Tuesday, January 10, 2017

Global reserve currency: army of the modern empire

In my post MMT and the US Economy I asked what the benefit was of being host to the world's reserve currency.

USD for Foreign National Currencies

Several countries use the US dollar as a national currency. Typically this happens when a currency fails and the people don't trust the state to issue a new one. By using the dollar they can bring relative stability to their own economies, and know they'll be able to conduct international trade. The tradeoff is the country loses the benefits of a sovereign currency. It has little control over the varying value of the dollar, and cannot inflate its way out of debt (which may actually be a benefit).

Are there benefits to the host country when their currency is adopted by a foreign state? A nation switching to the dollar should increase the demand for dollars. The value of the dollar reflects the value of the economy divided by the size of the money supply. When a nation adopts a currency they are effectively adding themselves to the numerator of the equation. To prevent deflation, the host government must increase the money supply. They can only do this by increasing spending, which increases the interest paid due to bond financing. Effectively the host country pays a tax whenever their currency is adopted by a foreign country.

This gives an insight into another benefit for the foreigners. They get to use a stable, liquid, fiat currency without the costs of overhead! But, they must acquire the currency somehow, and the only way to do that is to sell goods and services to currency holders. Effectively they are buying their monetary system instead of renting it. The downside would be if the country had to sell productive capital to make the acquisition, which would set back their economic growth.

By paying for the money supply up front, they make a one-time transfer of wealth to the host country. Any time they wish to increase the money supply they must transfer wealth to the host country. At any time they can import wealth by contracting the money supply. Each participant has some amount of control over the other. The foreign state can extract wealth from the host by selling dollars. However, the host country can counter by inflating the hell out of the currency, or by destroying it entirely.

USD for International Trade

The US dollar is the de facto reserve currency of international trade, accounting for 64% of the world's foreign exchange reserves. (Down from a peak of 71% at the turn of the century). This amounts to over 4 trillion dollars. Remember the US has to pay finance interest on all those reserves. Oil is almost exclusively traded in dollars, giving lend to the term petrodollar. Being the holder of the global currency makes it easy for US companies to do global business. An advantage cited in Wikipedia is
the world's need for dollars has allowed the United States government as well as Americans to borrow at lower costs, granting them an advantage in excess of $100 billion per year
I don't quite follow the claim, and the source offers no explanation. From an MMT perspective providing the liquidity needed to allow vast sums of overseas foreign exchange reserves denominated in USD doesn't mean that it's easier for the government to borrow but that it must borrow. Or more precisely, it must issue debt. Remember the government doesn't "borrow" dollars. It doesn't need to collect dollars to fund its operations. The author is clearly not speaking from an MMT perspective. Here is another source stating that the reserve status means more liquidity which allows easier access to capital for US firms. Again I'm confused. Doesn't dragging currency out of the country imply less liquidity? It might be the case that it allows US firms easier access to foreign capital, but that distinction is never made.

The argument that the interest rate is lowered doesn't follow either. If the US dollar is in high demand, shouldn't interest rates increase? I have to suspect that the advantage being calculated is that economic value must enter the US in exchange for the currency to leave, but that just means the US is in debt to foreign entities. A short-term advantage to be sure. The article continues
However, the U.S. dollar's status as a reserve currency, by increasing in value, hurts U.S. exporters.
See they admit the dollar value goes up. And of course it hurts exporters. An interesting paradox arises in that many Americans want to reduce the national debt and bring back manufacturing jobs. But to benefit US exporters (or at least to squash the flood of imports) the dollar would have to be devalued, which must be done through spending.

From this economics perspective, is it any wonder to anyone why US manufacturing has been gutted? Why make things when other countries are eager to send us their things in exchange for our currency? The downside of this of course is that foreigners now have claim to the real wealth of our nation. And what's scary is that when the dollar starts to lose it reserve status and other countries start to "sell" their dollars back, the American economy will not have the wealth or productive capacity to fund it. Saying that America now has an "advantage" of 100 billion a year is sort of like saying credit cards give you an advantage, except that we don't earn airline miles.

