'The dollar is our currency and your problem." So said the Secretary of the Treasury, John Connolly, in the early 1970s as world leaders and traders came to terms with the US abandoning the Bretton Woods agreements on dollar convertibility in favour of a floating system, writes Paul Gillespie
His remark bears recalling in a week when European leaders became alarmed over the dollar's fall and the consequent rise in the euro - from $0.85 to $1.30 over the past three years.. The collapse of Bretton Woods was bound up with the cost of the Vietnam war, just as the dollar's fall now is related to the US's twin budgetary and trade deficits, which are driven up by the war in Iraq.
Effectively the war is being funded by Asian savings, which flow into the US at the rate of $1.7 billion a day. There are fears in Europe and Asia that the US deficits are such an enormous problem that they could lead to a precipitate fall in dollar value.Waking up suddenly to such a disaster would drive up interest rates and nurture protectionism.
This week the head of the European Central Bank, Jean-Claude Trichet, described the dollar's fall as brutal (a term he first used in January). There is talk now of a co-ordinated euro zone intervention to sell euros to halt the dollar's rise. But the effectiveness of such a strategy at regional level is limited, if it is not co-ordinated at least with China and Japan. There is little or no sign of any international initiative along the lines of the Plaza agreement in 1985 which set the terms of a new bargain on the back of Ronald Reagan's burgeoning deficits, the product of vast military expenditures and taxation cuts.
Bush's ones are much more serious although arising from similar policies, with the budgetary deficit now running at $600 billion, 5.7 per cent of GDP. Given its structure it is not easy to see how Bush can correct it. A growing proportion goes to interest payments. Domestic US savings are low and even if incentivised would be very slow to take effect. He may well cut spending but that too is very slow.
Increased taxation would be much the best approach, but would be unacceptable ideologically and could affect its current 4.7 per cent growth rate. So it looks as if the dollar is the main tool involved.
The Reagan deficits were solved in the longer term by Bush senior's fiscal conservatism, an explosion in US productivity and technological innovation and by Clinton's economic policies which bequeathed a healthy budget surplus to Bush junior. There are considerable doubts on whether such a mix is available now. US technological leadership is slipping under Asian competition, while a disproportionate amount of its huge R&D spending is going to the military.
The US maintains its growth and productivity lead over the EU and has a better demographic profile for the medium to long term. But its loss of legitimacy over the last four years means there will be less and less willingness to tolerate, and fund, its continued reliance on unilateral force. The battle for Falluja signifies how important it is to regain control of Iraq and arrange a political transition there through elections next year, however limited it is in practice.
Writing a memo on Bush's foreign policy in the Economist Richard Haass, the former State Department policy planner who is now head of the Council on Foreign Relations in New York, says the greatest concern facing into a second term is that although the US remains the world's pre-eminent actor, "it is also stretched militarily, in debt financially, divided domestically and unpopular internationally".
This makes new wars of choice less likely. But in the words of Robert Tucker and David Hendrickson, writing in Foreign Affairs: "Washington is hobbled by a reputation for the reckless use of force, and it is going to take a long time to live that down. World public opinion now sees the United States increasingly as an outlier - invoking international law when convenient, and ignoring it when it is not; using international institutions when they work to its advantage, and disdaining them when they pose obstacles to its designs."
Haass believes it will be possible to restore US leadership by succeeding in Iraq, engaging North Korea and Iran, reviving Middle East peace efforts, preventing a Taiwan crisis, driving the Doha trade round, helping Darfur, repairing transatlantic relations, staying the course on terrorism and getting its domestic house in order.
It is quite a bucketful. And there is an intense debate in Washington, watched closely in Europe, about the direction of policy and who gets appointed. In his interview with the Financial Times this week Colin Powell said the Bush policy would be aggressively engaged with the world, raising speculation that he would like to stay on as Secretary of State, if only to head off the neo-conservative Paul Wolfowitz getting his job.
An alternative vision is set out by the neo-conservative writer and activist Frank Gaffney in the National Review Online. He urges seven steps on Bush. Falluja and other centres of resistance in Iraq must be destroyed. Regime change must be achieved in North Korea and Iran. Extra resources must be found for the US military and intelligence to enable them to fight "World War IV against Islamofascism".
The US must keep faith with Israel and avoid reducing its defensible boundaries. France and Germany must be dealt with, particularly the dynamic that made them "so problematic in the first term: namely, their willingness to make common cause with our enemies for profit and their desire to employ a united Europe and its new constitution - as well as other international institutions and mechanisms - to thwart the expansion and application of American power where deemed necessary by Washington".
Finally, Bush must adapt "appropriate strategies for contending with China's increasingly fascistic trade and military policies", Putin's accelerating authoritarianism at home and aggressiveness toward the former Soviet republics, and "the emergence of a number of aggressively anti-American regimes in Latin America". Confronted with such a spectacle it is no wonder influential Europeans say they no longer share core values on force, law and religion with the US and must develop a more autonomous European policy based on interests. The economic consequences of such a political disengagement are increasingly plain to see.