A currency upheaval is coming
Sometimes forces line up in just the right way to mark the end of an era. That era is dollar supremacy.
Colin Lloyd has marshaled some impressive evidence that the dollar’s status as the global reserve currency may not last. Indeed, its status is weakening. Should it come to lose its monopoly status, the place of the U.S. on the world stage will undergo a substantial change. The ability to call the shots, as it has done in the entire postwar period, will be weakened. Monetary policy will no longer be able to presume infinite markets abroad for dollar creation. The market for U.S. currency could come into question. All the implications here are impossible to foresee.
Let’s consider five trends that make the prospect very real.
The Trans-Pacific Partnership Pullout
One of the first actions of the Trump administration was to pull out of the Trans-Pacific Partnership (January 23, 2017). The pact involved 12 nations including Australia, Brunei, Canada, Chile, Japan, Malaysia, Mexico, New Zealand, Peru, Singapore, and Vietnam. There was plenty wrong with the agreement – and I would list its burdensome treatment of intellectual property to top the list. However, that’s not why Trump pulled out. His problem was that the U.S. has a technical (but inaccurate) “trade deficit” with some of these countries, from which he concludes that “they” owe “us” money, so no deal.
The presumption of this walkout was that the agreement would die. Not so. Later in the year, the remaining 11 carried on and struck a deal without the U.S. The great irony is that the deal was immediately made better by virtue of the U.S withdrawal. The intellectual property provisions that had been such an imposition were made far less threatening and more friendly to market innovation. The new deal was actually quite radical: it removes more than 98 percent of tariffs for trade between Canada, Mexico, New Zealand, Malaysia, Vietnam, Singapore, Brunei, and Peru. It covers 500 million people and represents 13 percent of global trade.
The end result was exactly what had been predicted: a huge gain for China and a loss of export markets by the U.S. As just one example, the Los Angeles Times points out that “Australian wine entering Japan is taxed at 5.6% and will eventually drop to zero. There’s no duty at all for wine from the EU and Chile. But for California, it’s 15%.” As it turns out, all these countries did have other options besides complying with every demand by the U.S. and dealing only in U.S. dollars. The loss from the pullout: forgone gains of $131 billion and a direct loss of $2 billion due to advantages remaining partners enjoy by trading with each other.
The Libra and the Bitcoin Rally
Cryptocurrency keeps being declared dead, even from the time Bitcoin was worth less than $1. Even the “crashes for the history books” result in new gains over time. The crypto sector in general is now sporting a $330 billion market capitalization. These are non-state money-like assets that are not just tradable in dollars but any money, good, or service. They are also global assets not restricted by the geographic lines of the nation-state. They are uncontrolled by any nation’s central bank. Whether Bitcoin or some other crypto can emerge as a serious global power is the stuff of speculation. But that these market-based tools have a future is no longer in doubt.
A key indication of this is the introduction of the new global currency connected with the Facebook platform, the Libra. Those of us who have long followed the crypto markets know with confidence that money can emerge from outside the state and be well managed by protocols that operate without human volition. For mainstream opinion, this is still quite the shock. They are appalled even.
Matt Stoller writes in the New York Times:
A permissionless currency system based on a consensus of large private actors across open protocols sounds nice, but it’s not democracy. Today, American bank regulators and central bankers are hired and fired by publicly elected leaders. Libra payments regulators would be hired and fired by a self-selected council of corporations. There are ways to characterize such a system, but democratic is not one of them…. The way we structure money and payments is a question for democratic institutions. Any company big enough to start its own currency is just too big.
What’s funny about this claim is that anyone can create a currency right now. You don’t have to be a big company. Giving it market value is another matter. And yes, there are a gazillion scams out there. The Libra will not likely be among them. This author seems completely lost in the new world of private money.
Remember that central banking (and monetary central planning) is premised on the idea that everyone in a jurisdiction uses the same money, it flows through regulated banks, and those regulated banks report to the same central bank, which manages the whole system. It’s a monopoly by design. Even a 5 percent penetration of that market with a private currency breaks that control and can upset and destabilize central bank control. The money that the centralized system controls loses its weight and power to influence macroeconomic outcomes. That is the world to which we are headed.
