Are US financial sanctions accelerating the demise of dollar rule?

America’s biggest strategic mistake*

by Kishore Mahbubani

It would be truly unwise for any American to underestimate the erosion of trust in America. Many of America’s best friends have warned America to take it seriously. […]
  No society is invulnerable. Every society has its own weaknesses. This is why the erosion of global trust in America is so dangerous. It could in turn expose the area of America’s maximum vulnerability, indeed, its Achilles’ heel: the dollar. The US dollar is currently well protected by a complex global financial system, which in turn generates a sense of invulnerability. Yet, a core vulnerability remains. More than most countries, America can afford to live beyond its means (although financial globalization has enabled some countries with strong domestic institutions and good macroeconomic fundamentals, like Australia and Canada, to also sustain prolonged periods of current account and fiscal deficits). Domestically, the US government spends more than it collects in income. This creates a fiscal deficit. Internationally, America imports more goods than it exports. This creates a trade deficit. How does America pay for these twin deficits? It borrows money. This is not abnormal. Many countries, not unlike many domestic households, borrow money. At some point, when they can no longer borrow money, they face a crunch. […]
  However, unlike these other countries, America can fund its twin deficits and pay for its excess expenditures by printing Treasury bills. The US Treasury only has to pay for the cost of paper. In return for handing out pieces of paper, the rest of the world sends real money (hard-earned cash) to buy the US Treasury bills. For example, Chinese workers have to work hard to produce low-cost goods to export to the rest of the world. These exports receive hard-earned dollars, which the Chinese government converts to yuan to pay to the workers. What does the Chinese government do with these hard-earned dollars? It uses many of these to buy US Treasury bills.
  The US Treasury then uses these dollars from China to pay for excess government expenditures. For the record, the largest purchasers of US Treasuries are China ($1.113 trillion), Japan ($1.064 trillion), Brazil ($306.7 billion), the United Kingdom ($300.8 billion), and Ireland ($269.7 billion). As a result of this, when the US government cannot pay for the twin deficits, it can simply print money (i.e., paper) to pay for these excess expenditures. And why does the rest of the world buy these pieces of paper (US dollars)? One key reason is that most of world trade is carried out in US dollars. Hence, when China buys Argentinian beef, it pays Argentina with US dollars. When Argentina buys Chinese cell phones, it pays with US dollars. This makes the US dollar indispensable for the global economy. Hence, it functions as the global reserve currency.
  Many American economists are aware of the enormous benefits that American people get from the US dollar serving as the global reserve currency. In June 2019, Ruchir Sharma wrote: “Reserve currency status had long been a perk of imperial might – and an economic elixir. By generating a steady flow of customers who want to hold the currency, often in the form of government bonds, it allows the privileged country to borrow cheaply abroad and fund a lifestyle well beyond its means.” […]
  Sharma wrote his article in response to suggestions by Donald Trump and Elizabeth Warren that America should consider devaluing its currency to become more competitive. He warned that this would be very dangerous because “America is not an emerging country. It’s an unrivalled financial superpower, a position built in large part on hard-won trust in the dollar, which is an enduring source of American power and prosperity.”
  The key word that Sharma has used is trust. The world has been happy to use the US dollar as the global reserve currency because they trusted the US government to make the right decisions on the US dollar that would take into consideration the economic interests not only of the 330 million American people but also of the remaining 7.2 billion people outside
  America who also rely on the US dollar to fund their international transactions. This trust is a key pillar of the resilience of the US dollar as a global reserve currency.
  In recent decades, this trust has begun to erode because America has occasionally used the privilege of having the global reserve currency as a weapon against other countries. […]
  In recent years, the US government has imposed even heftier fines on non-American banks for working with countries like Iran, Cuba, and Sudan. For example, BNP Paribas SA was fined US$ 8.9 billion in 2015. As a result, many countries that had trusted the US dollar now find it to be a double-edged sword, cutting the fingers of whoever holds it. This creates an obvious incentive to reduce dependence on the US dollar, which could eventually precipitate a fall in global demand for US dollars, crippling the United States’ ability to finance its twin deficits. […]