It might be in our best advantage to restore that productive capacity before it's too late. Our incoming president has campaigned primarily on that promise. And he doesn't seem adverse to the requisite spending. If he has his way the US productive base will grow, but so will the debt. It might be in America's best interest to "build & spend" and let loose with some inflation to help pay down the foreign-held debt. Can we really fight debt with debt? Ehh, I reckon we cannot. The ugly reality is that the US will ultimately have to default. We should not look at those foreign reserves as debt we owe, but as a price those countries paid to have the liquidity to conduct international trade, which benefited their economies. And we should do so while we still have the military strength to not be told otherwise.

USD as Tool for US Foreign Policy

The most important considerations when evaluating the benefits of operating a global currency are not economic, surprisingly, but political.  By controlling the world's reserve currency the US holds an immense economic weapon. You hear about it in the news. The US levies sanctions on Iran. The US levies sanctions on Iraq. On Russia. The US is able to do this by denying the target access to dollar-based markets. This is especially effective when applied to oil-exporting countries.

This allows the US to use the dollar a lever for coercion and is often applied with the desire of weakening the targeted government to the point they are overthrown internally. Sanctions allow a sort of indirect and soft warfare. They allow the appearance of clean hands, they spare the loss of US resources and lives, and they don't trigger the anti-war contingents of the electorate.

It is a common perception that the US goes to war to acquire oil resources. In actuality, the US goes to war to protect the reserve currency status of the dollar, and prevent the rise of regional hegemonies that could contest it. If you start to look at US actions through the lens of preserving reserve currency status you'll start to realize they are nearly obsessed with it. There is some argument to make in favor of the strategy. If the US is to adopt the role of maintaining world stability, it is preferable to do so by deploying financial rather than military weapons whenever possible.

It may be reflexive to view the US as imposing economic servitude on the world. That it is, to borrow the left's favorite word, oppressive. But look at the other side. International trade demands a global reserve currency due to the network effect. Look at it this way: would you want to conduct your day to day business in multiple currencies? Imagine your town had several Wal-Marts but one operated on pesos and one on euros and one on yen, etc. Not only would you have to constantly calculate exchange rates to make the best financial decisions, but you'd also have to keep stocks of all the relevant currencies and frequently pay currency exchange fees. Clearly business works better and more efficiently when there is a common currency. This provides extra incentive for the US to preserve her reserve status. It's not just that the US will lose the privileges that come with reserve status, but also that another country is likely to acquire those privileges. There are many reasons to oppose the US as world financial dictator, but there are more reasons to oppose China in that role.

Case Studies

Zimbabwe

Zimbabwe is one of several states that use the US dollar as official currency rather than issuing a sovereign currency. They adopted the dollar after the infamous hyperinflation of the Zimbabwean dollar circa 2008, and they exhibit some of the predicted effects of such a currency migration, namely in lack of liquidity. The country has even taken to minting small dollar-backed "bond coins" in denominations between a penny and fifty cents. Although they are desperately needed to facilitate common daily transactions, they've had a cool reception from Zimbabweans who distrust any sort of currency produced by their government.

Once the breadbasket of southern Africa, Zimbabwe is now a basket case. Most often this is attributed to Mugabe's decision to chase off the white farmers, legacies of British colonialism. The claim is the native farmers are not as capable as the British were. And I have no idea, that may well be true. In particular, I have heard them scorned because they stripped out much of the irrigation infrastructure and sold it off for scrap, particularly the copper pipes. From the outside, this appears extraordinarily foolish, especially in light of the fact that Zimbabwe now suffers perpetual famine and must import food. It certainly would seem to be a lack of leadership from a government that already destroyed the national currency.

On the other hand, the selling off of accumulated wealth to acquire dollars is just what would have to happen in this kind of a currency migration. As I mentioned before, buying your monetary supply upfront is fine as long as productive capital doesn't have to be sold to fund it. You can really appreciate what a pickle Zimbabwe is in. They can't issue a sovereign currency because no one trusts the government. They can't adopt a foreign currency without dismantling their critical infrastructure. One solution would be for the US to be generous and freely provide enough currency to run their economy. But even if Americans were so charitable (and often they are), African governments have a strong tendency to pilfer foreign aid. We go back to the same roadblock: the government can't be trusted. It is clear there is no economic solution for Zimbabwe without a political solution first.

