R. TAGGART MURPHY
EAST ASIA’S DOLLARS
from New Left Review

Americans have long been warned that running large, continuous deficits courts disaster. ‘We are living on borrowed money and borrowed time’, was the way Walter Mondale put it to the 1984 Democratic Convention, when the us government’s cumulative deficit was some $7 trillion less than it is today. Three years later, a spate of cartoons and op-eds would depict the 1987 stock-market crash as a vicious hangover; the just deserts of a wastrel nation. The ever-accumulating deficits so frightened the first President Bush that he famously reneged on his ‘read my lips’ promise not to raise taxes. In 1992, Ross Perot launched the most successful third-party presidential candidacy since Eugene Debs by making the rivers of red ink his central campaign issue. Clinton’s great boast was that he managed temporarily to close the government deficit, although the trade deficit continued to grow during his administration.

It was not supposed to work that way; the government deficit had long been understood as a prime cause of the trade deficit. But before the puzzle resolved itself, George W. Bush arrived in Washington and, with his tax cuts, wars and lavish spending directed at his electoral base, ripped open the sutures that the Clinton administration had stitched between us government spending and tax revenues. Both the government and trade deficits soon reached levels that would have been regarded as inconceivable by most economists a few years before. Doomsayers extended far beyond the ranks of Democrats and old-school fiscal conservatives; at the beginning of 2005 Warren Buffett announced that he was so scared by the deficit trends that he was largely going to quit buying stocks or bonds denominated in dollars. [1] At the Davos Forum that year, C. Fred Bergsten of the Institute for International Economics warned of a dollar crisis ‘within weeks’. [2] In a widely reported speech at Stanford a month later, Paul Volcker, former chairman of the Federal Reserve, spoke of an economy ‘skating on thin ice’. [3] With beleaguered Republicans dependent on low taxes and government largesse to remain in power, and Democrats unelectable on an explicit programme of higher taxes and spending cuts, these men saw no plausible scenario other than a dollar crash for any reversal in the ever-growing-deficit trends. At some point, the foreigners who help finance the two deficits would surely refuse to throw more good money after bad. They would dump their dollar holdings, leading to a crash in the dollar that would finally force Americans to live within their means.

But none of this has happened. The markets reacted to the doom-saying with the insouciance of a dog shaking itself dry. By the end of 2005 the dollar stood 15 per cent higher against the euro, 13 per cent higher against the yen, than it had in January; and this during a year when both government and trade deficits continued to set new records practically every month. Hence the conundrum: the savviest observers pronounce the trend lines of the deficits to be unsustainable; no realistic scenario can be imagined under which those trends will be reversed through political action, leaving only a dollar crash to do the job; yet the dollar crash stubbornly refuses to occur. Keynes once compared the stock market to a beauty contest in which the winnings went to whoever could pick the contestant thought by the other judges to be the most beautiful. If this is true of stocks, it is emphatically the case for currency markets. The day is long gone when the ebb and flow of international trade determined the value of currencies. Daily volume on the world’s foreign-exchange markets runs in the trillions of dollars, with the us dollar bought or sold in roughly 85 per cent of all currency trades—most of them speculative. If enough people believe that enough others will hang on to the dollar come what may, then the dollar will not fall, whatever happens to the us deficits.

There is no secret about the identity of the biggest dollar holders. They are the central banks and other financial institutions of Japan, China, South Korea, Taiwan, Hong Kong, Saudi Arabia and the Gulf Emirates. If the dollar is going to crash, one or more of these places is going to have to change its stance towards the American currency. They display such a seemingly reflexive commitment to accumulating and retaining dollars that some commentators have described the current global financial order as ‘Bretton Woods ii’—a continuation by other means of the dollar-centred international order that prevailed in the postwar decades. The label does not itself explain why these states behave as they do. But it suggests that, for whatever reason, they have motives other than maximizing returns on their foreign-currency holdings; that they have a vested interest in the continuation of a us-led financial system.
A voluntary order

The Bretton Woods system conceived by Keynes and Harry Dexter White in 1944 was more than a simple recognition of the reality that the United States would emerge from the Second World War in a position of overwhelming economic strength and that any workable global financial regime had to start from that premise. It mandated specific institutional action and imf approval to reset the exchange value of any currency in the system vis-à-vis the dollar. Most importantly, it required that the us maintain both the will and the ability to sell gold at $35 an ounce to foreign central banks on request, which meant that Washington had to take action whenever trade deficits threatened a precipitous loss of gold. When in 1971 the Nixon administration suspended the gold sales, did not use economic tightening to reverse the structural trade deficits, and could neither persuade nor browbeat its trading partners—notably Japan—to undertake compensating adjustments, the system collapsed. But despite a decade that saw the exchange value of the dollar plummet, the financial world continued to revolve around the dollar and does so to this day.

