The [Federal Reserve] Dollar System & US Economic

Reality Post-Iraq War

F. William Engdahl, Remarks in Feldkirch, Austria,

September 2003

http://engdahl.oilgeopolitics.net/1973_Oil_Shock/Dollar_System/dollar_system

.html

It's accepted wisdom that the United States, despite

recent problems, is still the strongest growth

locomotive for the world economy, the pillar of the

global system. What if we were to discover that,

instead of being the pillar, that the United States

was, in fact, the heart of a dysfunctional economic

system, which is spreading instability, unemployment,

and depression globally?

No other nation on earth comes near to the commanding

US military superiority in smart bombs, military IT,

or in sheer force capabilities. The US position in the

world since 1945, and especially since 1971, has

rested on two pillars, however: The superiority of the

US military over all, and, the role of the dollar as

world reserve currency. That dollar is the Achilles

heel of American hegemony today.

In my view, the world has entered a new, highly

dangerous phase since the collapse of the US stock

market bubble in 2001. I am speaking about the

unsustainable basis of the very Dollar System itself.

What is that Dollar System?

How the Dollar System works

After 1945, the US emerged from war with the world's

gold reserves, the largest industrial base, and a

surplus of dollars backed by gold. In the 1950's into

the 1960's Cold War, the US could afford to be

generous to key allies such as Germany and Japan, to

allow the economies of Asia and Western Europe to

flourish as a counter to communism. By opening the US

to imports from Japan and West Germany, a stability

was reached. More importantly, from pure US

self-interest, a tight trade area was built which

worked also to the advantage of the US.

That held until the late 1960's, when the costly

Vietnam war led to a drain of US gold reserves. By

1968 the drain had reached crisis levels, as foreign

central banks holding dollars feared the US deficits

would make their dollars worthless, and preferred real

gold instead.  

In August 1971, Nixon finally broke the Bretton Woods

agreement, and refused to redeem dollars for gold. He

had not enough gold to give. That turn opened a most

remarkable phase of world economic history. After 1971

the dollar was fixed not to an ounce of gold,

something measurable. It was fixed only to the

printing press of the Treasury and Federal Reserve.

The dollar became a political currency-do you have

"confidence" in the US as the defender of the Free

World? At first Washington did not appreciate what a

weapon it had created after it broke from gold. It

acted out of necessity, as its gold reserves had got

dangerously low. It used its role as the pillar of 

NATO and free world security to demand allies continue

to accept its dollars as before.

Currencies floated up and down against the dollar.

Financial markets were slowly deregulated. Controls

were lifted. Offshore banking was allowed, with

unregulated hedge funds and financial derivatives. All

these changes originated from Washington, in

coordination with New York banks.

The dollar debt paradox

What soon became clear to US Treasury and Federal

Reserve circles after 1971, was that they could exert

more global influence via debt, US Treasury debt, than

they ever did by running trade surpluses. One man's

debt is the other's credit. Because all key

commodities, above all, oil, were traded globally in

dollars, demand for dollars would continue, even if

the US created more dollars than its own economy

justified.

Soon, its trade partners held so many dollars that

they feared to create a dollar crisis. Instead, they

systematically inflated, and actually weakened their

own economies to support the Dollar System, fearing a

global collapse. The first shock came with the 1973

increase in oil by 400%. Germany, Japan and the world

was devastated, unemployment soared. The dollar

gained. 

This Dollar System is the real source of a global

inflation which we have witnessed in Europe and

worldwide since 1971. In the years between 1945 and

1965, total supply of dollars grew a total of only

some 55%. Those were the golden years of low inflation

and stable growth. After Nixon's break with gold,

dollars expanded by more than 2,000% between 1970 and

2001!

The dollar is still the only global reserve currency.

This means other central banks must hold dollars as

reserve to guarantee against currency crises, to back

their export trade, to finance oil imports and such.

Today, some 67% of all central bank reserves are

dollars. Gold is but a tiny share now, and Euros only

about 15%. Until creation of the Euro, there was not

even a theoretical rival to the dollar reserve

currency role.  

