Thoughts, essays, and writings on Liberty. Written by the heirs of Patrick Henry.

March 24, 2009

Is Dollar Hegemony About To End?

by Brad Warbiany

Just over two years ago, I offered a worst-case prediction of where this economic crisis could lead.

Wait, though, it gets worse. America isn’t an empire in the conventional sense of the word, but we are an economic empire. The dollar is the currency of the world, from middle eastern oil to the reserve currencies of countless nations. During the Great Depression, or during the stagflation of the 1970’s, other nations were stuck with the dollar, because nothing else was suitable. But if the dollar starts dropping in a major inflation, they now have options. And if they drop the dollar, it’s all over. All of a sudden, America won’t draw on the world for our own stability. Considering the actions of our politicians, that’s a bad, bad thing.

We may be witnessing the end of America as the world’s superpower. It may be the end of our status as the economic empire of the world. Some across the globe, of course, will cheer. After all, they feel like America is the premier force of evil in the world. For all the bad that we’ve done, though, we’ve been a pretty stable force, and worked to prevent the spread of fascism and communism, across the globe. America’s economic system has been the safe-haven for the world. When a position of power is vacated, what typically fills it is rarely positive. The end of the American empire will likely result in more instability worldwide.

There are two reasons that I’m very, very concerned about this.

First, American dollar hegemony has actually been, for all the stupidity we’ve encountered upon over the last few decades, a pretty stabilizing force. To bastardize an old quote, America’s economic system is the worst, except for all the others. There’s no reasonable guarantee that anything that follows dollar hegemony will actually increase stability. Rather I think it will be worse.

Second, I don’t want to pay for our government. While we’ve been pretty well looting the other nations of the world, printing money and sending it to them in exchange for durable goods, only to have them lend it back to our own government to pay for programs we’re unwilling to tax ourselves for. Essentially we’ve been taxing other nations to pay for our own government, with the unspoken understanding that we’d probably slowly print our way out of debt rather than actually pay our debt. I can understand why they don’t want to continue that, especially since we’re dramatically increasing the size of the government that we’ll be expecting them to pay for.

But that doesn’t mean it won’t happen.

Russia, as reported by QandO, made noises last week about putting an end to the dollar as the reserve currency of the world:

The Kremlin published its priorities Monday for an upcoming meeting of the G20, calling for the creation of a supranational reserve currency to be issued by international institutions as part of a reform of the global financial system.

The International Monetary Fund should investigate the possible creation of a new reserve currency, widening the list of reserve currencies or using its already existing Special Drawing Rights, or SDRs, as a “superreserve currency accepted by the whole of the international community,” the Kremlin said in a statement issued on its web site.

The SDR is an international reserve asset, created by the IMF in 1969 to supplement the existing official reserves of member countries.

Now, QandO again (along with Doug @ BTB) reports that one of our far bigger creditors, China, is making the same suggestion:

China’s central bank on Monday proposed replacing the US dollar as the international reserve currency with a new global system controlled by the International Monetary Fund.

In an essay posted on the People’s Bank of China’s website, Zhou Xiaochuan, the central bank’s governor, said the goal would be to create a reserve currency “that is disconnected from individual nations and is able to remain stable in the long run, thus removing the inherent deficiencies caused by using credit-based national currencies”.

Analysts said the proposal was an indication of Beijing’s fears that actions being taken to save the domestic US economy would have a negative impact on China.

“This is a clear sign that China, as the largest holder of US dollar financial assets, is concerned about the potential inflationary risk of the US Federal Reserve printing money,” said Qu Hongbin, chief China economist for HSBC

I’d like to believe that this is merely a warning to the Obama administration that destroying our currency won’t be accepted by the international community. It would be a very clear warning that if we proceed down this path, those who are currently tied into our dollar will try to quickly cut our losses and leave us out to dry.

But I really don’t think the Obama administration, the Bernanke Fed, and the Geithner Treasury will heed those warnings. You want a reason to fear Great Depression II? This is it.

In fact, it may already be starting. China is worried about the $1 Trillion they’ve already lent us, but the real key to ending dollar hegemony is to stop lending us more. If other countries stop buying US Treasury Bonds, we must find a way to fund our own deficits internally… And there’s some evidence that’s already happening:

Thanks to Brad Setser for the graph

Thanks to Brad Setser for the graph

Yep, foreigners are getting close to their limit. Will it hold? I don’t know, but in the meantime, the Fed is starting the printing press to make up the shortfall (h/t Calculated Risk):

The first outright Treasury coupon purchase will be conducted on Wednesday, March 25, 2009, and will settle Thursday, March 26, 2009. Results will be posted on the New York Fed’s website following the operation.

Starting on Wednesday, April 1, 2009, and continuing every two weeks, the New York Fed will issue a tentative operation schedule for its purchases of longer-dated Treasury securities, including the maturity sector or sectors to be targeted.

The signs are pointing to a major change in world structure.

  • The world is slowing down their purchases of American debt, fearing it won’t be repaid.
  • The world is threatening to liquidate the US Dollar as the de facto reserve currency, because they fear an impending devaluation.
  • The Obama administration, the Fed, and the Treasury appear to be willing to spend historic sums in the face of these developments in the hopes the world is bluffing.

I don’t want to be a doomsayer, but the outlook sure as hell ain’t rosy. America has been gorging at the buffet for the last 40 years, ever since the collapse of Bretton Woods system. The bill is about to come due, and we’re sure to be surprised when we realize it’s pay-per-item, and not all-you-can-eat.

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