There is every reason for the us to be happy with Bretton Woods ii since Americans reap vast benefits from the arrangement, most importantly in the ability to finance trade deficits with impunity—what French economist Jacques Rueff famously labelled ‘deficits without tears’. Among other things, that allows Washington to project military power around the world at little real financial cost, since the necessary money is first created by the Federal Reserve, then exchanged for goods and services from foreigners, and borrowed back by the us Treasury. [4] (Technically, it does not matter in what form foreigners hold dollars, whether us government debt, corporate debt, equities or anything else with a $ sign. As long as the securities are denominated in dollars they remain within the American banking system, where they serve to create credit in the us.)

But if the benefits to the us in Bretton Woods ii may be obvious, the benefits to those who prop it up are much less so. Indeed, the system is curious in at least two ways: unlike Bretton Woods i, there is no formal institutional requirement on anyone to support it; and adjustment burdens have generally been shouldered not by the system’s primary beneficiary—the us—but by its creditors. To be sure, Volcker put the American economy through a recessionary wringer in 1979, bringing inflation down and thereby slowing the precipitous decline in the purchasing power of the dollar that had set in after the collapse of Bretton Woods i. The first Bush administration raised taxes, while the Clinton administration succeeded in producing a balanced Federal budget. But the us would have needed to take these sorts of measures anyway. Washington was not acting disinterestedly to save a global system, but rather to head off runaway inflation and economy-crushing interest rates. On the other hand, Japan’s support for the dollar was a major cause of the 15 years of deflation and low growth it endured after 1990, while lower-income China used savings extracted from its impoverished citizens to finance American consumption.

Initially it was the opec nations, led by Saudi Arabia, that did most to prop up a dollar-centred international order after the collapse of Bretton Woods i. Their swollen revenues were put on deposit in London; where they were recycled by leading commercial banks in the form of loans to non-petroleum developing countries, financing the latter’s import bills. True, several opec nations briefly flirted with the idea of charging their customers in a currency other than dollars, but for a mixture of practical and geopolitical reasons (at the time, no other currency circulated in sufficient quantities and the Saudi regime depended on us military protection), they stuck with dollars.

But since 1977, when Japan became the first developed nation to recover from the worldwide mid-70s recession, it has played the starring role in dollar support operations. It was Japan that unleashed the floodgates of its burgeoning financial wealth in the early 1980s to finance the so-called Reagan Revolution—America’s first experiment in steep tax cuts without concomitant spending reductions. It was Japan that pumped credit into the international system in the weeks after Black Monday—19 October 1987—when the us stock market lost one quarter of its value in a few hours. It was Japan that largely financed the first Gulf War, sold billions of yen for dollars in the wake of the Mexican peso crisis of 1995, and kept buying dollar securities right through the Asian financial crisis, 9-11 and the invasions of Afghanistan and Iraq. In the last ten years China has joined Japan as a primary supporter of Bretton Woods ii; its official dollar reserves may even exceed the $880 billion Japan reported in May 2005. But when the vast dollar holdings of Japan’s private sector banks and companies are added to that official figure, it becomes clear that Japan continues to play the central role it has for 25 years now in supporting the global value of the dollar—and by extension, us hegemony.
Weight of the past

Why? What for? In strictly economic terms, Japan would seem to have only one compelling reason for its dollar support operations: as the world’s largest holder of dollars, Japan stands to lose the most in any general dollar crash (other than perhaps the us itself). Japan finds itself in the position of a market player who has cornered so much of what is being traded that he cannot liquidate his position without destroying its value—and in the meantime, has to pony up more and more to support it. But economic calculations can illuminate only part of a picture that includes fifteen years during which the Japanese financial system seemed to outsiders on the verge of a collapse that stubbornly refused to happen. It includes a political elite, groping with realities they had never anticipated and for which neither their own history nor examples from abroad offered much guidance. It includes a political system that suffers from an institutional flaw rooted deep in its past, and a series of elaborate disguises used by the elite to conceal the sources of its power. And finally, the picture includes a long history of active support for the dominant foreign country of the day, one aim of which is to forestall any threat to domestic power alignments.

The 1868 seizure of power by the modern Japanese elite came dressed up as a restoration, rather than a revolution, and took place in accordance with existing indigenous legal procedures, such as they were. In contrast to the Chinese revolution 81 years later, the last Shogun did not flee to a remote island and establish a rival regime to that of Tokyo; he formally ‘returned’ power to the Emperor. Yet despite the formal trappings of legitimacy, the Meiji Restoration was a coup d’état launched by disgruntled elements on the fringes of the existing elite. They seized on the ancient institution of the Throne, theretofore a virtually powerless token of legitimacy, and used it as a cloak under whose cover they smashed a feudal system of fiefdoms and quasi-independent power-centres, and centralized political and economic institutions of control in their own hands with a ruthlessness that would have drawn Napoleon’s admiration.