  More ominously for America, some influential voices are now saying that the world should stop using the US dollar as the global reserve currency. Mark Carney, governor of the Bank of England, in a speech at the annual Jackson Hole gathering of central bankers in the United States in August 2019, cast a critical eye on the predominance of the US dollar in the international monetary system. He noted that “the dollar represents the currency of choice for at least half of international trade invoices (around five times greater than the US’s share in world goods imports, and three times its share in world exports) and two-thirds of both global securities issuance and official foreign-exchange reserves.” Further, Carney asserted that the world’s reliance on the dollar “won’t hold” and that it is imperative that an international monetary system is built that is “worthy of the diverse, multipolar global economy that is emerging.”
  Former IMF chief economist Maurice Obstfeld also observed that other countries used to be “less concern[ed]” about America’s control of the global monetary system “when the US was viewed as a responsible leader of the world economy.” However, that status quo is now changing, as the actions of American leaders become far less predictable.
  Both Carney and Obstfeld are expressing a point of view that is growing in popularity around the world. This sentiment is perfectly reasonable. Countries all around the world see no reason why their trade with other countries (besides America) and their economic growth should be imperiled by unilateral American policies premised on the use of the dollar as a weapon. Here too America could undermine its own long-term interests by weaponizing the US dollar. The economic historian Barry Eichengreen recently said as much when he warned that “the more the Trump administration uses the dollar as a weapon, the stronger the incentive for other governments to invest in alternatives, and the faster this movement will be.” […]
  With modern technology, it may be possible to create new alternatives that would not have been viable before. One admittedly speculative example will illustrate this point. The primary role that the US dollar plays in, say, the trade between China and Argentina is to provide a measure of the relative value of Argentinian beef against the relative value of Chinese cell phones. If the main purpose of the US dollar is to measure the relative value of these two commodities, there is no reason why an alternative unit of measuring relative value could not be created.
  This is where technology can help, in particular, blockchain technology. Blockchain technology has been used to create alternative cryptocurrencies like Bitcoin, Litecoin, Ethereum, and Monero. Facebook also announced in June 2019 the launch of its own cryptocurrency, Libra. While I am no blockchain expert, the sharp rise in popularity of cryptocurrencies and the investment of large firms like Facebook in developing blockchain-based currencies suggests that it may eventually provide a sound, practical, and invulnerable way of measuring relative values. So far no countries have used alternative blockchain technology currencies to trade with one another because, ultimately, they don’t trust these currencies.
  This is where China can step in. It can set up an alternative unit of measuring relative value, a sort of alternative currency, based on blockchain technology. A sufficient number of countries would trust this alternative vehicle when and as they trust China to be an impartial arbiter in international issues. Many Americans would doubt this statement. However, there is empirical evidence to back this up. When China launched the BRI, America opposed it. In theory, most countries should have backed away from joining the BRI. In practice, most countries joined. As of April 2019, 125 countries had signed agreements with China on the BRI. This provides a clear indication that most countries would also trust a new blockchain technology currency that is ultimately backed by China. […]
  Countries may not necessarily keep their long-term savings and foreign currency reserves in this new China-backed digital currency; however, they would trust it for the purpose of trading goods and services. If China succeeds in creating an alternative blockchain technology currency, a country like India, a friend of America, could use this blockchain technology currency if it wishes to import oil from Iran and not worry about sanctions from America. In short, the weaponizing of the US dollar has created a powerful global incentive to create an alternative currency for global trading purposes. •

Excerpts from the book by Mahbubani, Kishore. “Has China won? The Chinese Challenge to Ameri-can Primacy”. Public Affaires 2020, pages 43ff, ISBNs: 978-1-5417-6813-0 (hardcover), 978-1-5417-6812-3 (ebook), 978-1-5417-5867-4 (international), reprinted with kind permission of the author.

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