For a government to be responsible for managing the world reserve currency is an awesome privilege. With it comes certain responsibilities for engaging the world economy and helping to become ever more open with ever fewer barriers. The U.S. right now is going in the other direction with ever more tariffs, random threats, bad-faith negotiations, and a president that celebrates tariffs as the key to prosperity. The U.S. has even created a watchlist of countries that is basically a list of targets that include Ireland, Germany, Mexico, Vietnam – as if any country running a trade deficit owes the U.S. money. It’s utterly preposterous but some people believe it. Reversing the flows of trade here is the equivalent of the Soviet plan to reverse ocean currents.
Moreover, the U.S. imposes sanctions against many countries, including Russia, Burma, Ivory Coast, Cuba, Iran, North Korea, Venezuela, Syria, Liberia, Sudan, Belarus, Congo, Zimbabwe, Iraq, and Congo. The list keeps growing. The world is to the point of ignoring them, because, in the end, there are assets and there are markets, and people have the need and right to trade. U.S. sanctions policy has, in the old phrase, “jumped the shark” to the point that traders are seeking alternatives to both the dollar and U.S.-controlled systems of payment and settlement. This has further weakened the dollar.
The tightening of sanctions against Iran are further incentivizing the search for the workaround. The Wall Street Journal reports on the Instex system:
Planning in Europe began after the U.S. threatened action against Swift—the Belgium-based system that banks use to communicate with each other about money movements—unless it cut off Iran’s banks. In response, Germany, France and the U.K. decided to set up Instex, an acronym for Instrument in Support of Trade Exchanges.
The system, which isn’t yet operational, will be based on the euro, the second-most-used currency in international trade. Initially, it will allow for trade with Iran of goods not covered by new U.S. sanctions, such as consumer products and medicine. It is needed because U.S. sanctions bar dollar transactions with Iranian banks, even on deals for unsanctioned goods. Once operational, Instex’s members could expand it to cover any trade with Iran.
The attack on Huawei takes this a big step further. Digital technology is a knowledge-based industry, and knowledge doesn’t like borders. The imposition of blacklists could end up being devastating to 5G technology in a way that directly harms American consumers and producers. American tech firms have been forced not to use the products and systems of one of the world’s most advanced and developed firms. Where previously there had been mutually beneficial cooperation there are now violence-based rules. This would have been unthinkable even a few years ago. This can’t be good for the status of the dollar.
Talk of Devaluation
The Trump administration is convinced that foreign countries benefit from gaining export markets by currency devaluation. This is not true. But if you believe it, you might be tempted also to believe that devaluing one’s own national currency is a good trade strategy. This partially accounts for why the Trump administration has been aggressively and loudly demanding that the Fed adopt a loose monetary policy, thinking that this will help exports and reverse the trajectory of trade flows. The actual result is exactly what the policy intends: the weakening of the dollar and the shrinking of markets willing to hold dollars.
It’s not a far-flung prediction that the Trump administration will continue to work toward dollar devaluation. It follows from the policy presumptions behind a mercantilist trade policy. However, one can’t both pursue such a course and expect that it will not affect the dollar’s status on the world stage. It’s not shocking that Reuters reports that “the U.S. dollar remains the world’s dominant reserve currency but central banks around the globe appeared to continue to diversify their reserves away from the greenback.”
The IMF reports that the dollar share of global reserves has fallen for three straight quarters. Fifteen years ago, the dollar’s share was 71.5 percent; today it is down to 61.7 percent and falling. Globalization of commerce is the single most prescient change in the world economy over the last quarter century. If the managers of the dollar instead seek isolation, protection, sanctions, blacklisting, and devaluation, powerful market forces will continue to seek alternatives.
No one of these factors will do the deed. But all five combined could fundamentally reshape the global monetary order, away from dollar centralization toward a wild mix of trading zones relying on non-dollar-based strategies and a melange of crypto-based private tokens that allow markets to continue to function despite every attempt of the U.S. government to control them.