In 2008, the dollar’s global reach enabled an American financial crisis to spread to the entire world, causing a deep recession and long-lasting malaise. Ever since, there has been a deep longing for an international financial system that doesn’t depend on dollar debt and isn’t dominated by the US. But the US dollar is now even more dominant in trade than it was fifteen years ago. Will its inexorable rise continue – or are there already signs of its eventual collapse?
The US dollar is the world’s premier currency. Goods on international markets are priced in dollars. International companies account in dollars. Global supply chains are priced in dollars end-to-end. Over 80 per cent of foreign exchange deals involve dollars. Over 70 per cent of international foreign exchange reserves are in dollars. The US dollar is the world’s single currency for international trade. And despite recent yield rises, US Treasuries are the world’s preferred savings vehicle.
The last time there was a global single currency for international trade was the classical gold standard of the late nineteenth century. Aficionados of this system like to believe it was self-governing and not controlled by any government or central bank. In fact, it was the most centralised monetary system in history – until now. The unit of account was the British gold sovereign, reflecting the fact that the British Empire at that time covered a third of the globe and controlled about another third through soft power backed by a powerful navy. European central banks, led by the Bank of England, cooperated to manage the gold price and international money flows. The US, which didn’t have a central bank at that time, relied on monetary support from the Bank of England to smooth out seasonal fluctuations in its agrarian economy.
The classical gold standard was abruptly brought to an end by World War I. During the twentieth century there were two attempts to recreate a gold-backed international currency system, but both were short-lived. Few people now want to bring back the gold standard of the 1920s, which is widely blamed for turning a financial crisis into a disastrous Depression. But there is much more love for the gold-backed dollar system introduced after World War II and known affectionately as the “Bretton Woods” system, after the place in which it was born.
Repeated dollar debt crises in developing countries have wrecked economies and caused misery for millions
The Bretton Woods system established the US dollar as the currency of international trade, finally replacing the British pound. But the world wanted more dollars than the US’s economic production could support. In the 1960s, the US’s growing trade and fiscal deficits made the dollar’s gold peg impossible to hold.
The Bretton Woods system dissolved in 1971 when President Nixon suspended the dollar’s gold convertibility. But this didn’t mean the end of the international dollar system. Far from it. Freed from the golden shackles that limited the amount that could be created, the US dollar become more and more ubiquitous. Agreements between the US and Middle Eastern oil-producing nations ensured that oil was priced in dollars. The “petrodollar” became the international trading currency, and the flows of dollars to the Middle East found their way into US Treasuries, ensuring their pre-eminence in global reserves.
Since then, more and more trade has been conducted in dollars. Now, it is virtually impossible to trade internationally without access to dollars. And the US has taken advantage of its hegemony to create a two-tier international trade system.
Since the 2008 financial crisis, the US has quietly been developing its own circle of “favoured nations”. These countries – mostly rich Western nations – can obtain all the dollars they need by swapping their own currencies for dollars at the Fed. But other countries must earn, buy or borrow dollars on international markets.
Purchasing dollars on international FX markets or borrowing dollars through international debt markets can become prohibitively expensive when the Fed tightens monetary policy. And relying on market-driven inflows of dollars runs the risk of those flows abruptly reversing, causing severe economic damage to the economy. Repeated dollar debt crises in developing countries have wrecked economies and caused misery for millions – and are still doing so today.
Many countries have opted to build up dollar reserves by running persistent trade surpluses. This appears sensible: if you have ample dollars, you can still pay for your imports even if your own currency is in freefall and no one will lend you any dollars. The IMF has encouraged developing countries to build up FX reserves.
When everyone is trying to export as much as possible and import as little as possible, global trade grinds to a halt. In practice, however, the US acts as consumer-of-last-resort for the exporters of the world. Export-led nations trade in dollars and save in dollars. And when things go wrong, the fact that they are holding claims on the US means they can call on the US to pay for the damage. The US in effect acts as insurer to the world.
But the US is not comfortable with this role. It likes the rest of the world to buy its debt and use its currency, but it’s not so keen on the rest of the world drawing on its dollar claims when the global financial system gets into trouble. And it hates soaking up the world’s surplus production, especially that of countries it doesn’t consider its friends. Like Britain before it, the US puts its own interests ahead of those of poorer nations and is harsh to those that threaten its hegemony. The US’s trade barriers and financial sanctions are increasing both in scale and severity.
Unsurprisingly, countries that have fallen foul of the US’s sanctions regime are now looking for ways of trading with each other outside the dollar system. And even those that have not as yet displeased their US paymasters are kicking against the traces. The US dollar has become like the gold standard of old, a shackle that forces countries to act in ways that appear to be against their own interests. As the zeitgeist shifts from globalism to nationalism, more and more countries are looking to break their dependence on the dollar.
Single international currencies only work when there is goodwill and cooperation between nations. Right now, there are wars and rumours of wars, and the geopolitical clouds are darkening. Nations are withdrawing behind their borders and forming antagonistic groupings. The world is fragmenting. There are already signs that the international dollar system could give way to a system of multiple competing currencies.
We should view this development with alarm. History shows that replacing a single international trading currency with multiple competing currencies is not a recipe for global prosperity. It is much easier for companies based in different countries to trade with each other if everyone is using the same currency. And it is well-nigh impossible for international goods markets to function properly if there is no agreement about the currency in which those goods should be priced. The fact is that the world is a much more prosperous place when countries agree to use the same currency for trade.
The international dollar system comes in for much criticism, some of which is undoubtedly deserved. As currently constructed, it forces much of the world to dance to the Fed’s monetary policy tune, with unfortunate consequences. And the favouritism shown by both the Fed and the US government creates tensions in the international system that could threaten its existence. It’s certainly worth considering whether it could be replaced with something that better serves the interests of all nations.
But if the dollar system breaks up, the world will be a much poorer place. We should think very hard before throwing away the advantages of a single currency for international trade in pursuit of national sovereignty.
Frances Coppola is an independent financial economist and the author of “The Case for People’s QE “ (Polity, 2019)