Is the dollar in danger?
The United States sits atop a horizontal empire, the self-organizing, incentive structure of capitalism with its layers of value. This is not the Marxist porridge of “to each according to his needs”. You have to earn your place. Think of the US dollar as the thread or even the tape that binds the layers together. Nearly 60% of the $12.8 trillion in global foreign exchange reserves are dollars. Is America’s “exorbitant privilege” – the almighty dollar as the world’s premier reserve currency – under threat? Should you even care?
Sanctions have bitten Russia. Much of its $630 billion in foreign exchange reserves is frozen. The yachts of the oligarchs have been seized. Visa, Mastercard and American Express suspended in Russia. The shutdown of Apple and Google Pay has blocked cashless travelers on the Moscow metro. From Netflix to Nike,
voluntary sanctions are in effect.
Was removing Russia from the global financial system the right decision? Opponents believe this is the beginning of the end for the dollar as a reserve currency, as Russia will move closer to China and adopt the yuan or turn to cryptocurrencies. China could start selling dollars. In fact, since 2014, China and Russia have significantly reduced their reliance on the dollar for bilateral trade.
The dollar has been the world’s reserve currency since the Bretton Woods agreement in July 1944, with the dollar pegged to gold and other allied currencies pegged to the dollar. It was not a bureaucratic statement. The United States was in a strong position after funding the Allied effort in World War II. America nearly lost this privileged status in 1971 when war and welfare deficits led President Richard Nixon to abandon the gold standard.
Today, countries still keep America’s virtual Benjamins in their virtual bank vaults – the gold of modern banking. China has over $1 trillion in Treasury bonds. Russia has about $100 billion out of about $500 billion in its increasingly frozen currencies.
But why do these countries keep dollars? What backs up currency? The conventional answer is the “full faith and credit” of the US government. Ha, that and $3.65 will get you a big Starbucks latte, but no longer in Moscow. What really supports the dollar is the future tax-generating capacity of America’s growing productive economy and a defense structure to defend the strength of that economy. Without it, there is no horizontal tape.
South Korea, Thailand, Indonesia and especially Russia learned this the hard way during the currency crisis of the late 1990s. They did not keep enough foreign exchange reserves to protect their own currencies. after the excessive demand for credits and bank loans denominated in dollars. Argentina, Venezuela and Zimbabwe have also learned it.
China, like Russia, has a slightly higher gross domestic product per capita than Mexico – about a sixth of the value of the Chinese yuan in the United States is based on its continued economic growth, now forecast at just 5.5% for 2022. While China needs to continue assembling more iPhones, toys, shoes, and grills for global customers, it’s struggling to move to the upper horizontal layers.
Everything China holds in Russian rubles has lost more than 40% of its value in just a few weeks. Ouch. If Russia or other countries hold the yuan, they risk a similar devaluation if, for example, China is pressured by sanctions for invading Taiwan. China and Russia should be wary of the mutual illusion of only relying on the ruble and the yuan. And hopefully Russia will stock up on crypto, the decline of which could make the currency crisis of the 90s feel like a picnic.
As Ben Franklin might tell American leaders today, “You have reserve currency status, if you can keep it. What to do? The Federal Reserve should solidify the dollar by immediately raising interest rates. Treasury Secretary Janet Yellen has to shout “a strong dollar is in our national interest” from the top of the mountains. Ending budget deficits would also help by creating a bidding war for outstanding Treasury bills. US companies need to update complacent supply chains. If products like drugs and iPhones only come from China, that’s a problem. For this reason, the Biden administration should abandon the union-loving “Buy American” rhetoric we heard in its State of the Union address, which echoes Donald Trump’s “America first.” Apple can’t assemble iPhones in union-ridden Michigan. America’s strength comes from buying goods and services from our allies in the lower horizontal layers like Vietnam, South Africa, and Eastern European countries. Don’t mess with that.
It’s time for the US to figure out where China or Russia might have even a small advantage – pharmaceuticals, genetics, artificial intelligence, cyber warfare – and create Operation Warp Speed-type programs to stimulate these industries through orders and advance payments, not donations.
Sanctions on Russia will not immediately endanger the dollar, but wars are when transitions happen. America should not risk its reserve currency status. Inflation will really get tough if other countries start dumping dollars. America’s privilege is worth maintaining – easier said than done.
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