“In the past six centuries, six currencies held global reserve status – the Portuguese escudo, the Spanish peso de ocho, the Dutch guilder, the French franc, the British pound and, most recently, the U.S. Dollar. Each occupied the throne for roughly 80-100 years, corresponding with its country’s international preeminence…. The greenback has been more or less at the helm since the 1920s, though its official coronation only took place during World War II. A century later, are we due for a change of the guard?”
By Jason Worth
(Note: If not specified otherwise, any quotations in this book review refer to text by the authors from the book being reviewed.)
Increasing numbers of countries are initiating or joining efforts to de-dollarize, and as more countries successfully shift their purchases or sales of commodities and other products from dollars to other currencies, the United States will be faced with increasing economic and financial challenges. The policies of the U.S. government and domestic financial institutions like the Federal Reserve Bank are increasingly to blame for much of the de-dollarization efforts. It is not too late, but we may be getting there soon, for the U.S. government and relevant institutions to revoke or modify certain policies to stem, if not reverse, this transition. This is the thesis of a new book by Gal Luft and Anne Korin, co-directors of a Washington DC-based think tank.
To understand what de-dollarization means in practice, and to really understand how it could harm the U.S. and its citizens, we must first appreciate the strength and role of the U.S. dollar in world commerce. Since World War II, the U.S. dollar has been the preeminent currency of choice around the world, earning it the mantle of the “world’s reserve currency”. Think of it this way, if you needed to purchase a rare drug to save your life, you didn’t know who owned the drug or where in the world they lived, and you could only pick one currency in which to attempt to make such a life-saving purchase, what currency would you choose? If you’re rational, you’d pick the U.S. dollar, since it would be the currency with the greatest chance of being accepted by an individual or company around the world. Combine the high acceptability of this currency with its relative long-term stability at retaining its value (although this point is debatable), and you can see why countries have historically gravitated to holding and using U.S. dollars.
The dollar’s position as the world’s leading currency was initially due in large part to our country’s strong position coming out of World War II. Whereas many other nations were impoverished from the war and needed to rebuild basic infrastructure and industries, the United States was minimally impacted by physical damage. Our commerce and industry were robust in the early post-war years, and only the United States had the financial capacity to launch the Marshall Plan effort to rebuild Europe and acquaint post-war Europe with the direct benefits a U.S. dollar could provide. The strength of the dollar was solidified and enhanced over the next few decades by other attributes of our culture which fostered innovation and financial strength, such as our Capitalistic culture that rewarded growth through entrepreneurial risk-taking and a top notch educational system that produced competent business managers, technology developers, researchers and scientists. Today, despite the fact the United States represents only five percent of the world’s population and accounts for a fifth of the world’s GDP, 80% of international payments are made using U.S. dollars.
In the early days, the world reserve currency status was rightfully earned. But as the years went on, Washington-based policies and the actions of leading U.S. companies and banks sought to capitalize on America’s hegemonic power to further ensconce the U.S. dollar as the world’s go-to currency. One particularly good example of this is the agreement in 1975 between the United States and House of Saud in which, at the request of U.S. officials, Saudi Arabia agreed that it would only sell its massive supplies of crude oil products on the world’s markets in U.S. denominated prices and in receipt of U.S. dollars. Hence the term “petrodollar” was coined, to clearly illustrate the close interrelationship of the U.S. dollar to the pricing and sale of arguably the world’s most critical commodity. In return for agreeing to price Saudi oil output in U.S. dollars, the United States agreed to sell to Saudi Arabia major military arms and equipment from U.S. manufacturers and provide diplomatic and other support. In a fractious Middle East comprised of seemingly never ending civil and cross border warfare, such armaments were critical to enabling the Saudi Royal family to protect not only its country’s sovereign borders but also the Saud family’s position as Saudi Arabia’s rulers. And whereas the U.S. has sanctioned other countries for actions similar to those that Saudi Arabia could be accused of (such as human rights oppression and fostering terrorism), U.S. policy toward Saudi Arabia is not consistent and that country typically receives a free pass.
