01/04/2024
THE DAY THE DOLLAR DIES?
Since roughly the last year of World War II, the U.S. dollar has enjoyed what one-time French finance minister Valéry Giscard d’Estaing once called the “exorbitant privilege” of being the world’s reserve currency. It’s had that position since roughly 1944 when it seized the role of the world’s currency hegemon from the British pound sterling.
But now, that standing is threatened by a whole variety of U.S. policies and assaults by our foreign adversaries. And the results for the dollar—and the people of the United States—could be catastrophic.
HOW WE GOT HERE
By July 1944, it had become clear that Allied advances over the N***s in Europe all but ensured the Allies, and particularly the United States, would dominate the postwar world. It was then that 730 delegates from 44 countries convened at Bretton Woods, New Hampshire, to reestablish the postwar global monetary order.
Together, they agreed to a multinational system whereby global currencies would be convertible to the U.S. dollar at fixed exchange rates that could be modified, if necessary, within a very narrow band. The dollar, in turn, would be convertible to gold at $35 an ounce. It was left to the United States to ensure that the dollar/gold exchange rate remained stable.
But by 1971, social welfare spending on Lyndon Johnson’s “Great Society,’’ the Vietnam War, and dollar investment in overseas businesses, factories, and other assets, as well as the balance of payments deficits resulting from imports from more fully recovered Japan and Europe, had greatly expanded the number of dollars in global circulation. U.S. officials recognized the nation’s gold reserves were insufficient to honor its commitment to convert the dollar into gold at $35 an ounce. That year, Europeans started converting small amounts of their dollar for gold. Then, the British asked for a “guarantee” of the dollars they held in reserve.
A currency crisis was brewing. And the United States needed to circumvent it before it happened.
So in August 1971, President Richard Nixon, at the urging of his advisers, convened a secret meeting at Camp David over three days, concluding on Aug. 15, a Sunday. That evening, the president announced to the world in a nationally telecast statement a purported “temporary” closing of the gold window—prohibiting conversion of dollar to gold—to stop any run on U.S. gold reserves. That “temporary” closing lasted until 1975, when a meeting of the International Monetary Fund (IMF), another legacy of Bretton Woods, approved a “managed” or “dirty float” of currencies at a conference in Jamaica. The IMF was to operate to maintain stability via some ambiguous “guardrails,” at least nominally, but central banks—including the U.S. Federal Reserve, the Bank of England, Bank of Japan, et al.—were able to intervene to support their respective currencies.
The dollar was—finally and officially—off the gold standard and was now a “fiat currency”—meaning the dollar had value in the United States simply because the government said it did.
But in other countries, after President Nixon closed the gold window, the U.S. dollar became, with other currencies, essentially a commodity. If you wanted to buy U.S. property or securities or acquire U.S. products, you needed to obtain dollars to pay for them. Since the dollar had been overvalued by its link to gold, closing the gold window caused the dollar’s value to decline and inflation to increase.
To ameliorate some of the decline, President Nixon’s Treasury Secretary, William Simon, made a secret deal with Saudi Arabia in 1974 whereby the United States agreed to sell arms and give protection to the House of Saud in exchange for the Saudis investing their U.S. dollar reserves from oil sales in U.S. Treasurys instead of some other “hard” asset.
Oil had been traded in U.S. dollars almost everywhere since the Lucas Gusher at the Spindletop oil field in east Texas was discovered in 1901. The Saudis explicitly guaranteed to maintain the pricing of their oil sales in U.S. dollars. The 1974 arrangement with the Saudis helped the United States to run government budget deficits, and to improve its balance of payments deficit, as well as to maintain the global demand for the dollar, termed “petrodollars” after the Saudi deal, because any country that wanted to buy oil had to buy U.S. dollars to buy it.
WHERE WE ARE TODAY
In 1974, when Secretary Simon arranged his deal with the Saudis to avoid a “dollar crisis,” our national debt was roughly 32 percent of GDP. We were winding down our decades-long involvement in Vietnam and Southeast Asia and had secured a detente with Cold War adversaries China and the Soviet Union.
Today, the United States is over $34 trillion in debt, around 120 percent of our GDP—more than it was even during World War II. A bit over $7 trillion of that—the value of the entire U.S. annual budget—is held by foreigners. We are on our way to $1 trillion a year in debt service, more than our defense budget. And the $10 your grandmother stuck in your birthday card that was lost in the commotion of your birthday party in 1971 would, if found today, be worth $1.20.
