Musha Research Commentary

27November 2023

S\Strategy
Bulletin (No. 345)

Exchange Rates to Achieve the National Interest of the UnitedStates, the Hegemonic Power～The End of the 1971 Regime, Is this the Beginning of the Era of the Dollar's Monopoly (2)The end of the second postwar regime that began in 1971
The postwar system can be divided into the 36 years from 1945 and the 52 years from 1971
to the present. The framework of the current world political and economic order, which can becalled the second postwar system, was formed by the two Nixon shocks in 1971. However, itcould no longer be sustained due to the "Frankenstein" of China and its challenge to U.S.
hegemony. The world is now entering an era in which a new order is being sought to replace
the Nixon shock regime.
The restoration of US-China diplomatic relations and the expulsion of Taiwan from the UN. by
Nixon create "Frankenstein"
The first Nixon Shock was the restoration of diplomatic relations between the U.S. and China.
He severed diplomatic relations with the Republic of China (Taiwan), a permanent member of
the UN Security Council, and invited Communist China into the world order. This policy, basedon the expectation that economic development would promote democracy in China and that
China would eventually become a leader of the world's liberal democratic order, proved to bea great mistake 50 years later. In his later years, Mr. Nixon recalled that he might have createda "Frankenstein" monster.
This decisions that passed Japan by unnoticed also left trail of bad luck on Japan's diplomaticalliance. 30 years later, according to the confidential minutes of Nixon's visit to China revealedin 2003, Nixon stated that "Our policy is to deter Japan as much as possible from economic
expansion to military expansion," "to discourage Japan from supporting the Taiwan
independence movement," "It is in the interest of peace in the Pacific to restrain Japan" and"Japan will not pay attention to the U.S. if there are no U.S. troops in Japan," etc. (10/3/2016
Yomiuri Shimbun, Jiro Deguchi). This overtly speaks of respect for China and caution toward
Japan as an ally.

Figure 1: Current Account Balance of Major Countries as % of World GDP
2.25
2.00
1.75
1.50
1.25
1.00
0.750.50
0.25
0.00
-0.25
-0.50
-0.75
-1.00
-1.25
-1.50
-1.75

(%)

Rest of the world
Other Aisan emerging and developing countries
Major oil exporters
ChinaGermany
JapanUS80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 12 14 16 18 20 22 24 26 28⇒ Est.

Note: Major oil exporters include Algeria, Azerbaijan, Bahrain, Iran, Iraq, Kazakhstan, Kuwait, Libya, Oman,Qatar, Saudi Arabia, Syria, Turkmenistan and UAE. Source: IMF, Musha Research

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Ryoji Musha
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Tel ＋81-3- 3740 2143
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327 November 2023
Floating exchange rate system that does not correct the U.S. deficit, essentially a dollar
standard
Strategy Bulletin vol345

The second Nixon shock was the cessation of the dollar-gold exchange. The reserve currency, the dollar, lost its gold
backing, and there was talk of fears of a major plunge. However, the value of the dollar did not fall as much as the dollar
scattering by spinning a rotary press due to the departure of the gold backing. Figure 1 shows the ratio of the current
account balances of major countries to the world's GDP, and only the U.S., as the largest debtor nation, has
accumulated foreign debt single-handedly. The U.S. pointed to Japan's huge trade surplus with the U.S. in the 1980sand 1990s and China's huge trade surplus with the U.S. since 2005 blaming the undervaluation of its currencies but
made no efforts to reduce its own deficit. This tells us that the floating exchange rate system under the dollar reserve
currency regime was an asymmetric one.
Floating exchange rates are believed to be fair because they contain a mechanism for correcting imbalances. The
mechanism was persuasive: the currency of a country with a trade deficit would reduce its deficit by weakening, andthe currency of a country with a surplus would reduce its surplus by strengthening. The logic goes that a weaker currency
for a deficit country will lead to higher import prices and lower imports, while a weaker currency will make the country
more competitive and thus increase exports (the opposite is true for a surplus country). On this basis, the U.S. hasmonitored and sometimes sanctioned major trading partners suspected of currency manipulation. In the past, Japanand China accumulated their holdings of U.S. government bonds through foreign currency intervention to avoid sharp
currency appreciation, but U.S.-led international public opinion condemned this as currency manipulation and dirty float.
Historical facts over the past 40 years, however, show that this logic has not been applied to the United States. Normally,
the U.S. dollar, the currency of the U.S. with a large deficit, should have plummeted, putting a stop to imports by causing
U.S. import prices to soar, but the dollar's decline was limited and did not function as a brake on U.S. imports.
As a result, the U.S. current account deficit continued to increase, and 50 years after the Nixon Shock, the world
accumulated huge claims on the U.S. and huge U.S. foreign debt (Figure 2 and 3). This was the very supply of thegrowth currency, the dollar, by the U.S. to the rest of the world.

Figure2: Cumulative Current Account of Major
Countries (1980-2022

Figure3:US. Current Account and% to GDP
2200%

US$ bil.

110000Current accountbalance (RHS)
2023 Q1 -907.0-1-2-100-200-300-3-400-4-500-5-6-600

Current account balance(as share of GDP, LHS)
2023 Q1 -3.4-700-7-800-8-900-9-1000
70 73 76 79 82 85 88 91 94 97 00 03 06 09 12 15 18 21
Source: US Dept. of Commerce, Bloomberg,
Musha Resaerch

Dollar Scattering Caused Asia to Take Off
The increase in the U.S. external debt, or in other words, the scattering of the dollar, was a blessing for the world
economy: Japan achieved economic breakthroughs in the 1980s and 1990s through exports to the U.S., Asian NIES
such as South Korea, Taiwan, and Hong Kong took off in the 1990s and 2000s, and China achieved high growth after
the Beijing Olympics in the late 2000s. The starting point for all of this growth was the dissemination of the dollar. The
over presence and "Frankensteinization" of China, which is responsible for almost half of the world's manufacturing
production, was indeed the result of the two Nixon Shocks. This dollar-dripping system is the essence of modernglobalization.