Due to the Saudi pricing of oil in U.S. dollars, most other countries that sell oil have followed suit and also priced their output in U.S. dollars. As a result, the worldwide sale of oil in U.S. currency is the first in a long chain of transactions that provides the U.S. dollar and U.S. government their strength. Let’s follow an example of how this currency chain works. A Thai or Brazilian company buying oil from Saudi Arabia must first convert their Baht or Real currencies into U.S. dollars in order to have the required currency for purchase. This places an ongoing and essentially never-ending state of demand for U.S. dollars in the world markets. This also entails currency conversion exchange fees that most likely profit U.S.-based trading firms, and gives U.S. oil-consuming companies a slight advantage over foreign competitors who have to pay such an exchange fee that U.S. firms do not. Next, the vast profits flowing into the Saudi Arabian oil production and distribution firms each year land in their bank accounts in the form of U.S. dollars. Would it make sense to convert these into Bahts or Reals to invest in their customers’ equities or sovereign bonds from Thailand or Brazil? No; not necessarily. For one thing, it would entail an unnecessary currency exchange fee, and for another, the risk profile of these companies and countries are typically not as safe as that of the United States. So Saudi Arabia invariably uses a large part of its profits to buy U.S.-denominated Treasury bills, notes and bonds, as well as the stocks of U.S. and multinational corporations on U.S. stock exchanges. Likewise, other countries that export a lot of products to the U.S., like China and Japan, typically receive payment in U.S. dollars. Just like Saudi Arabia, these other countries typically reinvest their U.S. dollars into U.S. dollar-denominated financial instruments. This part of the cycle places a seemingly never-ending demand for U.S. financial debt and equities. And so the cycle goes, with proceeds from oil and other products sold to the U.S. or otherwise denominated in U.S. dollars reinvested in U.S. debt and U.S. equities.
The seemingly never-ending demand for U.S. sovereign debt affords Washington-based policy makers and U.S. taxpayers with another advantage, low-cost of capital funding sources. What other country on this planet can afford to rack up more than $22 trillion of debt, with no apparent way to repay it on a sound course? What other country on this planet could afford to dole out hundreds of billions of dollars in “bail-outs” and other subsidies in the aftermath of economic crises like to Chrysler in 1979, the Savings and Loan Industry in 1986, Fannie Mae, Freddie Mac, AIG and other financial institutions in the aftermath of the 2008 recession? And there’s yet another large government-backed “stimulus” package due to the current coronavirus malaise underway as we speak which could total $6 trillion or more before all is said and done. No other country on this planet could finance such a large undertaking without significantly eroding the purchasing power of its currency, except the U.S. And the U.S. is able to do so essentially because of the U.S. dollar’s status as the world’s reserve currency and the fact that so many countries have excess dollars in hand by virtue of being net exporters to the U.S. or otherwise transacting in dollars.
And yet, despite the historical stability of the U.S. dollar, increasingly more countries around the world want to reduce their use of them. This shift is largely due to actions in recent decades of the U.S. government and its leading institutions, like the Federal Reserve Bank. Probably the biggest reason countries today are trying to de-dollarize is because of the United States’ actions to effectively weaponize the dollar. Military conflicts have become and are increasingly viewed as problematic, due to their expense, typical lack of public support and the general attitude that they don’t achieve their stated objectives. However, economic sanctions “are more popular, cheaper and easier to implement than the use of force.” And America employs them constantly. Using the historical example of Cuban cigars, rather than intercepting shiploads of Cuban cigars to stifle or punish the Cuban regime (effectively a military action involving embargo), the United States today instead exerts pressure on financial institutions to prevent financial payments for cigars from reaching Cuban-controlled accounts. And this economic reach, initially imposed via “primary sanctions” domestically on U.S. entities, has since been expanded to entities around the world via “secondary sanctions.” Continuing the example of Cuban cigars, secondary sanctions would punish a bank in Germany or Japan, for example, for facilitating payments to Cuba on behalf of a client for such cigars. By cutting that bank off from the U.S. financial system for its transgression, “…the U.S. essentially tells the world that it has a choice: abide by our unilateral policies or suffer what most corporations or businesspeople would consider a financial death sentence.”