The samurai from the hinterlands of Japan’s southwest who converged on Edo in the 1860s, renamed it Tokyo (literally, eastern capital), forced the abdication of the Shogun and brought the Emperor and his Court in from Kyoto, were not inclined to share power with Osaka’s merchants or await the organic development of capitalist institutions. They sought to forestall the fate of the rest of the non-Western world—colonization at the hands of the imperialist powers—while suppressing at home an increasingly restive and impoverished peasantry. The merchants were generally ruined or expropriated and the countryside squeezed even more mercilessly than it had been under the shoguns to extract every spare yen to finance Japan’s race for industrialization. Controlling stakes in the fledgling banks and industries were concentrated in the hands of former samurai, backed by a new bureaucratic mandarinate organized along Prussian lines. Meanwhile, imported institutions of social control were grafted onto an existing feudal order to deter domestic unrest. These institutions included universal male conscription, a militarized public-education system, a deliberate reworking of folk-religious practices into a politicized, centrally administered State Shinto, and the inculcation of a hyper-nationalist ideology of Emperor-worship.

Throughout their half a century of rule—roughly 1868 to the early 1920s—the leaders of Meiji Japan also played a deft and high-stakes game in positioning themselves in a global financial-cum-military order revolving around the City of London. That order saw the machinery of a supposedly neutral universal gold standard working in tandem with the law of comparative advantage to bring about what was touted as a best-of-all-possible-worlds outcome. In fact, the order was managed by the Bank of England and policed by the British Navy. Countries such as Turkey and Egypt that ran out of gold or silver and defaulted on their debts found themselves facing loss of territory and even independence at the hands of the Western powers.

Japan’s leaders were acutely sensitive to the power dynamics that underlay the global financial regime of the time. [5] The rapid draining of gold from the country in the wake of Commodore Perry’s 1854 ‘opening’ had been a proximate cause of the collapse of the shogunate; the domestic gold:silver exchange ratio was 1:5, so out of line with the prevailing international ratio of 1:15 that savvy traders quickly bought up much of the country’s circulating gold coin using its overvalued silver. The entire financial thrust of the subsequent industrialization had as its primary motive the accumulation of gold—or more precisely, the accumulation of claims on gold. For when Japan actually succeeded in acquiring ownership of sufficient gold—extracted as reparations from a prostrate Qing dynasty after the 1895 Sino-Japanese War—to render its credit acceptable abroad, the country’s leaders chose to buy the goodwill of Britain by leaving the gold in the vaults of the Bank of England, rather than bring it back to Japan. The policy was known as zaigai seika—literally, ‘specie kept outside’. It relied on the ability of ‘high-powered money’ (that is, money used to create other money: gold, bank reserves, international reserves) to play two simultaneous roles: in this case, as backing for Japan’s own credit creation and also as part of Britain’s money supply.

Keynes would describe the mechanism in his first major published work, Indian Currency and Finance, when he noted how earnings from India’s surplus trade with Britain that were left in London became part of the domestic money supply there and did not lead to a loss in British purchasing power. Keynes was cited by a later Bank of Japan governor in justifying zaigai seika. The policy would form the financial backdrop for the signing of the Anglo-Japanese Alliance in 1902, which sealed Japan’s admission into the club of nations supporting the existing global order. In 34 years, the country had moved from a poor backwater, whose very future as an independent nation was in doubt, to an important pillar of British hegemony in East Asia and an imperialist power in its own right. The resultant freedom of action, among other things, gave Japan the wherewithal to raise on global markets the funds necessary to wage and win the 1904–05 Russo-Japanese War, which in turn helped lay the groundwork for the Russian Revolution.
Changing hegemons

But for all their success, the Meiji architects of Japan’s rise to global respectability had not solved core political problems, including the construction of institutions with the full legitimacy to determine succession and bestow the right to rule. [6] For power was theoretically exercised in the name of an Emperor who did not in fact rule. Behind the façade of the imported institutions of parliamentary government and the elaborate fiction of Imperial blessing, the men who had seized power in 1868 continued to run the country themselves as a kind of collective oligarchy, controlling the great bureaucracies they had built. They failed, however, to leave their successors any sort of mechanism that could adjudicate among competing claims to power. The passing from the scene of the Meiji oligarchs coincided with the collapse of the British-centred world order in the fields of Flanders. A power vacuum in East Asia was among the many consequences of the inability of Great Britain and the unwillingness of the United States to assume system-sustaining functions in the wake of the First World War. Mid-ranking officers in the Japanese Army grabbed the levers of control at home and filled that vacuum, raining destruction down on their neighbours and ultimately their compatriots.

