Money talks…

Back in June, I attempted to demonstrate how intertwined the economies of the United States and those of East Asia have become, concluding that a flu on one side of the Pacific would likely spread to the other. My argument rested largely upon supply chains, consumer products, and rates of inflation. In the July/August issue of New Left Review, R. Taggart Murphy takes up a similar premise in a very satisfactory essay titled “East Asia’s Dollars.” Murphy, a former investment banker currently teaching in Japan, places the current actions of Japan’s and China’s central banks within an interesting historical context, charting a century-long policy on the part of Japan and, more recently, China of augmenting the money supply of global hegemons. Murphy explains the origins of this policy as follows:

“For when Japan actually succeeded in acquiring ownership of sufficient gold—extracted as reparations from a prostrate Qing dynasty after the 1895 Sino-Japanese War—to render its credit acceptable abroad, the country’s leaders chose to buy the goodwill of Britain by leaving the gold in the vaults of the Bank of England, rather than bring it back to Japan. The policy was known as zaigai seika—literally, ‘specie kept outside’. It relied on the ability of ‘high-powered money’ (that is, money used to create other money: gold, bank reserves, international reserves) to play two simultaneous roles: in this case, as backing for Japan’s own credit creation and also as part of Britain’s money supply.”

Obviously, the parallels to today’s Asian central banks are startlingly clear, as the same symbiotic relationship has developed between Japan and China and today’s global hegemon, the United States. Because of Asia’s willingness to snap up dollar-denominated securities—US government debt, corporate debt, and equities—the United States government has been shielded from the ill effects of its own profligacy. In essence, the US simply prints more debt as needed, the Asians buy it, and thereby become further enmeshed in the US economy. Murphy describes it this way:

“There is no secret about the identity of the biggest dollar holders. They are the central banks and other financial institutions of Japan, China, South Korea, Taiwan, Hong Kong, Saudi Arabia and the Gulf Emirates. If the dollar is going to crash, one or more of these places is going to have to change its stance towards the American currency. They display such a seemingly reflexive commitment to accumulating and retaining dollars that some commentators have described the current global financial order as ‘Bretton Woods II’—a continuation by other means of the dollar-centred international order that prevailed in the postwar decades. The label does not itself explain why these states behave as they do. But it suggests that, for whatever reason, they have motives other than maximizing returns on their foreign-currency holdings; that they have a vested interest in the continuation of a US-led financial system.”

The magic question, unsatisfactorily addressed by Murphy, is why…why do the Asians continue to support American imbalances, imbalances that would have self-corrected years ago were it not for the readiness of Asians to buy our debt? In this way, the current system is self-perpetuating; the more debt they buy, the more debt they are obliged to buy in order to protect their investments. If Asian countries were to begin shedding dollars, their dollar holdings would become devalued in proportion to the amount sold.

The part of Murphy’s argument that I find deficient is the suggestion that the Asian nations are acting against their self-interest in buying dollars. He views such a strategy as the product of powerful domestic interests seeking to “forestall any threat to domestic power alignments” by yoking themselves to the economy of the most powerful external actor, in this case, the United States. Murphy then suggests—but never delves into the issue in earnest—that far better returns on Asian money could be made in other markets, other investments.

When you parse the language of Murphy’s argument, you discover that, at root, his main gripe centers upon those “domestic power alignments” that gain stability and legitimacy from their dollar holdings. His long historical survey of Japan, for instance, culminates with the broad claim, “The flirtation with more radical, destabilizing neoliberal notions has been terminated and an opposition party that might have imposed some form of political accountability on the bureaucracy has been decisively routed.” Of course, Japan’s bureaucracy is only marginally less accountable than that of, say, the US. After all, the central plank of the Federal Reserve System is its political independence. I’m not quite sure what to make of Murphy’s suggestion that the postwar leadership of Japan is a failure because of its undemocratic features. Further reforms are surely needed—they always are—but Japan still commands the world’s second-largest economy. Complaining too loudly, clamoring too vehemently on behalf of “more radical, destabilizing neoliberal notions,” strikes me as shrill and overmuch.

Further to the point, when one examines Murphy’s contention that Asian money would be better off in other markets and other investments, one discovers a paucity of what those other investments would look like. Where, precisely, would Murphy have the Asians park their money? Of course, the third-world markets have been perky of late, but, please, all those who wish to sink a huge amount of cash into Turkey or Argentina, form a line to the right. Such holdings for central banks will never be anything more than mere tools of diversification or means by which they can manipulate local politics. So again, I would ask, where should the Asians put their money if not into dollars?

Murphy concludes his article by cataloging the dangers to the status quo as follows:

“For markets are jittery everywhere; their fears almost endless. Renewed inflation in the United States, an unseasoned Federal Reserve chairman who has yet to confront his first real crisis, a politically crippled Bush administration, the implosion of the US housing bubble; all on top of spiking commodity prices, the ever-present threat of calamitous disruption to the flow of petroleum by events in the Middle East, the galloping US trade and government deficits, and indeed worries over the Chinese financial system—any one of these, or yet something else, could trigger a panicked flight from the dollar that would overwhelm the ability and willingness of the East Asian central banks to contain the flood.”

The dollar has been far more durable over the past year than most would have guessed, and far be it for me, a rank amateur, to outguess the pros. But I would suggest that all the possible sources of instability in the world—excepting, of course, homegrown US economic woes—are actually guarantors of dollar value, not “triggers” that would cause “a panicked flight from the dollar.” In short, Asian nations have not invested in dollars merely because of the political self-interest of a powerful few, but because global instability makes the dollar a fairly safe place to park cash, despite the imbalances of the US budget and current account to date. If you’re holding only government debt, that’s as unwise as Murphy would have it, but as long as corporate debt and equity produce decent returns, there are innumerable ways to make dollar investments profitable. When you pair that with their risk profiles, such investments look a lot safer than most alternatives.

Having said that, Murphy’s broader point concerning the unsustainability of US government spending is spot on. Asia cannot buy dollars forever, and eventually, the “Bretton Woods II” system as Murphy defines it will collapse beneath the weight of its imbalances—unless, of course, US politicians get religion and rectify the ledger, but no one—neither the Asian governments nor the American consumer—seems to want that to happen.