View from USA: King Donald is dethroning the dollar

Pic.: The New York Times

The dollar is the world’s currency, not just America’s, The New York Times writes. It is the unit in which most cross-border transactions worldwide are quoted and settled. A remarkable 89 percent of global foreign exchange transactions are in dollars. Nearly 60 percent of the foreign currency reserves of central banks from Beijing to Zurich are held in dollar-denominated bank deposits and Treasury securities. The dollar is the lingua franca, if you will, of international financial markets.

For the moment, anyway.

The $40 trillion question is whether this happy situation will persist. Recent ructions in the market for U.S. Treasury bonds have raised the issue of whether dollar-denominated securities — long viewed as bulletproof and government-resistant — are really as safe and liquid as central banks and private investors had come to expect. Not because of anything market related, but because of the Trump administration’s threats to political and financial institutions, both domestic and international.

Doubts about the dollar’s staying power are not entirely new. Exactly half a century ago, in 1976, the eminent monetary economist and M.I.T. professor Charles Kindleberger announced that the dollar was “finished” as an international currency. Kindleberger was reacting to President Nixon’s 1971 decision to unilaterally abandon the gold standard — the fixed link between the dollar and gold. That entailed closing the Fed’s Gold Window that allowed foreign governments and central banks to redeem their dollar holdings for gold at a fixed price of $35 an ounce. It led to the end of the Bretton Woods system, the post-World War II system of flexible exchange rates pegged to the dollar.

More broadly, observers like Professor Kindleberger were disturbed by the pressure Nixon applied to the Federal Reserve chair Arthur Burns to keep interest rates low to aid the president’s re-election bid. They were troubled by accelerating U.S. inflation and by the Watergate scandal, which tarnished the image of the administration and America in the eyes of the world.

Professor Kindleberger was wrong, of course. Dollar dominance lived to see another day, or more precisely, another 50 years and counting.

The explanation, in hindsight, is clear. U.S. political institutions rose to the challenge of Watergate. Nixon faced imminent impeachment and was forced to resign. His Democratic successor, Jimmy Carter, appointed a fiercely independent and inflation-averse Federal Reserve chair, Paul Volcker. Mr. Carter disregarded his adviser Bert Lance’s warning that doing so might jeopardize his re-election. Mr. Volcker duly raised interest rates, as high as 20 percent, and Mr. Carter duly lost his re-election bid. But by the mid-1980s, double-digit inflation was history and chronic dollar weakness had given way to dollar strength.

At the same time, the United States was using its geopolitical leverage and alliances to encourage other nations to trade in dollars. In 1974, following the first OPEC oil shock, Treasury Secretary William Simon flew to Saudi Arabia with the goal of securing agreement by King Faisal to invest the kingdom’s oil export earnings in dollars, in exchange for continued access to U.S. arms and military support. In 1977, Mr. Simon’s successor, W. Michael Blumenthal, promised to help Saudi Arabia obtain expanded voting rights in the International Monetary Fund in return for a commitment to price oil in dollars.

As Professor Kindleberger eventually acknowledged, there was no alternative to the global dollar. No other currency could serve as a vehicle for cross-border transactions at scale.

But now, finally, there is reason to think that there is an alternative. Observing the actions of the Trump administration, allies and trading partners are voicing concerns about separation of powers, rule of law and the rise of corruption in the United States. For centuries, every leading international and reserve currency — not just the dollar, but the British pound sterling in the 19th century and the Dutch guilder in the 18th — has been the currency of a democracy or a republic. As President Trump seeks to fire the Fed members who won’t do his bidding, to cancel contracts for wind projects he dislikes or to target political foes for prosecution, foreigners have come to doubt whether this is still true of America.

Moreover, every leading international currency has been backed by a strong financial institution insulated from politics. The Trump administration’s continuing threats against the Fed governor Lisa Cook, and Mr. Trump’s history of attacks on the central bank, have disconcerted investors and raised questions about whether the Fed will retain the autonomy needed to act as a reliable steward. If the Fed fails in that, the dollar may not hold its value, further undermining its global role.

Then there are doubts about America’s commitment to its international alliances, such as NATO or the Mutual Defense Treaty binding America and South Korea. Historically, countries hold, use and support the currencies of their alliance partners. Allies are customers, too. Buying U.S. debt is a show of good faith and appreciation of their partners, as King Faisal understood in 1974. In the 1960s, when the dollar’s fixed link to gold came under strain, it was the central banks and governments of West Germany and Japan that held the dollar and supported it, given that the U.S. had boots on the ground in both countries and provided their nuclear umbrellas.

More recently, the central banks of Japan ($1.12 trillion) and South Korea ($135 billion) have held a larger share of their reserves in dollars than their commercial and financial links with America would lead one to predict. No doubt, they are rethinking this dependence. As have European officials such as the European Central Bank president, Christine Lagarde, who has emphasized Europe’s need to become more financially and monetarily self-reliant — code for less dollar and U.S. dependent.

The dollar’s champions are still trying to make the case that there is no alternative to the dollar. But Europe and China are working as fast as they can to rectify this deficiency. Europe is advancing a Capital Markets Union designed to create a central market for capital in euro-denominated financial securities, to reduce friction and let money flow freely. China is expanding the renminbi-based Cross-Border Interbank Payments System to compete with large U.S. banks and the dollar.

They are acting as if there is no time to waste. On the evidence, they are right.

read more in our Telegram-channel https://t.me/The_International_Affairs