What is little understood, is how the role of US trade

deficits and the Dollar System are connected. The

United States has followed a deliberate policy of

trade deficits and budget deficits for most of the

past two decades, so-called benign neglect, in effect,

to lock the rest of the world into dependence on a US

money system. So long as the world accepts US dollars

as money value, the US enjoys unique advantage as the

sole printer of those dollars. The trick is to get the

world to accept. The history of the past 30 years is

about how this was done, using WTO, IMF, World Bank

and George Soros to name a few.

What has evolved is a mechanism more effective than

any the British Empire had with India and its colonies

under the Gold Standard. So long as the US is the sole

military superpower, the world will continue to accept

inflated US dollars as payment for its goods.

Developing countries like Argentina or Congo or Zambia

are forced to get dollars to get the IMF seal of

approval. Industrial trading nations are forced to

earn dollars to defend their own currencies. The total

effect of US financial and political and trade policy

has been to maintain the unique role of the dollar in

the world economy.  It is no accident that the

greatest financial center in the world is New York.

It's the core of the global Dollar System.

It works so: A German company, say BMW, gets dollars

for its car sales in the USA. It turns the dollars

over to the Bundesbank or ECB in exchange for Marks or

Euros it can use.

The German central bank thus builds up its dollar

currency reserves. Since the oil shocks of the 1970's,

the need to have dollars to import oil became national

security policy for most countries, Germany included.

Boosting dollar exports was a national goal. But since

the Bundesbank no longer could get gold for their

dollars, the issue became what to do with the mountain

of dollars their trade earned. They decided to at

least earn an interest rate by buying safe, secure US

Treasury bonds. So long as the US had a large Budget

deficit, there were plenty of bonds to buy.

Today, most foreign central banks hold US Treasury

bonds or similar US government assets as their

"currency reserves." They in fact hold an estimated $1

trillion to $1.5 trillion of US Government debt. Here

is the devil of the system. In effect, the US economy

is addicted to foreign borrowing, like a drug addict.

It is able to enjoy a far higher living standard than

were it to have to use its own savings to finance its

consumption. America lives off the borrowed money of

the rest of the world in the Dollar System. In effect,

the German workers at BMW build the cars and give it

away to Americans for free, when the central bank uses

the dollars to buy US bonds.

Today, the US trade deficit runs at an unbelievable

$500 billion, and the dollar does not collapse. Why?

In May and June alone, the Bank of China and Bank of

Japan bought $100 billion of US Treasury and other

government debt! Even when the value of those bonds

was falling. They did it to save their exports by

manipulating the Yen to dollar to prevent a rising

yen.

Because the world payments system, and most

importantly, the world capital markets---stocks,

bonds, derivatives-are dollar markets, the dollar

overwhelms all others. The European Central Bank could

offer an alternative. So far it does not. It only

reacts to a dollar world. German banks destroy the

German economy as they rush to imitate US banks. The

Dollar System is destroying the German industrial base

. German national economic policy as well as

Bundesbank and now ECB policy is oriented on the far

smaller export sector, to maximize trade surplus

dollars, or to the big banks, to attract as many

dollars as possible.

China plays a key role today

The biggest dollar surplus country today is China.

Globalization is in fact just a code word for

dollarization. The Chinese Yuan is fixed to the

dollar. The US is being flooded with cheap Chinese

goods, often outsourced by US multinationals. China

today has the largest trade surplus with the US, more

than $100 billion a year. Japan is second with $70

billion. Canada with $48 bn, Mexico with $37 bn and

Germany with $36 bn make the top 5 trade deficit

countries, a total deficit of almost $300 billion of

the colossal $480 deficit in 2002. This gives a clue

to US foreign policy priorities.

What is perverse about this system is the fact that

Washington has succeeded in getting foreign surplus

countries to invest their own savings, to be a

creditor to the US, buying Treasury bonds. Asian

countries like Indonesia export capital to the US

instead of the reverse!

The US Treasury and Greenspan are certain that its

trade partners will be forced to always buy more US

debt to prevent the global monetary system from

collapsing, as nearly happened in 1998 with the Russia

default and the LTCM hedge fund crisis.

Washington Treasury officials have learned to be

masters at the psychology of "monetary chicken."

