Further Thoughts on USD

In the Financial Times, there is an article Dollar at mercy of central banks which says that the Asian central banks are supporting the US dollar in order to stop their own currencies from appreciating.

In November, Alan Greenspan, US Federal Reserve chairman, suggested foreign investors would reach a limit in their desire to finance the US current account deficit and diversify into other currencies or demand higher US interest rates, "elevating the cost of financing" the deficit and "rendering it increasingly less tenable".

I think that higher interest rates is more likely to prick the credit bubble and wipe out the paper wealth of the US middle class through collapsing house prices. The worry is the flow-on effect to the Australian ecomomy where the fear of increased interest rates under a Labour government appearred to be a big factor in the win by John Howard.

Slowly moving away from the US currency means a continued fall in the US dollar against the Euro. This would increase inflation by increasing the cost of imports but making US exports even cheaper. Wage inflation would be unlikely given that organised labour is still very weak and that "full" employment is a government statistical myth. The price of oil seems to be capped at USD50 through, I suspect, US military pressure on Saudi Arabia and Iran. This would have the unintended effect of making oil cheaper throughout the rest of the world and boosting their economies, especially China.

A detailed survey out today suggests that central banks are increasingly moving official reserves out of the dollar and into the euro.

The article's conclusion is that:

Asian central banks are unlikely to pull the plug on dollar assets altogether. But they may be close to ending their willingness to provide cheap financing for an ever increasing US current account deficit.

In other words, the US ruling class seems resigned to losing some economic power in the USA but gaining through their foreign assets in those booming economies. The US middle class still has their illusion of paper wealth through the housing bubble which could be further inflated through purchases by foreigners of these 'cheap' houses.

However, the weakening of the US domestic economy has the effect of weakening the US military eventually. The weakening can only be staved off by moving government expenditure from social programs into the military and by creating more military hardware to be used by less personnel. In other words, the US military will have to become more capital intensive. This will benefit the USAF and USN at the expense of the US Army.

With the increased weakening of the US Army, the ability of the US ruling class to quell domestic dissent will become more problematic. If there are insufficient troops and police to be put on the streets, are the US rulers willing to use bombs (non-nuclear or nuclear) against the trouble spots? At this point of time, this question is moot given the passivity of the US people, in general.