Biden is Undermining Dollar Hegemony

Not long ago, I was talking about recent financial events related to an article I penned in The Prickly Pear with a small gathering of people, who are generally quite knowledgeable about money. A few got completely lost when discussing the dollar and its “reserve status”. It seems when one starts talking about the Bretton-Woods treaty and the “petrodollar”, eyes just want to glaze over. It just seems too arcane for most of us.

That is too bad because it really is important.

I used an example to try to convey the importance, and while imperfect, it seemed to turn the lights on in the mind of some of my audience. Like all examples, it cannot get into granular detail or it won’t be understood by most people. We will take the risk that we mistreat some of the complexity to be understood.

I explained: what if my neighbor was given a special license that allowed him to counterfeit his own money legally, and that he (the neighbor) could use this special money to pay all of his debts and also could use this money to purchase fuel for his car and home? This privileged neighbor could own multiple homes and properties because he could print money to pay his mortgage payments. He could own all the cars he might want because he could print the money for car payments and also print the money to buy fuel.

I then asked, “do you think this neighbor, having this special privilege would have a higher standard of living than you or me or any other of the households in the neighborhood?  

That is the power of the “inordinate privilege” bestowed on the U.S. dollar. We alone among the nations can print money to pay our external debts and our dollar is used exclusively to pay for oil. Many other commodities also are paid for in dollars.

How did the U.S. get this valuable privilege? And why is the Biden Administration destroying it?

There are three legs that support dollar hegemony. Here is a very brief story of how this support for the dollar was put in place.

The first is the inherent economic, political, and military power of the US. After World War II we had most of the gold, the largest economy, a good reputation for the rule of law, and the most guns in the free world. The United States, due to its tremendous power would take over the role of issuing the reserve currency of the world from a declining Great Britain that was destitute from two World Wars just 20 years apart.

Secondly, the power comes from treaties. In July 1944, scarcely a month after the Normandy invasion, 700 delegates from 44 nations gathered at a grand hotel in New Hampshire (The Washington Hotel in Bretton-Woods) and worked out the international financial architecture for the post-war world.

The net result was the use of U.S. dollars as a reserve for other nations’ banks, and other institutions were formed such as the World Bank, and the International Monetary Fund. In subsequent years, there were add-on institutions such as the G-7, G-10, and G-20 nations.

By treaty, the U.S. dollar was convertible on demand by foreigners to gold. That is why the world agreed to make the US dollar special. Ironically, U.S. citizens were denied this previous right in 1933.

This ability to convert dollars into gold was later abrogated by President Richard Nixon in August of 1971. But since the dollar was so important and so entrenched in the structure of trade and banking, the world continued to accept the dollar as if it were gold-backed because there was really no alternative.

But by 1974, it was clear that something additional was needed to shore up the dollar. Having broken the tie to gold, the dollar was in a sense tied to oil.

The third leg supporting the dollar was an agreement hashed out by William Simon, U.S. Secretary of the Treasury with the Kingdom of Saudi Arabia in 1974. We agreed to protect them, to arm them, in turn, they agreed to accept ONLY dollars in payment for oil. Hence, while gold was no longer backed by gold, everyone needed dollars to buy energy. That made the dollar more valuable. The so-called Petrodollar was born.

These arrangements have not been perfect by any means.  There have been recurring currency crises, and the world has chaffed at times at profligate spending by Washington, the issuer of the reserve currency. We have had to arm and support oil-producing regimes that we may not like. It has entangled us in Mid-Eastern war and intrigue. But with all that, we are that special neighbor who has it so good.

To remain in this position, we must remain powerful. We must remain a rule of law nation, control our spending and deficits, and keep our commitments to Saudi Arabia if we expect them to keep their commitments to us.

There is an added complication. The dollar is needed in great quantity for the growth of international trade. That means the U.S. has to supply those extra dollars by running a balance of payments deficit. This, in turn, can hollow out the industrial capacity of the nation because a deficit in trade means we import more than we export.

The Belgian-born U.S. economist Robert Triffin called this a dilemma because, over time, a country with a chronic trade deficit grows weaker, and you don’t want a weak country issuing the reserve currency. It is a paradox that is not easy to solve.

Now fast forward to today.