And in the world, the United States is engaged in escalating conflicts with two powerful, nuclear-armed, adversaries, China and Russia, as well as the war Iran’s terrorist proxy, Hamas, is waging on our ally, Israel.
-Citing three current and former U.S. officials, NBC News reported that China’s leader Xi Jinping boldly told the U.S. president that he intends to acquire Taiwan, a vital interest of the United States. Not only do we (and the rest of the world) get most of our chips from Taiwan, but 50 percent of the world’s maritime container traffic passes through the Taiwan Strait.
-The Ukraine-Russia war continues and has escalated in the last few days with no end in sight. In a conflict where U.S. Secretary of Defense Lloyd Austin has pledged American prestige by asserting in October that we will “deliver what it takes, for as long as it takes, so that Ukraine can live in freedom.” But just last month, President Biden seemingly walked back his commitment by saying the United States will back Ukraine “as long as we can.”
-U.S. Navy forces deployed to the Red Sea to protect shipping and deter Iranian belligerence against Israel were attacked by Iranian-backed Houthi militants in Yemen. Scores of U.S. armed services members have been injured in Iraq and Syria in similar attacks.
Within our own borders, violent protests that went unchecked after the death of George Floyd, the storming of the Capitol on Jan. 6, and the Marxist-inspired pro-Hamas protests have rattled the sense of American stability among foreigners more than at any time since the Vietnam War.
Given all that, it should not be a surprise that other countries are moving to de-dollarize their holdings. The world has growing concerns about the stability of the United States and our ability to meet our debt obligations. The Saudis, whom we have relied upon for 50 years to help maintain demand for the U.S. dollar as the world’s global reserve currency, had announced that they are joining the BRICS, the international coalition of Brazil, Russia, India, China, and South Africa. Egypt, Ethiopia, Iran, Saudi Arabia, and the United Arab Emirates joined on the same day.
Were that not enough, now the Biden administration is contemplating a policy that cannot help but exacerbate de-dollarization. According to the Financial Times, the United States and the G-7 “are actively exploring ways to seize Russian central bank assets” in their countries to fund Ukraine because political opposition to continuing Ukraine support in the United States and Europe threatens the flow of money that has kept Ukraine afloat. The paper reported it had seen a document written by the United States that said, under international law, “G7 members and other specially affected states could seize Russian sovereign assets as a countermeasure to induce Russia to end its aggression.”
Robert Schiller, the Nobel Prize-winning Yale economist, reportedly told Italian news outlet La Repubblica in an interview published Sunday that he warned against the tactic. “[T]his will be confirmation for the Russian leader that what is happening in Ukraine is a proxy war [and] it could paradoxically turn against America and the entire West,” Mr. Schiller said. He warned it could create “a cataclysm for the current dollar-dominated economic system” because it would sow doubt among other countries that their investments in U.S. Treasurys, markets, and financial institutions could be seized by the United States in a political dispute.
America’s “exorbitant privilege” has allowed us to roll up extraordinary levels of debt in exchange for, basically, IOUs we’ve given to our creditors. And given our level of debt and particularly our debt-to-GDP ratio, our trading partners are now questioning our ability to repay it, the same as any other creditor.
In addition to this fiscal environment, malicious actors from foreign countries seeking to undermine the United States for their own geopolitical advantage, particularly China, are actively pursuing efforts to subvert the U.S. dollar as the world’s reserve currency. Part of their strategy is to close trade in their own currencies.
SUMMARY
The U.S. dollar is under assault by the global market. While we continue to enjoy the largest, most transparent, and best-regulated capital markets in the free world, and the largest per capita consumer market, the other elements of dollar supremacy are eroding. Its status as the world’s reserve currency—its “exorbitant privilege”—is unlikely to last into the next decade. That will have enormous negative consequences for American citizens for the latter decades of this century. Interest rates needed to fund our debt will soar, closing out other alternative, productive investments in businesses and innovation.
Congress must absolutely get a handle on our spending to make vigorous, real, reductions and have the courage to raise taxes principally on its own donor class so that we get to a balanced budget no later than 2030. To grow our way out of debt as we did our World War II debt, we must make our nation more productive and more resilient. That means graduating more chemical engineers and computer scientists and fewer social workers and grievance studies graduates. It means fiercely protecting our technology and re-shoring high-value-added manufacturing. It means making smart policy choices, across the board, to keep our people healthier, our children far better educated, and much more physically fit to reduce healthcare costs. And we need to ensure our family structures and institutions are more resilient so that charities and families—not governments—support our most challenged citizens.
If we don’t, we will come to the day the dollar dies—and with it, the republic.
