The Case for New Global Financial Order
The dollar extends Washington’s jurisdiction far beyond its own borders, and thus almost all of the world’s international trade is effectively under U.S. supervision.
For politicians, economics is primarily about politics. Since Valéry Giscard d’Estaing, France’s finance minister dubbed the dollar’s dominance America’s “exorbitant privilege,” it has been a conventional wisdom that the status of the U.S. dollar accrues substantial economic advantages to the United States. Indeed, the United States dollar is the world’s most powerful currency. About 50–80 percent of international trade is invoiced in dollars. The dollar makes up over 60 percent of global central banks’ reserve assets. Almost 90 percent of foreign exchange transactions are conducted in dollars.
However, the economic dominance of the dollar is not necessarily a “privilege.” Rather, it is an “exorbitant burden” upon the United States economy. The contemporary international financial system’s reliance on a single national currency as a medium of international exchange, payment, and store of value is profoundly unbalanced and inherently unstable, and it would be in the interest of every country to replace it with a better alternative.
In an ideal world economy, there are no current account deficits. If a particular country runs a current account deficit with another state, exchange rate mechanisms should restore the system to equilibrium. However, because the U.S. dollar is the most desirable currency in the world, foreign governments and central banks accumulate dollar-denominated financial assets as a form of reserves and to trade with other countries. This is how an increase in foreign capital inflows enhances the international role of the dollar. Excessive demand pushes the dollar towards overvaluation, reduces the trade competitiveness of American exporters on the world stage, and leads to the loss of jobs by increasing the trade deficit.
For example, according to the study by Coalition for Prosperous America finds that the dollar is over appreciated by as much as 27 percent, and “adjusting the dollar to a competitive level would yield large benefits to the economy, including an estimated $1 trillion in additional GDP and up to an additional 5.2 million new jobs over six years.”
America’s current account deficit is the reflection and implication of the dollar’s dominance, which, in turn, is the outcome of the policies pursued by export-oriented economies, such as China, Japan, and Germany (or “surplus states”). Therefore, it is surplus states, and not the United States, who are interested in the continuation of the dollar’s global supremacy.
Surplus states have high savings rates, well above their investment needs—usually the product of policies that suppress domestic consumption and transfer of income to the top. The rich, businesses and governments, unlike ordinary households, save or invest most of their income rather than consume. This leads to deficient demand in the surplus country, as local residents become unable to consume everything they produce—and thus production surplus is exported abroad. Excess savings (or profits from net exports), meanwhile, are usually moved into other countries in the form of the purchases of financial assets. Since excess savings over investment equals current account surplus, countries that absorb surplus financial inflows of its states must, by definition, run current account deficits, or consume more than they produce. Importantly, the dominance of the dollar contributes to financial crises, since it is accompanied by the massive influx of foreign funds into the U.S. economy, which, by depressing interest rates, leads to the formation of asset bubbles—which was the case in 2008 global financial crisis.
However, the implications of the dollar’s dominance extend beyond the economic sphere. America’s current account deficit (itself a product of dollar hegemony), or China’s current account surplus with the United States, has led to the loss of millions of manufacturing jobs in the United States. And subsequent resentment of voters against Chinese import penetration has been responsible for the resurgence of populism in the United States, as one study demonstrates.
The researchers found that in the 2016 election, Trump performed best in counties with the largest job losses due to Chinese import penetration. Therefore, the authors argue, the “China shock” may have been responsible for Trump’s victory in the 2016 presidential elections. According to their estimates, if the penetration of Chinese imports had been 50 percent lower, then Hillary Clinton would have won the key swing states, such as Michigan, Wisconsin, and Pennsylvania.
While economic and sociopolitical consequences of dollar hegemony are mostly negative, curbing the dollar’s role in the international economy will have far-reaching geopolitical implications. When economists and political scientists discuss the U.S. dollar’s hegemony, they usually consider its implications only in their respective fields, overlooking important interconnections between economic and wider geopolitical aspects of the dollar’s dominance whose consideration is essential to constructive policymaking.