n 1977, Congress passed the International Emergency Economic Powers Act, which authorized the president to block transactions and freeze assets of those who constitute a “threat to the national security, foreign policy, or economy of the United States.” (Take a second to reflect on how vague and all-encompassing that sentence is.) And because of the relative ease of imposing financial sanctions, the U.S. has tapped that power quite frequently since then. Today, one in ten countries in the world is under U.S. sanctions, including Russia, Iran, Venezuela, Belarus, Burundi, Central African Republic, Cuba, Lebanon, Syria, Libya, Somalia, Yemen, Iraq, Sudan, South Sudan, Zimbabwe, Myanmar, the Democratic Republic of Congo and North Korea. Other countries like China, Pakistan and Turkey may not be under official sanctions programs (yet!), but are targeted for other economic putative measures like export controls, tariffs and embargos. “…With a cumulative population of nearly 2 billion people and with a combined gross domestic product (GDP) of more than $15 trillion, [this] has created an axis of resentment which, in turn, has triggered an unprecedented pushback against America’s financial hegemony.”
Individuals and entities targeted for sanctions appear on a list known as the Specially Designated Nationals and Blocked Persons (SDN) under the Office of Foreign Assets Control (OFAC). To demonstrate the U.S.’ effective abuse of its hegemonic financial power, consider that “…since 2001, the number of entities added annually to the SDN has grown threefold. In 2013, the list was 577 pages long. In 2019, the number of pages was 1,307. In the first year of the Trump Administration, there has been a nearly 30 percent increase in the number of designations over the number added during President Obama’s final year in office.” In January 2018, 210 prominent Russian political figures and business leaders were added to a similar list, under the Countering America’s Adversaries through Sanctions Act (CAATA), including 96 “oligarchs.” None of these individuals had been charged with a crime. They just happened to appear on a Forbes Magazine list of world billionaires, knew President Putin, and probably benefitted from their relationship with him. One of the entities caught up in this list and targeted for sanctions included Russia’s main arms control export entity, Rosoboronexport. In an amazing example of the overreach of U.S. secondary sanctions, Rosoboronexport engaged in a transaction with a Chinese military procurement company. By extension, through its targeting of Rosoboronexport, the U.S.’ sanction now carried through to a Chinese firm, and in doing so the United States was effectively interfering with Russia’s ability to conduct bilateral trade with China. Is it any surprise that these two nations are among the most committed to de-dollarizing?
After World War II, our national debt to GDP ratio stood at 30%. Today it is over 100%, and due to the coronavirus-related stimulus spending, likely to grow significantly beyond this. By 2050 it is estimated to rise to 180 percent. And despite these massive debt levels, which for any other country would push up interest rates to a level needed to encourage investors to take on increasing risk of not being repaid (or if repaid, with a currency greatly devalued in purchasing power), U.S. interest rates on these debt levels have actually declined to near zero at this point. This is unheard of, and it’s only due to the never-ending demand for U.S. Treasuries as exporting nations have a surplus amount of U.S. dollars to park somewhere. (In fairness, the U.S.’ near zero interest rate is also due to other countries taking our lead and setting their national interest rates at very low levels.)
Other countries that have come close to replicating or exceeding this pattern have frequently resulted in some degree of financial ruin with tough economic and societal prices paid to unwind or restructure their debt obligations. Think of Argentina and Brazil, and the former Soviet Union, before it splintered into pieces and began its forays into Capitalism. Unsustainable debt levels have been a concern in recent years for the “PIGS” countries (Portugal, Italy, Greece and Spain.) And it is very much happening right now in Venezuela. And yet, with somewhat similar conditions over an extended period of time, the U.S. just marshals along with high debt levels that, since the Clinton Administration, have not declined in either nominal terms or as a percentage of our GDP. But this may not last forever. “Even in the current environment of relatively low interest rates, the United States spends $1.5 billion every single day on interest payments… A 2018 study by the Committee for a Responsible Federal Budget (CRFB) projects the amount of money the U.S. government will spend on servicing its debt will surpass Medicaid spending by 2021 and defense spending by 2024. The Congressional Budget Office (CBO) estimates that in 2025 the United States will spend on debt payments more than it spends on all nondefense discretionary programs combined, from funding for scientific research, to health care and education, to infrastructure.” Spending on interest payments in 2028 is estimated to be $915 billion, or 13% of all outlays. By comparison, in 1933, the cost of servicing the British debt was 10%, and this debt level prevented Britain from mounting the necessary resources to adequately prepare it for war with Germany. Based on existing and anticipated U.S. government debt levels, something will have to give at some point, and we don’t appear to be adequately preparing for this. Foreign countries attempting to de-dollarize now might be doing so in anticipation of future declines in the value of the U.S. dollar due to unacceptably high debt levels.
