollar when it crashes.

While a unilateral U.S. attack on Iraq could detonate a precipitous fall of the dollar, the attack would not be the cause of the problem. While market commentators have their excuse-of-the-day as to why the markets continue to collapse, David Coxe, the chairman and chief strategist for the Bank of Montreal's Harris Investment Management in Chicago, says correctly that one can't blame all of the financial markets' current problems on nervousness over an Iraq war. "Iraq is the excuse everyone is using," Coxe said. "But I would assign it no more than a 10% weighting of what is really wrong with our economy and our stock market."

Living Off the Rest of the World

The U.S. current-account deficit—what the United States owes the rest of the world because of trade and financial imbalances—is the largest in world history. It is officially estimated at least $500 billion for 2002, and is anticipated to rise to $600 billion in 2003. (EIR regards these official estimates as grossly understated.) Presently, financing this deficit requires a capital inflow of at least $1.9 billion every trading day.

Prior to the scuttling of the Bretton Woods monetary system in 1971-72, no country was permitted to run up such a huge imbalance; a much smaller imbalance would trigger what was then called a "balance of payments" crisis, and the offending country would have to settle up. But since the dollar is no longer linked to gold, nor pegged to a fixed exchange rate, the United States has been free to run up a massive deficit and flood the world with dollars.

The physical reality underlying this, is that the post-industrial United States economy produces far less—in real terms—than it used to. About 80% of the current-account deficit consists of the trade deficit, the excess of imports over exports. What we used to manufacture, we now import. We have been living off the rest of the world, much of which produces the things that we consume, under slave-labor conditions. And American consumers have been paying for this flood of imports, with the greatest consumer debt bubble ever created. Now, the day of reckoning is rapidly approaching.

A fitting metaphor for this mess—as well as a demonstration of the absurdity of President Bush's so-called "stimulus" program—was what happened when he was scheduled to give a speech at a warehouse in St. Louis on Jan. 22, touting the supposed job-creating benefits of his tax cuts. The President's remarks were to be delivered against a backdrop of a huge stack of cartons, as befitting a warehouse. But before the television cameras could be turned on, someone had to put tape on all the boxes, to cover over the "Made in China" markings.

Now, let's look at recent developments. The dollar is down, by some estimates, about 20% when measured against a basket of currencies over the past year. (It is far more, if properly measured against hard commodities, and about 30% against gold.) For foreign investors, this depreciation magnifies their losses in the U.S. stock market; for example, while the Dow is down about 18% over the past year in dollar terms, that represents a loss of 27% in Japanese yen, and 35% in euros.

Now, consider again the $1.9 billion needed every day to finance the U.S. economy's profligacy. Where is it going to come from? Europeans have become net sellers of U.S. securities over the past year. Taking note of this phenomenon, the Wall Street Journal ran a major story on Jan. 20 entitled, "Sliding Dollar's Fate May Be Decided in Asia." The Journal noted that Japanese, Chinese, and other Asians have now become the largest overseas investors in U.S. securities, in terms of net new money pumped into U.S. stocks and bonds. Last year, Asians accounted for 40% of the foreign-investment flows into the United States, somewhat counterbalancing Europe's pullback.

The question asked by the Journal is, how much longer can this Asian support for the dollar last? Asian central bankers are beginning to move into other currencies, especially the euro, and also into gold, whose price has jumped by 31% since Sept. 11, 2001. "If Asians pull back from investing in the U.S., there isn't much else to support the dollar," warned an economist at Morgan Stanley investment bank.

Russian, Chinese, Other Warnings

Meanwhile, omninous signs for the future of the dollar have come out in statements by both the Russian and Chinese central banks.

On Jan. 25, the Russian Central Bank announced that it now has "no less than 50%" of its reserves—which amount to almost $50 billion—invested in dollar assets. But this is going to change: The Central Bank said that it will cut its share of dollar-denominated assets, and instead buy euros, British pounds, or Swiss francs.

Two days earlier, Zhu Min, general manager of the Bank of China—one of the world's top 30 banks, with $400 billion in assets—warned that the purchase of dollar-denominated investments on a large scale, by China and the nations of Asia, may not be sustainable.

Because of its huge trade surplus with the United States, China is paid for its American exports in dollars, and then normally buys U.S. Treasury securities (and other instruments), bringing the dollars back into the United States. China has become one of the world's five largest holders of U.S. Treasury securities.

Speaking at the World Economic Forum in Davos, Switzerland, Zhu explained that "Asia has been exporting to the U.S. and buying U.S. Treasury bills, and so far everybody has been happy. But I don't think it [the U.S. current account deficit] is sustainable. Dependence on Asian flows to sustain the deficit is not healthy."

"I think this year the foreign exchange regime will be very much volatile," he added.

A City of London financial source told EIR that the Russian and Chinese statements were not statements of intent, but announcements of ongoing operations; he called this is a chief reason for the dollar's dive. "The dollar will continue to weaken," the source said. "There are central bank sellers about. My reading, is that what we heard the other day from the Russian Central Bank, is not something for the future, but was a statement made, after they have begun to move out of the dollar. That is probably one of the reasons for the dollar loss in respect to the euro. The Russians know the Iraq war is brewing, and, by doing this, they can exert some pressure, while making moves to ensure that their holdings are not hostage to an American action in event of war. All this suggests that the Russians are taking a harder line respecting [war in] Iraq than some had thought. The same goes for the Chinese."

The Danger for President Bush

This brings us to the recent warnings about the effect that a unilateral U.S. launching of war on Iraq, will have on the dollar's fortunes. This point was made with particular force in the Jan. 26 Sunday Observer of London, by its senior commentator Will Hutton. Because of the weakness of the U.S. economy and the threat to the dollar, the United States needs multilateral support for an Iraq war even more economically than militarily and diplomatically, Hutton wrote. "The United States' military capacity may allow unilateralism; its soft economic underbelly ... does not." He argued, that "The multilateralism that Bush scorns is, in truth, an economic necessity," and noted that while the United States may be a military superpower, "it is a strategic position built on economic sand."

Hutton noted the massive U.S. indebtedness to the rest of the world, citing net liabilities of more than $2.7 trillion—nearly 30% of GDP—which puts the United States at a Latin American, basket-case level. Pointing out, as we have shown above, that this makes the United States dependent on a substantial flow of foreign capital into American markets, Hutton noted with some irony: "The Old Europe that Donald Rumsfeld mocked last week has been helping to prop up the U.S. economy."

Hutton's commentary concluded that if the United States and Britain go to war without support of key members of the UN Security Council like France and China, the flow of dollars from abroad into America will slow down dramatically, and there will be a stampede of foreigners trying to sell. If the war is prolonged, or the post-war situation unstable, the pressure on Wall Street and the dollar would be severe, and "Bush might even have to turn to his despised European allies to ask for a multibillion-euro support package for the dollar, because they hold the only currency capable of shouldering the burden."

Another version of the same scenario was posed in a Jan. 25 Dow Jones story, which warned that a prolonged Iraq war could set off a vicious downward spiral in the markets, in which foreign investors liquidate their dollar holdings. The story noted the fact that Russian and Asian central banks are already beginning to dump dollars.

Business Week Online on Jan. 31 predicted that the biggest danger facing the U.S. economy "is that war could turn the dollar decline into a rout." It noted that the economy "is extremely vulnerable to a dollar decline, since America has never been so dependent on foreign capital," and added, "The threat that war may spark a run on the dollar is the largest macroeconomic threat to the economy."

President Bush, take heed.