Treasury Secretary Snow used an implied threat of

letting the dollar collapse, after the Iraq war, to

warn Germany about the risk of trying to be too close

to France with the Euro. Some weeks after the dollar

had fallen sharply, and German export industry was

screaming pain, Snow reversed his stand and the dollar

stabilized. Now the dollar again rises as foreign

money flows back in.

But debt must be repaid you say? Does it ever? The

central banks just keep buying new debt, rolling the

old debts over. The debts of the USA are the assets of

the rest of the world, the basis of their credit

systems!

The second key to the Dollar System  deals with poorer

debtor countries. Here the US influence is strategic

in the key multilateral institutions of finance-World

Bank and IMF, WTO. Entire countries like Argentina or

Brazil or Indonesia are forced to devalue currencies

relative to the dollar, privatize key state

industries, cut subsidies, all to repay dollar debt,

most often to private US banks. When they resist

selling off their best assets, they are charged with

being corrupt. The growth of offshore money centers in

the Caribbean, a key part of the drug money cycle, is

also a direct consequence of the decisions in

Washington in the 1970's and after, to deregulate

financial markets and banks. As long as the dollar is

the global currency, the US gains, or at least its big

banks.

This is a kind of Dollar Imperialism more slick than

anything the British Empire even dreamed of. It is a

part of  the current America "Empire" debate no one

mentions. Instead of the US investing in colonies like

England to earn profits on the trade, the money comes

from the client states into the US economy. The

problem is that Washington has allowed this perverse

system to get out of all control to the point today it

threatens to bring the entire world to the point of

collapse. Had the US instead promoted long-term policy

of investing in the economic growth and

self-sufficiency of countries like Argentina or Congo,

rather than bleeding them in repayment of unpayable

dollar debts, the world would look far less unstable

today.

The internal debt bomb in the USA

The question is if the Dollar System is reaching its

real limits? The Dollar System for the past 30 years

has been built on growing dollar debt. What if the

rest of the world decides it no longer wants to give

its savings to the US Treasury to finance its deficits

or its wars? What if China decides that it should

diversify its risk by buying Euro debt? Or Japan or

Russia? That day may come sooner than we think.

In addition to colossal debts to the rest of the

world, the US internal debt burdens have reached

alarming levels in the past three decades, especially

the past decade.

The total US debt-public and private-has more than

doubled since 1995. It is now officially over $34

trillion. It was just over $16 trillion in 1995, and

"only" $7 trillion in 1985. Most alarming it has grown

faster than income to service it, or GDP.

Since the Asia crisis in 1998, the US debt situation

has exploded. The heart of the debt explosion is in US

private consumer debt. And the heart of consumer debt

is the home mortgage debt growth, helped by two

semi-government agencies-Fannie Mae and Freddie Mac.

Since 2001 and the collapse of the stock market

wealth, the Federal Reserve has cut interest rates 13

times to a 45 year low.

US Households took on new home mortgage debt in the

first six months this year at an annual rate of $700

billion, double the debt growth in 2000.  Total

mortgage debt in the US totals just under $5 trillion,

double the debt in 1996. It has grown far faster than

personal income per capita. That is larger than the

GDP of most nations.

The aim has been to inflate a housing speculation

market in order to keep the economy rolling. The cost

has been staggering new debt levels. Because it was

created with record low interest rates, when rates

again rise, millions of Americans will suddenly find

the burden impossible, especially as unemployment

rises. Fannie Mae and Freddie Mac combined guarantee

$3 trillion in US home mortgages. The US banking

system holds much of their bonds. When the housing

bubble collapses, a new banking crisis is

pre-programmed as well, with JP Morgan/Chase, Wells

Fargo and BankAmerica the worst.

The US economy has only managed to avoid a severe

recession since the collapse of the stock market three

years ago, by a record amount of consumer borrowing.

"Shop until you drop" is a popular American

expression. The Federal Reserve has pushed interest

rates down to 1%, the lowest in 45 years. The aim is

to keep the cost of the debt low such that families

continue to borrow, in order to spend! Some 76% of the

US economy GDP today is consumer spending. And most of

that is tied to a record boom in home buying.