With most foreign-currency reserves held by non-American central banks being in dollars, this dominance provides the United States with a unique tool of exerting influence in pursuit of its geopolitical objectives and facilitated Washington’s enforcement of the rule-based international system. The U.S. dollar is effectively the default means of pricing and settling international transactions. Considering the dependence of the world economy on the U.S. financial system, threatening to cut off a particular state from the Society for Worldwide Interbank Financial Telecommunication is powerful leverage: businesses and individuals are forced to choose between having access to the U.S. financial system or dealing with a sanctioned entity.
The dollar extends Washington’s jurisdiction far beyond its own borders, and thus almost all of the world’s international trade is effectively under U.S. supervision. The dominance of the dollar allows the White House to ensure global security, counter international financial fraud, corruption and crime, and punish states that have violated human rights and international law. The stability of the rules-based world order and America’s dominant voice in global affairs rest on the success of the dollar-centered financial system.
A reduction in dollar hegemony may lead to a less stable and peaceful world. Economic sanctions have largely replaced direct military interventions as a means of challenging adversaries, but the curtailment in the role of the dollar will make economic warfare less effective. North Korea and Iran were partially cut off from the world’s financial system, which undermined their ability to wreak chaos and infringe on international law. Following the 9/11 terrorist attacks, Washington utilized the dollar’s dominance to curb financing for terrorist organizations like Al Qaeda through the Terrorist Finance Tracking Program.
Thus, while the U.S. dollar’s dominance harms the U.S. economy and fuels social division and political polarization, it is the bulwark of the U.S.-centered world order. Washington has been propping up the dollar’s hegemony primarily for geopolitical reasons—but only by voluntarily giving up the dollar’s primacy can America overcome its domestic challenges.
At its core, the primacy of the dollar poses a dilemma for the United States—Washington has to balance its domestic and foreign policy interests. It is impossible to tackle the adverse economic effects of the dollar without significantly diminishing America’s global influence. Limiting the dollar’s global role may accelerate America’s disentanglement from international affairs.
There are many unilateral moves Washington could make to restrict the dollar’s global role, including depreciating the currency by implementing the Market Access Charge mechanism, placing restrictions on the ability of foreign states to hold dollar-denominated reserves, and taxing foreign capital. But, while these measures will help the United States, the next three largest economies—China, Japan, and Germany—will most likely oppose these steps, resulting in a backlash against Washington’s unilateralism with potentially profound geopolitical reverberations.
Surplus countries have long relied on exports to generate their economic growth. Even though ending the dollar hegemony will ultimately be a win-win situation for everyone, this will most likely force surplus states to redeploy their excess savings at home by expanding domestic demand, necessitating a reform of their growth strategy. This will be a politically difficult process, as there are vested interests that benefit from the export-dependent growth model of surplus states, as Michael Pettis and Matthew Kelin have pointed out in their recent book, Trade Wars Are Class Wars.
For example, to rebalance China’s growth towards consumption, Beijing will have to transfer income to ordinary households. As Michael Pettis has remarked, “For Chinese consumption to be broadly in line with that of other developing countries, ordinary households must recover at least 10–15% points of GDP at the expense of businesses, the wealthy, or the government. This rebalancing involves a massive shift of wealth—and with it, political power—to ordinary people.” China will not be able to make renminbi a truly international currency without liberalizing its economy, e.g. ending capital controls and redistributing economic power—which, however, would mean a diminution in Beijing’s control.
While the United States can manage to convince its allies Japan and Germany to adopt rebalancing policies, forcing a readjustment upon China will have grave geopolitical consequences. Beijing has been shifting to consumption-oriented growth in recent years, but these efforts have not been enough: much of its economy is still dependent on exports, its savings rate is inordinately high, and consumption is too low. The imposition of a tax on foreign capital inflows will most likely spark Beijing’s resentment (as its holdings of U.S. debt, worth around one trillion dollars, will be affected), and tensions between the two countries will intensify.