Worldwide concerns over the U.S. financial position were exacerbated after the 2007-2009 financial crisis. In 2010, the United Nations issued a report saying “…the dollar has proven not to be a stable store of value, which is a requisite for a stable reserve currency.” It also observed that as the global economy continues to be tied to the U.S. dollar, the Federal Reserve’s actions with the dollar are undertaken primarily to enhance the United States’ position, oftentimes at the expense of other countries holding large quantities of U.S. dollars.
The countries most active at de-dollarizing are Russia, China, Iran and Venezuela. Meanwhile, Pakistan, India, Turkey, Saudi Arabia and the European Union are effectively sitting on the fence watching with interest and likely hoping to some extent for a new alternative to take shape.
Russia is perhaps the most active in this effort. For one, they have sold almost all of their U.S. Treasury holdings and used the proceeds, about $110 billion worth, to buy physical gold in its place. It has encouraged its trading partners to replace the U.S. dollar with other currencies, including not only the ruble but also the euro and yuan, among others. Those trading partners who agreed to accept the ruble received benefits, such as expedited return of value added taxes. Russia also educated its European trading partners, who themselves were willing to increase use of the euro in place of the dollar, that discontinuation of the U.S. dollar represented a form of energy security in so far as the United States could not intervene to prevent dollar settlements should it deem this or that trading partner worthy of economic sanctions. Russia also views this currency matter through a broader geo-political/military prism, with the understanding that as the United States’ currency wains, so too will its main adversary cease to fund its military war machine with its prior ease. To illustrate this concept, the authors of De-dollarization chose as an introduction to the book a quote from Vladimir Lenin: “The best way to destroy the capitalist system is to debauch the currency.”
Iran is “patient zero” in the backlash against the U.S. dollar, having been under various sanctions since 1979. Although Iran experienced some relief in the final year of the Obama Administration by agreeing to certain restrictions regarding its pursuit of nuclear research, that was all undone and rather quickly by the incoming Trump Administration which quickly clamped down on Iran. Although Iran’s economy had initially picked up because of the Obama era actions, the subsequent impact on Iran due to the Trump Administration’s reversal was devastating with inflation of 40% in 2018, and the Iranian currency plummeted in value. But Iran has time-honored experience at evading U.S. sanctions. It sells its energy resources in non-dollar currencies, such as the euro, rupees and yuans, and at all costs seeks to avoid using any U.S.-based banks.
Although Europe and the U.S. have enjoyed a long and reasonably productive history, including the U.S.’ costly efforts to help Europe rebuild after the war, Europe has never been particularly comfortable with the dollar as the world’s reserve currency. In particular, the French are the most uncomfortable among them, viewing Washington’s loose monetary policy as beneficial to America at the expense of other countries. It was Europe’s run on the dollar in 1971 that led President Nixon to take the dollar off of the gold standard. And in recent years, Donald Trump’s very public assertions that Europe is saddling the U.S. with financial burdens and needs to pay significantly more for its military defense prompted EU Council President Donald Tusk, considered one of Washington’s closest allies on the continent, to remark “with friends like that [referring to Donald Trump], who needs enemies?” Not only was Trump’s withdrawal from the Paris Climate Accords, his attacks on NATO, and support for Brexit all a challenge to Europe in one way or another, but the re-imposition of sanctions on Iran also challenges lucrative business dealings the European continent has with Iran. Plus, all of the administrative burdens placed on European banks to track and report to the United States on things like bank account ownership and commerce payment activities all have left a bad taste in the European financial establishment’s mouth. The U.S. sanctions on Russia also imperiled the Nord Stream 2 gas pipeline directly linking Russia with Europe, but Europe has pressed ahead with this initiative despite the U.S.’ displeasure. In January 2019, Germany, France and the UK introduced INSTEX, Instrument in Support of Trade Exchanges, to act as a clearing house matching Iranian oil, gas and metals exports against European goods via a barter arrangement. This avoids the use of any U.S. dollars and, as a result, helps to circumvent any U.S. sanctions. In these early days of INSTEX usage, it remains to be seen how the U.S. will hit back at this initiative or punish European non-conformance; but Europe is clearly exploring initiatives that put Europe first and seeks to circumvent U.S. economic hegemony. In addition, Italy’s embrace of China’s Belt and Road Initiative, which included a visit to Italy by President Xi Jinping in March 2019, and the borrowing by Italy of $12 trillion yuan in bond market financing, were further illustrations of Europe’s willingness to consider non-U.S. financial alternatives.