But the rate of new debt growth among families is

rapidly reaching alarm levels, while the overall

manufacturing economy continues to stagnate or

decline. Today US factories only operate at 74% of

capacity, near historic lows. With so much unused

capacity, there is little chance companies will soon

invest in new factories or jobs. They are going to

China.

So Greenspan continues to rely on foreign money to

prop up his consumer debt bubble, at low interest

rates. Were foreign money to stop propping the US

economy, now at some $2.5 billion daily, the Federal

Reserve would be forced to raise its interest rates to

make dollar investments more attractive. Higher rates

would trigger a crisis in consumer debt, mortgage

defaults, credit card and car loan failures. Higher

rates would plunge the US economy into a depression.

This may be about to happen, despite poor George

Bush's desires to get reelected.

There is a limit how much debt US families can pay to

keep the economy afloat.

There is no US recovery, merely a debt spending boom

based on this home buying explosion.

Total US household debt reached a high in June of $8.7

trillion, double that of 1994. Families are agreeing

to longer debt payments for basics like homes or cars.

The length of new car loans now averages 60.7 months,

and the amount of car debt financed increased to

$27,920, and the average new home costs $243,000.

With rapidly rising unemployment and a real economy

that is not growing, at some point there will come a

violent reality clash, as the market for home lending

reaches its limit. At that point the danger is the

consumer will stop buying, and the manufacturing

economy will not be able to create new jobs and a real

recovery. The jobs have gone to China!

We might already be at or very close to that point. In

the past six weeks, US interest rates have risen

sharply, as owners of  US bonds have started to sell

in panic levels, fearing the bonanza in real estate

may be over, and trying to get out with some profit

before bond prices collapse. The European Central Bank

is advising member banks to not buy any more US

Freddie Mac or government agency debts.

The problem is this process of creating debt, domestic

and foreign, to keep the US economy going, has

gathered so much momentum it risks destroying what

remains of the US manufacturing and technology base.

Henry Kissinger warned in a conference of Computer

Associates in June, that the US risked destroying its

own middle class, and its key strategic industries via

outsourcing to China, India and other cheap areas.

Today only 11% of the total workforce is in

manufacturing. In 1970, it was 30%. Post-industrial

America is a bubble economy about to pop.

Fed chief Greenspan even warned China about the rate

of its trade increase with the US, pressuring China to

upvalue the Renminbi to make its goods less

competitive in dollar markets, and slow the job loss.

But this is dangerous. China holds $340 billion in US

Treasury bonds and other reserve assets. The US needs

the Chinese dollar savings to finance its soaring

deficits.

It is caught in its own web: American jobs, hi-tech

jobs as well as factory jobs, are vanishing

permanently as US factories source to China, India or

other cheap areas. If Washington pressures China and

others to cut back exports they risk to kill the goose

that lays golden dollar eggs. Who will buy that

growing Government dollar debt? Private bond traders

are desperately trying to sell their US bonds. Germany

can only buy so much dollar debt, also Japan. 

The US waged war in Iraq not out of fundamental

strength but fundamental weakness. It is economic

weakness however, not military. 

Oil and food, and money as strategic weapon

The fundamental reason for the Iraq war, beyond

agendas of Richard Perle or other hawks, is hence,

strategic in my view. US economic hegemony in this

distorted Dollar System increasingly depends on a

rising rate of support from the rest of the world to

sustain US debt levels. Like the old Sorcerers'

Apprentice. But the point is past where this can be

gotten easily. That is the real significance of the US

shift to unilateralism and military threats as foreign

policy. Europe can no longer be given a piece of the

Third World debt pie as in the 1980's. Japan has to

cough up even more, as does China now.

Even ordinary Americans have to give up their pension

promises. If the Dollar System is to remain hegemonic,

it must find major new sources of support. That spells

likely destabilization and wars for the rest of the

world.

Could it be that in this context, some long-term

thinkers in Washington and elsewhere have devised a

strategy of establishing US military control of all

strategic sources of oil for the one potential power

rival, Eurasia, from Brussels to Berlin to Moscow and

Beijing? The dollar vulnerability and debt problems

are well known in leading policy circles.

As Henry Kissinger once noted, "Who controls the food

supply controls the people; who controls the energy

can control whole continents; who controls money can

control the world."

* * * * * * * * * * * * * 

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