US budget deficit soars

TWO British journalists opened the door to a room on the 7th floor of New York's Plaza Hotel in September 1985 and gasped in astonishment.

Sitting around a horseshoe-shaped table in front of them, unprotected by any security whatsoever, were the 10 finance ministers and central bank governors of the Group of Five (G5) strongest industrial countries in the world.

At the centre was US Treasury Secretary James A Baker III, the most powerful politician in Washington after President Ronald Reagan. He was the man who had convened the meeting, which would reshape America's economic policy.

On his right the was legendary Federal Reserve chairman Paul Volcker.

A single topic was on the agenda. The US current account deficit was rocketing towards $160bn - or 3% of gross domestic product (GDP). The budget deficit was soaring over the $200bn mark.

Baker had concluded that a tidal wave of protectionism might sweep through the United States if the dollar was not devalued.

Over the next year, as Baker wanted, the dollar plunged by some 40% against the German mark and the Japanese yen.

He then reconvened the G5 at the Louvre in Paris in February 1986 to get an agreement that its members would co-operate to try to stabilise the greenback.

As Randall Henning, a fellow at Washington's Institute for International Economics recounts in his book Currencies and Politics in the United States, Germany and Japan, the management of the dollar through the late 1980s required heavy doses of foreign exchange intervention.

It also needed the setting up of informal target fluctuation ranges for the major currencies and incessant inter-governmental co-operation.

Even then, avoiding a 'hard landing' for the US currency was a close run thing - especially in 1987 when foreign central banks financed two-thirds of the then-record current account deficit.

Fast forward to December 2003. The dollar is in trouble again, slumping to new lows against the euro in the face of a $500bn current account deficit - a massive 5% of GDP now and rising.

The budget deficit is 'out of control' in the view of US investment bankers Goldman Sachs. Federal Reserve Board chairman Alan Greenspan is issuing warnings about the growing threat of American protectionism in a country which has just banned the import of Chinese bras.

True to form, too, Greenspan and learned academics are protesting that just as the bubble economy of 1998-2001 was a 'new paradigm', so today the rest of the world will happily continue to finance America if it wishes to live beyond its means, if not indefinitely at least until the clouds clear.

But one of the striking characteristics of this Bush Administration, unlike its two predecessors, is that whether in the Treasury or the White House, its pillars of economic governance have been fashioned from butter, not brick.

There is no economic policymaker in Washington with the clout of James Baker, or Robert Rubin - Bill Clinton's Treasury Secretary.

So there is no danger that a couple of journalists could accidentally stray into a meeting of G7 finance ministers, plus the ex-officio member from China, anxiously trying to co-operate in managing the looming international currency crisis.

Everybody - as the Chinese government made clear when they rebuffed him this summer - knows that US Treasury Secretary John Snow has no clout with the President. Even if he did, who is the strong man who would speak for the euro at the table?

As Henning remarks in his book, the history of the last dollar crisis teaches that it is easy to underestimate the importance the markets attach to G7 co-operation, especially in times of stress like these.

Financiers who look to the US today see how low a priority the President has put on diplomacy in general - and financial diplomacy in particular - and they factor this into their crisis management scenarios. This is not a reassuring thought.