The U.S. government in the course of putting on punishing sanctions on Russia, seized without any legal proceeding, the sovereign reserves of Russia. That weakens the reputation for rule of law and moreover showed that owning U.S. dollars is a promise to be broken when it is convenient for the U.S. to do so. It also showed that owning reserves outside of the home country of the owner, may not be safe.

This seizure of Russia’s reserves assets was part of a package of sanctions that may well have been necessary and received the support of our European and Japanese allies. But the bank reserve part of this package may prove quite problematic and should have been avoided.

A bank reserve is not a reserve if it can be defaulted on or seized. And if the dollar reserves can instantly be made “not money”, then what the heck is it?

This move is extremely damaging as a precedent and other nations that potentially could get into conflict with the U.S. have taken note. Many of these nations are our biggest creditors and trading partners, such as China. But for sure Japan, Germany, Brazil, India, and Mid-East oil producers have some appreciation for what has just happened.

It is likely some sort of new reserve currency and bank reserve arrangements may have to develop. Certainly, something big has changed here that was not agreed to by all the countries that ratified and later joined the Bretton-Woods currency structure. The new arrangements will have to answer questions such as: where will reserves be held if they are to be secure? In what form can reserves be held and remain secure? This seems a logical response to what we did. We have weaponized the international reserve and payments system.

This likely adds to the stature of gold since it already is a competitive reserve asset to the dollar, it is not money backed by any given nation, is not a promise, and can’t default. It is politically neutral.

New arrangements might be gold, a basket of currencies, or a basket of commodities. However, that is a discussion for another day.

In addition, the exclusive use of dollars for oil payments is now in jeopardy. Biden and his State Department are about to sign a major agreement with Iran, allowing them over time to get nuclear weapons. That Russia is part of the talks is insane. This is extremely damaging to other non-Shia oil-producing countries that are fighting Iran in Yemen and elsewhere. The Wall Street Journal and others are reporting that Saudi Arabia and other producers are now discussing using currencies other than dollars for payment.Press reports indicate they would not even answer Biden’s phone calls.

In short, our addled President and his new age advisors, are busily tearing up the international banking and payments architecture as we have known it. It may be intentional or it may be because they are that stupid. It is hard to know.

Also, while tearing up the international currency system they also are blocking a rational response to this crisis, more oil production at home. Environmental fanaticism is more important than your standard of living.

As for the dollar, this could well start a trend, which already had some momentum, to move away from using the dollar as the reserve currency and the oil payments currency. Currently, there are no other currencies capable of replacing the dollar in the short term. But longer-term, if China and India start to pay for oil in other currencies, the process of dollar erosion begins in earnest.

The big dollar holders have a problem. How do you move away from, and weaken, the currency that you have so much invested in? It is a bit like milking a rattlesnake. It will have to be done carefully.

In practical terms, it means over time, it will reduce future demand for dollars. A falling dollar will add to our already punishing high rate of inflation. Foreign goods will become more expensive. All that cheap stuff in Walmart will get more expensive, as will oil, minerals, and credit.

A weaker dollar may make the U.S. exports a bit more competitive in the short run, but we could achieve much the same thing by deregulating, cutting taxes, and curbing the excesses of our legal system. In short, more productivity. But the tort bar gives huge sums to Democrats as do radical environmentalists, some of which get their funding from Russia.

What about the cost of borrowing, or credit? When foreigners hold dollars, they actually don’t hold them not in cash form, but U.S. Treasury Bonds. Thus, less demand for dollars means less buying by foreigners of our bonds. That means more bonds (which support our huge budget deficits) intersect with less demand. The value of bonds falling means higher interest rates for all of us.  

Even without adding any additional debt, the U.S. must roll over $17 trillion over the next two years. It is not helpful to make the dollar less attractive.

In short, Biden is attacking all three legs which gave us dollar hegemony and the benefits of the special privilege. The end result will be higher inflation, higher interest rates, a lower standard of living for Americans, and continued conflict. It likely will cause the world to break into trading and currency blocs, and diminish the process of globalization and integrated trade. It unwinds much of the dominance the U.S. achieved after World War II.

Biden has done this with relatively few people understanding the full implications of these actions and with virtually no input from Congress. It appears he feels the best way to deal with a dictator like Putin, is to act like one himself. Or, he and his advisors are just that foolish.

Do you remember that wealthy neighbor who had the “special privilege” to print money to pay his debt and buy oil? He is just about to lose that special situation that made him wealthier than the other neighbors.

Remember in November who did this to the country and to your standard of living.