Yet Japan’s devastating military defeat at the end of the Second World War did not lead to the replacement of one government with another. Washington’s endless self-congratulation notwithstanding, the American Occupation did not engineer any fundamental break in the nature of Japanese rule. The constitution written by the occupiers no more settled the question of who had the ultimate right to determine the country’s agenda than had the leaders of the Meiji era. True, it aspired to reposition sovereignty with the Japanese citizenry, supposedly acting through its legislature, rather than the Emperor. But the great bureaucracies that determined what actually went on in Japan were still unaccountable to any outside source, be it Emperor or Diet. The judiciary was still independent in name only. There was no oversight—from elected legislature, court of law, or monarch—over what any of the great bureaucracies were doing, and no accountability.

But two things had changed. First, the prewar and wartime bureaucracies with the means of physical coercion at their disposal—the military; the Naimusho, or Interior Ministry—were either fragmented into less powerful shards or emasculated altogether and brought under the thumb of the Budget Bureau of the Ministry of Finance. Meanwhile, the great economic ministries—Finance; Munitions, now renamed International Trade and Industry—were left largely untouched. Second, the United States assumed for Japan those functions by which a state is most commonly identified: providing for national security and conducting foreign relations. In most nations, questions of security, foreign policy and the allocation of public funds to competing domestic interests form the stuff of politics. But with foreign and security policy taken out of Japan’s hands, and reconstruction the obvious priority in the immediate postwar decade, political discussion largely vanished; with its disappearance, a necessary infrastructure—most importantly, a vigorous, independent quality press and a cadre of public intellectuals—atrophied.

With the 1955 merger of the two major conservative parties to form the Liberal Democratic Party, the postwar configuration of Japanese political life was complete. The merger was taken to forestall any possibility of leftists coming to power, something that the us had effectively insisted on as a condition for ending the Occupation. But the 1955 system also included the sublimation of all other national goals into single-minded devotion to economic growth and acquiescence in the us–Japan ‘alliance’. [7] The aim was to build an industrial superpower under American military protection and within a stable dollar-centred global financial framework; the Japanese elite did not concern themselves with the long-term sustainability of either.

As Japan emerged from postwar devastation and launched a renewed drive for industrial growth so dazzling that it acquired the label ‘miracle’, it seemed as if the tale of the Meiji years was being retold. Again, Japan moved in the space of a couple of decades from a poor backwater to a major player, snuggling up to the superpower of the day. Again, it would serve as a crucial military asset for that superpower vis-à-vis the great Eurasian continental—and now Communist—empires. Again, it would leave the proceeds of its export earnings within the superpower’s banking system, providing indirect financial support for the superpower’s ability to project military force. And again its subordination to a financial-cum-political global order managed and policed by the superpower would permit it to sidestep fundamental political questions.

The contemporary Japanese political setup thus resembles a flourishing vine that has grown to great heights, but would likely tumble should the pole around which it twists—the United States—ever itself fail. But the image requires qualification, for not only does the pole support the vine, but the vine has, for the past 35 years, become an increasingly important prop for the pole. The us needs Japan today to a far greater degree than Britain ever did. Japan’s companies manufacture a range of both high value-added components and finished products on which American technological and military supremacy totally depend. Japan’s continued central role in financing the us trade and government deficits and propping up a dollar-centred international order is, as we have seen, the key explanation for Washington’s ability to project and sustain a vast global military establishment without crushing domestic tax burdens. Since the mid-70s, at every crisis point when it has looked as if upheavals in the foreign-exchange market might force the us to live within its means, it has been the Japanese elite that has acted to support the dollar, the Bretton Woods ii regime and, by extension, the continuation of American hegemony. As Mikuni Akio and I have argued, this has not been due to any particular affection for Washington on the part of that elite, but ‘because it identifies its own survival with the continuous build-up of (Japan-owned) dollars in the American banking system’. [8] Any alternative would demand a fundamental reconsideration of the assumptions of the 1955 system, and thus risk fostering another dangerous and debilitating intra-elite struggle.
Fleeting fantasies

For a brief period—from the late 80s until the early 90s—the Japanese elite did appear to give serious thought to a fundamental restructuring of the relationship with Washington along more independent lines. From the 1979 publication of Ezra Vogel’s Japan as Number One, they had been told by both their own home-grown cheerleaders and a diverse group of seemingly clued-in foreigners (I was part of the chorus, although like most non-Japanese I expressed some reservations) that they were on the verge of global economic pre-eminence, if they hadn’t already achieved it. Japan appeared to have surpassed the United States by every significant measure of economic strength save sheer size; and that was only a matter of a few more years. Particularly after the 1987 stock-market crash, interpreted in Tokyo as a damning verdict on American profligacy and economic weakness, the Japanese elite seemed convinced they were living in the last days of American economic hegemony.

To be sure, the us still provided useful military protection against what was seen as Japan’s major external security threat and close neighbour, the Soviet Union. And the residual buying power of the American market was…
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