(08/29/05) Clyde Prestowitz in The Australian
Dumping of US dollar could trigger 'economic September 11'
There is a potentially fatal flaw at the heart of the global economy:
the strong possibility of financial meltdown following a collapse of
confidence in the greenback, Clyde Prestowitz tells Bruce Stannard
THE nightmare scenario that haunts global strategist Clyde Prestowitz
is an economic September 11 -- a worldwide financial panic triggered by
a sudden massive sell-off of US dollars that would lead inexorably to
the collapse of economies around the world. If that happens, Prestowitz
predicts: "It would make the Great Depression of the 1930s look like a
walk in the park."
Australia would be sucked into the vortex of such a recession, which would cause great hardship throughout the world, he warns.
Prestowitz is not a doomsayer, neither is he alone in his views. As
president of the Economic Strategy Institute, a Washington think tank,
he is in regular contact with the most influential US business leaders,
several of whom -- Warren Buffet and George Soros included -- have
taken steps to hedge their currency positions against the possibility
of a cataclysmic plunge in the greenback.
"Right now," he says, "we have a situation in which the US is running
huge trade deficits -- about $US650 billion ($766 billion) in 2004 --
which are financed by borrowings from the central banks of Asia --
mainly the Chinese and the Japanese. All the world's central banks are
chock-full of US dollars -- they're holding many more dollars than they
really want. They're holding those dollars because at the moment
there's no great alternative and also because the global economy
depends on US consumption. If they dump the dollar and the dollar
collapses, then the whole global economy is in trouble.
"However, some countries have a bigger stake than others in maintaining
the status quo. China and Japan have a big stake in maintaining the
flow of their exports to the US and keeping the US economy humming.
Russia, on the other hand, does not export much to the US. India
doesn't export much to the US. Yet Russia and India are also big
dollar-holders. They hold many more dollars than they really want or
"It doesn't take any great stretch of the imagination to see what could
happen if one of these central bank managers decides to dump dollars.
We had a situation recently when a mid-level official at the Central
Bank of Korea used the word `diversification'. It was a throwaway
remark at some obscure lunch, but there was instantaneous overreaction.
The US stock market fell by 100 points in 15 minutes because the
implication was that South Korea might be shifting out of US dollars.
"So picture this: you have a quiet day in the market and maybe some
smart MBA at the Central Bank of Chile or someplace looks at his
portfolio and says, 'I got too many dollars here. I'm gonna dump $10
billion'. So he dumps his dollars and suddenly the market thinks, 'My
god, this is it!' Of course, the first guy out is OK, but you sure as
hell can't afford to be the last guy out.
"You would then see an immediate cascade effect -- a world financial
panic on a scale that would dwarf the Great Depression of the 1930s."
Prestowitz says the panic could be started by something as simple as a hedge-fund miscalculation.
"We had exactly that scenario in the US recently," he points out, "when
a big hedge fund called Long Term Capital Management went belly-up.
These guys were pros. They had two Nobel prize-winning economists
writing their trading algorithms, and their traders were the creme de
la creme among New York bond traders.
"They made a big bet -- a trillion dollars leveraged 20 to one, and
they blew it. They went belly-up. That threatened to bring down the
whole system so US Federal Reserve chairman Alan Greenspan had to
organise a bail-out through the Federal Reserve Bank of New York.
"Now consider this: there are currently 8000 hedge funds in the US
alone. Every day $6 trillion of derivative instruments trade on
international markets. If there are four people in the world who
understand those trades, I'd be surprised. So the potential for another
disaster is not insignificant. This is why Warren Buffet, chairman of
investment giant Berkshire Hathaway, is betting $US21 billion against
the dollar. This is why currency speculator and hedge fund manager
George Soros has also made a big bet against the dollar.
"Soros is one of the greatest currency speculators of all time. He was
the guy who broke the British pound in the early 1990s by betting $US10
billion it would fall. He made a quick billion when it did. In 2002, he
warned that the greenback was in danger of losing a third of its value.
Of course, it could be argued that Soros is a professional hedge fund
manager whose job is to play the ups and downs of currencies and his
remarks could be seen more as manipulation than prophecy. And yet, in
conversations with me, Soros has expressed concern about the market
fundamentalist view that prevails in Washington and parts of Wall
"This is the belief that markets are self-correcting and best left
alone. Soros calls this a dangerous siren song. Far from being
self-correcting, he emphasises, markets tend to excess. They
over-shoot. Anyone with any experience of markets knows this.
"When markets are going down, all the weaknesses get concentrated, and
you need intervention at the right time to stop things from getting out
of control. If the dollar started to melt down, the results could be
really nasty. A 1930s-style global depression is not out of the
To underscore the point that he is not alone in this, Prestowitz cites
Paul Volcker, head of the Federal Reserve before Alan Greenspan, who
has said publicly there is a 75 per cent chance of a dollar crash in
the next five years.
"No wonder people look at this and say, 'Holy cow!'," he says. "No one
knows for sure what will happen, but clearly the global markets could
implode very quickly. The lack of an alternative to the dollar is the
only reason it hasn't taken a big fall already."
Prestowitz, formerly a trade adviser and negotiator for former US
president Ronald Reagan, believes the US will continue to be the
world's most powerful economy for the foreseeable future. But he
foreshadows an inexorable decline, a trend that is likely to continue
"depending on the way we play our cards".
"Right now, we're playing them just about as badly as it's possible to
play them, and that has geo-political implications." he says. "We've
outsourced trying to deal with North Korea to China, we really can't
deal with Iran, so we've outsourced that to the EU, which is
struggling, and Iran is cozying up to China. Other bad actors like
Zimbabwe's Robert Mugabe and Sudan are cozying up to China.
"America's global hegemony is already under challenge, and that
challenge is going to become more and more evident as the extent of the
relative US economic decline becomes evident. Right now, the US dollar
is probably 40 per cent overvalued versus the Japanese yen or the
Chinese renminbi. How's the US going to look as a global power when the
dollar is at 50 per cent of its current value ?"