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Inflation Abroad--The US Dollar Overseas
view from a jetliner at 30,000 feet can be clarifying. So the view of
the American economy and its prospects from abroad can be instructive.
From overseas the latest Washington political
gaffe or media outrage doesn't even make it to translation. No one in
Saudi Arabia, where I have been for a week, asked me if I thought the
Democrats or Republicans were responsible for the AIG bonuses. Perhaps
it was simple courtesy, but more likely it was not considered important
enough to discuss. That people with government power serve people with
financial power is not seen as worthy of comment, except maybe with a
shrug, 'that's the way things work'. But that is not to say people are
unaware of the politics and actions of the United States. It is just
that their concerns are sharpest for the policy questions that affect
them the most. The view from overseas, like that from an airplane, only
catches the major formations, the economic policies that have the
consequences to reach across oceans.
Three topics came up again and again in the
questions I was asked: is the US banking system stable? Will the
American government succeed in reviving the economy? Will US fiscal and
monetary policies devalue the dollar?
Saudi Arabia's banks and financial system were
relatively untouched by the hurricane that struck Western finance last
fall. The Kingdom's banks had not bought debilitating amounts of
asset-backed and mortgage-backed securities during the boom. Naturally
conservative, the banks are now in a position to help the government
when it supports the economy rather than require their own bailout.
But no bank exists in isolation. When panic
strikes the world financial system everyone suffers. The United States
is still the largest component of world finance. None of the world's
banks can be secure, even in their own country, if US banks, especially
the money center banks, are staggering. Although many, perhaps most,
banks around the world would survive a US bank collapse, the risks
would be enormous. The negative effects on economic growth might linger
for a decade. After the events of last fall, the dependence of the
world financial system on confidence has never been more evident. The
determination of the Federal government to insure that the US banking
system continues to function has never been more important.
In the run up to the financial crisis last summer,
the fashionable discourse was whether various areas of the world
economy, primarily the EU and China, were 'decoupled' from events in
the United States. Could these large economic blocs continue to prosper
without the US? No one is asking that question now.
The world economy will have a very difficult time
recovering if the US is not leading the way. It is not the details of
the Obama administration's stimulus plans that interested my
questioners in Saudi Arabia, but a more basic consideration, will they
work? In the US, a common idea is that by 2010 the economy is likely to
be recovering on its own regardless of the stimulus bill. But the view
from abroad is much simpler, returning growth is the point, not the
method by which it is achieved. If economy is growing in 2010, even
poorly, the Obama administration will get the credit.
Probably the greatest concern of the people I
spoke with was for the inflationary potential of the US government's
fiscal policies and the Federal Reserves' new quantitative easing
policy. An often expressed idea was that the government was creating
debt on one hand and buying it with the other; a sleight of hand that
did not impress my interlocutors.
US Government debt is about to skyrocket. The
easiest way to reduce the debt burden on future generations is to
inflate it away. I encountered a good deal of skepticism of the idea
that when the time is appropriate, the Fed will withdraw the excess
liquidity from the economy. The suspicion is that when the Fed and the
US government have to choose between no growth and low inflation and
higher growth and higher inflation, they will choose the second every
The Saudi Riyal is pegged to the dollar and Saudis
have just witnessed the inflationary effect of a weak Dollar on their
economy. If the peg remains, US inflation is a direct import to the
Kingdom's CPI. In addition, oil is priced in dollars. Though it is
improbable that an inflationary Dollar would prompt another massive
speculative bubble, the damage that a high oil price would do to the
worldâ€™s economy in its weakened state would be substantial. A weak
Dollar will also revive pressure for the alternative pricing of oil in
Lastly, the Saudi Government is one of the worldâ€™s
largest holders of US Government debt. US Treasuries are a low return,
low risk instrument. With inflation, that all changes. Not only does
the value of those low returns diminish under inflation but the
returned principle is also devalued. The prospect of inflation is
probably the greatest threat to the continued investment of foreign
governments in US sovereign debt.
If the Dollar has remained the central currency in
the worldâ€™s economic system it is because there is no genuine
alternative. Governments that might prefer, in their ideal world, to
strip the US of the economic advantages provided by the Dollar have to
resort to speculation about the arcane qualities of the IMF's Special
Drawing Rights (SDR) just because there is no credible alternative.
To the Saudis and the world it will not matter why
the US banking system remains stable, only that it does. The world will
not care what happened to US capitalism if large banks are nationalized
but only that the US and the world financial system functions. Likewise
for the US economy. No one overseas will look askance if it is
government spending and not tax cuts that revives the economy. But if
deficit spending and quantitative easing destroys the value of the US
dollar, the US currency will lose its reserve status and no one will
care that it was for the best intentions
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