China and Other Countries
De-dollarization also recounts the actions of other countries like Turkey, Venezuela, India and Pakistan to deepen financial and economic ties with other countries, sometimes in direct and blatant opposition to U.S. wishes. And it devotes an entire chapter to the bold initiatives of China to expand its economic, financial and military powers worldwide. The situation with China is a complex one, and one that does not necessarily need to be as confrontational as it most likely will become. For example, the two economies are so intertwined that what is bad for America is often bad for China, as evidenced by the 2008-2009 financial crisis in America where within several months of Lehman Brothers’ collapse, Chinese exports plunged nearly 30 percent and 20 million Chinese workers lost their jobs. Back then China threw the U.S. a lifeline by purchasing more than half of the $600 billion in U.S. Treasuries the U.S. offered to the world. Today, Chinese support for American Treasuries might not be so robust. Furthermore, China’s $350 billion annual trade imbalance could be more balanced should it increase its purchases of U.S. goods and products. This is an initiative the Trump Administration has been publicly promoting with some level of success as Trump has announced in recent months trade commitments by China to purchase more from U.S. farms and factories (which will undoubtedly come at the expense of businesses in Europe and Latin America, to the chagrin of those countries holding U.S. dollars).
De-dollarization’s authors warn that China’s historical ability to finance America’s debt-fueled spending spree may not continue. This is in direct contradiction to U.S. Treasury Secretary Steve Mnuchin’s response to a question that he is “not concerned at all” regarding China’s potential change from its prior apparent insatiable appetite for U.S. government debt. (China already owns about $1.5 trillion, equal to roughly one-quarter of total U.S. foreign debt.) In contradiction to Mr. Mnuchin’s position, China is already undergoing an intense internal debate on what to do with its existing American debt. “The debate is not about dumping the treasuries China already owns. It is about the wisdom of rolling over those that mature. Currently, China has not a scintilla of appetite for increasing its current holdings to the levels needed to meet the steadily growing U.S. fiscal needs. In fact, since the beginning of the trade war, its holdings of U.S. bonds has been steadily declining.”
The transition away from the U.S. dollar has been a gradual one, in large part because no other currency has the requisite ability to knock the dollar off of its mantle. However, foreign companies and countries are increasingly trying to identify and use alternatives to the dollar. Once this de-dollarization initiative picks up sufficient steam, and alternative currencies are increasingly put in the U.S. dollar’s place, the U.S. could find the slide away from the dollar too strong to prevent. Depending upon the speed and severity of this shift, the ramifications for the U.S. economy and its citizens could be dramatic. Interest rates on U.S. government debt would need to rise in order to attract sufficient capital to continue to finance the U.S.’ debt fueled spending spree. This would divert increasing amounts of spending currently earmarked for things like Medicaid, Social Security, defense and infrastructure projects to service the federal debt. As interest rates for government debt increases, so too in chain reaction would rates for other debts like residential mortgages and corporate debt. This would drive down the value of our homes and the prices of publicly traded equities. National wealth in the United States, which the rest of the world has effectively subsidized for decades, would be reduced, and potentially quickly. And as investments would be diverted from U.S. dollar-denominated equity securities to others, perhaps in Europe or China, reduced demand for U.S. equities would further erode the value of stocks resulting in further wealth decline.
It is not too late for U.S. and Federal Reserve Bank officials to more fully appreciate this threat and take the necessary corrective actions. Not unlike a demanding spouse in a bad marriage, the corrective actions would entail the United States to be more flexible, understanding and compassionate in its dealings with other countries rather than imposing its will through financial coercion. It would entail the U.S. to act less in a winner-take-all fashion and recognize it is but a player, albeit a powerful and important one, in an increasingly multipolar world economy. In my opinion, it’s been quite some time since the United States acted on the world stage with this level of humility and understanding. I fear it would take a devastating blow to our economy or national security to force us to dig down and find that level of humility, if we could even find it.
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