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Economics

The Poisoned Chalice

19 September 2004

The Poisoned Chalice

By Gwynne Dyer

As the opinion polls move steadily in favour of President George W. Bush and the likelihood of a John Kerry presidency recedes, Democrats in the United States can take solace in two facts. If their man is not in the White House for the next four years, then they will not end up carrying the blame for the almost inevitable US defeat in Iraq — and they will not have to preside over the biggest financial crisis to hit the United States since the Great Depression.

“The US dollar is going the way that [the British pound] went as it lost its place as the world’s reserve currency,” said Jim Rogers, the Wall Street wizard who in 1973 co-founded the Quantum Fund, one of the first and most successful hedge funds, in a recent interview. “I suspect there will be exchange controls in the US in the foreseeable future….Whoever is elected president is going to have serious problems in 2005-06. We Americans are going to suffer.” Why?

If Mr Kerry won, this would be the third time in a row that an incoming Democratic president inherited a gigantic budget deficit from his Republican predecessor. Jimmy Carter took over a budget deficit of almost four percent of Gross Domestic Product in 1976 and halved it in four years. Bill Clinton was handed a budget deficit amounting to six percent of GDP in 1992 and turned it into a 1.5 percent surplus in eight years. Mr Kerry would inherit a five percent deficit from Mr Bush, about par for the course – but for the first time he would also be burdened with a huge current account (trade) deficit.

When Jimmy Carter was president, US trade with the rest of the world was more or less in balance, which made it relatively easy for him to address the budget deficit. America’s trade balance went deep into the red during the Reagan years, but by the time Bill Clinton came into office it had recovered dramatically and so he, too, could fix the budget deficit without having to worry about a big trade deficit. But in the last Clinton years the current account plunged into deep deficit, and it’s now even worse.

It’s the combination of the two deficits that is potentially lethal. The United States got away with running a big trade deficit for most of the past twenty years because foreigners, mostly in Asia and Europe, kept on investing in the US, and that huge inflow of foreign capital largely covered the deficit. They invested in the US not because it was the world’s fastest-growing economy (it wasn’t), but mainly because the US dollar was seen as the safest currency, the world’s “reserve currency” in which other countries settle their debts even with each other.

That was then; this is now. The inflow of foreign capital is dwindling, the current account deficit is up to half a trillion dollars a year — and the budget deficit, thanks to the Bush tax cuts and the Iraq war, is also up to half a trillion dollars a year. Neither Mr Bush nor Mr Kerry even discusses the issue, and the value of the US dollar has been drifting steadily down for a year and a half now.

Foreigners have seen the value of their US investments effectively cut by 20 percent because of that fall in the dollar, and they are getting nervous. Foreigner investors hold about $8 trillion in US securities, and everybody realises that a concerted move to bail out of them would trigger a collapse of the dollar and the destruction of their investments. On the other hand, everybody also knows that the first investors to get out will save most of their money, and the laggards will lose most of theirs. It is a highly unstable situation.

A far-sighted Democratic strategist might therefore conclude that this is the wrong year to win the presidency. Democrats don’t want the blame for an impending economic crisis that is mostly due to the Bush tax cuts — and since their chosen candidate has no strategy for pulling out of Iraq, why not let the Republicans collect the blame for that debacle, too?

There is going to be a smash; it’s too late to avoid it; let the other lot stay in the driver’s seat for now. We’ll win next time, and stay in power for a generation. But there is no sign that anybody in the Democratic Party is making such a calculation: they are genuinely committed to fighting Bush.

At the least, that will lend authenticity to their defeat, and win them credit for next time. And if John Kerry should win, thanks to some wild card we have not yet seen, it may be rough on the Democratic party but it wouldn’t necessarily be bad for the United States or the world.

Though Mr Kerry now vows to “stay the course” in Iraq, he is likelier than the crew around Mr Bush to accept reality and pull American troops out before too much damage is done. And if economic disaster strikes the United States in the next four years, as it well may, he is less likely than Mr Bush to devote all his energy to shifting the blame for it onto foreigners.

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To shorten to 725 words, omit paragraphs 4 and 10. (“When…worse”; and”At the least…world”)