Downgraded dollar is well deserved

Credit threats are decades-overdue consequences of US fiscal myopia and insularity


Uncle Sam’s credit isn’t what it was. When Standard & Poor’s put a question mark over the medium-term future of the dollar by placing it on negative watch, it meant the greenback could lose its historic triple A status if the US economy isn’t restored to rude health within two years. In practical terms that means a convincing reduction in America’s chronic deficits.

Unfortunately, recent history isn’t on America’s side in this. Washington’s record on deficit reduction varies from the woeful to the half-hearted, while its stewardship of the greenback’s role as the world’s reserve currency has usually been neglectful or indifferent.

The essential problem is that the dollar’s triple A rating requires a matching sense of obligation in its management. After all, about $4.5trn is held outside America and a downgrading would hurt investors badly.

The fix for a return to a clean triple A isn’t a mystery, but the roots of the problem go back a long way.

President Eisenhower was the last incumbent of the White House to apologise for running a deficit, even though it was a statistically insignificant $3bn.

President Kennedy changed all that with his $10bn tax cut, signed into law by LBJ after JFK’s assassination in 1963. It was the biggest single tax cut in American history and it set a profligate pattern. By the time Ronald Reagan took office in 1981, the economy was running out of control and it took Paul Volcker, the new chairman of the US Fed, to rein in the money supply in the teeth of the furious protests from the business community that always seem to accompany a bout of fiscal discipline in America.

The economy was corrected by the middle of Reagan’s first presidency, but then he spoilt it all by opting for towering deficits again (economics bored the former actor to tears).

When George Bush became president in 1989, he kept up the bad work, running annual deficits of an average $150bn-plus and forcing treasury to plug the gap by raising loans at great cost to the general economy.
Populist politicians with an eye on local votes must take a lot of the blame. When the Fed tightened rates in 1994 during Bill Clinton’s first term, one leading senator got a few headlines by likening this highly responsible action to “a bomber coming along and striking a farmhouse.”

The common denominator in most Americans’ economic views, such as they are, is myopia and insularity. As former Fed chairman Alan Greenspan notes in his fascinating and highly revealing book The Age of Turbulence, “Americans have always resisted the idea that a foreign country’s problems can have major consequences for the United States.”

Rare among presidents, Clinton was a champion of fiscal discipline. By his second term the surpluses were so huge that debt was down to zero. Sure enough, Republican congressmen demanded $800bn in tax cuts over 10 years. Clinton vetoed the bill.

Then George W Bush undid all the good work, declaring “Tax cuts, so help me God,” when he took office in 2000. Within six months federal spending was rampant and the US economy was in the red.

Today, the net result is painfully visible in America’s current account deficit – in effect the reflection of its dollar dealings with the rest of the world. In 1991, the measure stood at zero. By 2006, it was 6.5 percent. This year it will be 10.8 percent, by the IMF’s reckoning.

Here’s a number to ponder. Boosted by massive bouts of economy-pumping quantitative easing, America’s net government debt now stands at 70 percent of gross domestic product, higher than some of the most troubled European economies. It’s little wonder that the BRICS, complaining of “the deficiencies of the current international monetary system,” launched in April a structure for bilateral trading in their own currencies rather than in the dollar.

A crack has been opened in the greenback’s global role, and it can only widen.