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27 November 2023

Strategy Bulletin vol345

3Dollar Dripping is the Distal Cause of the Japan-China Real Estate Bubble
It should also be noted that the accumulation of surpluses with the U.S. led to an oversupply of currency in Japan andChina, which in turn led to the formation of the subsequent real estate bubbles. Figure 4 and 5 show the trends of Japanand China's external current account surpluses (vs. GDP) and household debt (vs. GDP), and the linkage between thetwo can be seen in both Japan and China.

Figure4: China-Japan Current Account Balance Figure5: China-Japan Household Debt to GDP
12 (%)

8010(％ of GDP)

708JapanChina

60

650Japan

4402China

30020-280 83 86 89 92 95 98 01 04 07 10 13 16 19 22

10Source: IMF, Musha Resaerch

0

⇒
Est.

80
8590
9500
Source: BIS, Musha Research05

101520Dollar Spending Boosted U.S. Consumption and Upgraded Industrial Structure
The dollar disbursement also worked within the U.S. Chart 7 shows the trend in U.S. import dependence, which had
remained at 10% until the Nixon Shock in the early 1970s but has reached 80-90% since 2010. The U.S. economy,
which used to be self-sufficient, producing most of its clothing, TVs, and automobiles domestically, has been greatlyopened. This has led to the hollowing out of the manufacturing sector, but this has been compensated for by theemergence of new industries and employment, such as IT and services. From another perspective, the hollowing outof the U.S. manufacturing industry has promoted the upgrading of the U.S. industrial structure.

Figure6: US Current Account Balance andBreakdown
80090(US$ bil.)+12.5%(annual)

600
400

Fugure7: US Import Dependance of Goods andExport Ratio

80Services＋Primary incomebalance

70200

60050-200(%)

Current accountbalance

Import dependency ratio(Import of gooods/Domestic
demand for goods)

40-40030-60020-800Goodsbalance

Export ratio(Export of goods/Productionof goods)

10-1,000
0-1,200

47 51 55 59 63 67 71 75 79 83 87 91 95 99 03 07 11 15 19-1,400
99 01 03 05 07 09 11 13 15 17 19 21 23→ 25Source: BEA, Musha Research

Note: Production of goods = Gross value added by manufacturing
Domestic demand for goods = Gross value added by manufacturing + Importof goods - Export of goods
Source: US Dept. of Commerce, Musha Research

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27 November 2023

Strategy Bulletin vol345

3

In the early 1970s, the ratio of U.S. consumption to GDP was 60%, but 50 years later, in 2023, this ratio will be awhopping 68%. This is because cheap imports have boosted the real purchasing power of U.S. consumers (Figure 8).

The U.S. Current Account Deficit Will Shrink
Modulations began to appear in the dollar supply under this Nixon shock regime. First, the dependence of the U.S. on
imports of goods has reached 80-90%, and the goods trade deficit has reached its limit. Future U.S. imports will be very
mild, in line with economic growth. Second, the U.S. services and income balance (i.e., international trade in invisiblethings) surplus is expected to increase significantly. Thus, the U.S. current account deficit will decline (see Figure 6).
This will probably serve as a brake on the supply of dollars and shift the global supply and demand for foreign exchange
from a dollar surplus to a dollar shortage, opening an era of dollar appreciation and dollar monopoly.

Figure8: Consumption/GDP of Major Countries
75(% of GDP)

(1995 Q1=100)

US

70
6560

Figure9:US Employment by Sector(19951Q=100)

JapanEuro
Area

55
50
45
40

China

35
30

190
180
170
160
150
140
130
120
110
100
90
80
70
60

Education& helthservices

Nonfarm total
Private sector
Government sector

Profession
al & biz
Leisure andservices
hospitality

Construction

FinancialTrade, transportation& utilities

Information

Manufacturing

95 97 99 01 03 05 07 09 11 13 15 17 19 21 23
Source: US Dept of Commerce, Musha Research

Soure: World Bank, Musha Research

U.S. Dominant Presence in the Cyber World, the World's Largest Growth Market
The biggest bright spot in the global economy is not Asia or the Global South, but cyberspace without borders. In this
rapidly developing mass of knowledge, cyberspace, the Internet, AI, and other fields, the U.S. has a near monopoly ofglobal demand and is fishing for its use. Europe and Japan are trying to penalize the monopoly of Internet platform
providers, but since there are no alternative suppliers in their countries, this is a futile attempt. Looking at the U.S. S&P
500 index GAFAM+NVIDIA and TESLA, which are named after The Magnificent Seven, have gained 50% since thebeginning of the year. On the other hand, the share prices of the remaining 493 companies have remained almost flat.
Do we see this as a bubble or the rise of companies driving a new industrial revolution? Given that the U.S. market isa mix of the brightest and the least bright sectors, this disparity is not surprising.

the resulting dollar appreciation will strengthen the financial power of the U.S
In addition to the improvement in the U.S. current account balance that we have been discussing, the economic growthrate of the U.S., the home of innovation, has begun to outpace that of other countries, and the resulting high interest
rates are encouraging the concentration of capital in the U.S. The question then becomes how to supply the world withdollars, the currency of growth. In the future, the U.S. investment and loans are likely to replace import payments aschannels for supplying dollars to the rest of the world. This will strengthen the position of the U.S. as the hegemonicpower. It is hypothesized that the resulting dollar appreciation will strengthen the financial power of the U.S. as thehegemonic power and become a driving force for the restructuring of the world order.

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