Tuesday, November 10, 2009

Why have Emerging Markets Financed U.S. Profligacy?

A reader of ours directed us to a great piece on the reserve currency dilema from an emerging market perspective. A pertinent excerpt from the article which appeared in the Economic Times of India.
Russian President Dmitry Medvedev has recently presented an interestingly different perception about the state of the world stating that the artificially maintained unipolar system was based on one big centre of consumption financed by a growing deficit and thus growing debt, one formerly strong reserve currency and one dominant system of assessing assets and risks. He went on to castigate the US military presence across the world stating that it survives on what is effectively a massive subsidy by the rest of the world while the US continues to appropriate the exports, companies and real estate of the rest of the world in exchange for paper money of questionable worth.
While it is easy to dismiss the perception as Communist propaganda there is certainly more than a grain of truth in the rather provocative interpretation of the state of the unipolar world. There is no denying the fact that the global financial meltdown of the last two years is largely because of the simple fact that the unbridled consumption by the US and its citizens has been going on unchecked for an unsustainably long period.
It is worth recapitulating the process by which the global economy currently finds itself in dire straits. Unbridled consumption by US citizens, US buyouts of foreign companies and the massive US military spending across the World — all paid for in the domestic currency of the US — find their way ultimately to the foreign central banks of the countries that have balance of payment surpluses. These dollars are effectively recycled by the central banks back to the US when they invest in “safe” financial assets like US treasury bonds.
The other alternative for these surplus countries is to let their currencies appreciate in the free market relative to the Dollar with negative ramifications on their export competitiveness, the health of their export intensive businesses and unemployment. As long as the export surplus countries continue to hoard dollars which is effectively US IOUs, despite being the world’s largest debtor country, the US does not have to undergo IMF style “structural adjustments”.
The standard prescriptions under ‘structural adjustment programmes’ are tax and interest rate hikes, currency devaluation, reduction in trade and fiscal deficits, pruning social safety nets, selling government-owned enterprises and natural resources, etc., to the satisfaction of pressing creditors. However, it is surprising to note that the US response to the financial crisis over the last two years is at complete variance to the “standard” operating procedure in a structural adjustment programme.
Indeed, to the lay observer it appears that the global reach of the mighty military prowess of the US sits rather uncomfortably with the perceptible decline in its economic strength. These apparent contradictions would possibly take decades to get reconciled but history has been witness to many events that appeared incredulous when the first undercurrents were visible.
The fall of the once mighty British pound as a reserve currency between the two World Wars, a defeated Japan in the second World War becoming an economic powerhouse, and more recently, the leap of Communist China from utter poverty to relative prosperity — all in a few decades — are examples worth recalling. It is therefore reasonable to prophecy that the longer the US continues to live off the savings of others, the more likely it is that the laws of economics would catch up with it some time.

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