Iraq

The number one priority of US foreign policy is to maintain the dollar as the reserve currency. As a result, the number one geopolitical objective of the US is to prevent the rise of an oil-producing superstate in the Middle East. If such a state arose, it could dictate to the world how oil purchases were transacted, rather than being told.

When Iraq invaded Kuwait, they nearly doubled their oil reserves, vastly outweighing their Iranian adversaries reserves (although falling a bit short of Saudi Arabia). The way Arabia is carved up leaves a few Gulf states with great oil reserves that are too small to defend themselves. If it were not for the ability of the US to project global military dominance then the arrangement wouldn't last for long. The US responded. It forcibly removed Iraqi forces from Kuwait, and inflicted a heavy toll on Iraq's military to forestall any future aggressions. The order had been maintained.

Note that the war was never sold to the American people on these economic and geopolitical bases. We weren't told that failing to act would encourage aggression by the stronger powers and cause the smaller nations to lose faith in the American order, ultimately causing the dollar to lose its monopoly status in the international oil trade. No, we were told some lies about incubator babies. I don't know if the decision for that war was good or bad morally, but clearly it was good for America in many ways. In our democracy the government can't sell war to the people. Theoretically the people should be given maximal information so they can make a rational decision to best further the national interest. In reality the American public must be lead around by their emotions.

America went to war with Iraq again in 2003. Again the war was sold on lies and appeals to emotion. We were provided with fabricated intelligence telling us if we didn't act our cities were at risk of destruction by Iraqi WMDs. Colin Powell went into the UN waving around a vial of anthrax. Polls showed the majority of Americans believed that Iraq was linked to 9/11. But the real reason was never greatly publicized: in 2000, Saddam Hussein decided to stop trading in petrodollars.

It has always troubled me as to why we invaded Iraq. I understood that the neocon objective is no regional hegemonies but Iraq didn't make sense. Its military was already greatly reduced, and Saddam's strongman tactics not only kept stability within the otherwise fractured boundaries of Iraq, but were a balance against the Iranian threat of a Shia superstate. (As it happens most Gulf oil lies in Shia regions). But with the economic understanding it makes more sense. A typical person reading about Iraq switching currencies for oil sales would not be phased. Who cares, they can sell it however they want, right? But in fact this was Iraq's nuclear option. A giant middle-finger and existential challenge to the American empire. Iraq by itself could not destroy the dollar's status. But if they were allowed to openly tell America to fuck off, what's to stop the next country from doing so, and the next?

From a neocon policy point of view Iraq was a big mistake. Bringing down Iraq has unleashed great Iranian influence in the region, which we are fighting like hell to contain. (Syria can be viewed somewhat as a proxy war against Iran). But they had no choice. Threats to the dollar dominance must be met head-on. When Barrack Obama complains about the mess Bush left for him, it is all political theater. The Iraq invasion was caused by the same policies that drove him to overthrow governments in Libya and Syria, to bomb Yemen, and to push the empire right up to Russia's western border.

Libya

Libya is very similar to Iraq: it was a threat to the dollar monopoly of oil sales. Gadaffi had long resisted US hegemony but typically did the bare minimum to get along. Oil was sold in dollars. He openly ended WMD programs to remove pretense for Western invasion. He was also benevolent for a dictator, giving his people the second-highest standard of living in Africa.

But at the same time, he was using his petrodollars to purchase gold stockpiles. His plan was to amass enough to stand up a gold-backed currency and a pan-North African economic zone. This was a direct threat to the dollar. Again we heard the appeals to emotion and the fabrication of crimes against humanity. We were told Gadaffi, leader for 26 years, would soon start committing genocide against his own people if urgent action was not taken. The UN no-fly zone was established on the premise that regime change would not be pursued. I have to wonder if Russia ever really believed that. Surely they understood the geopolitical battle being waged.

By any other objective measure, Libya has been a disaster of epic proportions. The legitimate ruler dethroned and the standards of living eroded. ISIS free to commit mass beheading on the beach. A US Ambassador was brutally tortured to death. Open-air slave markets. And, perhaps worse of all, it created a migration crisis in Europe that is destroying the EU and leading that sleepy continent on the path towards civil war and internal strife. None of those outcomes are desirable to the US, but if that's what it takes to keep them selling oil in dollars, then that's what happens.

Political tangent

From this perspective, is it any wonder why Hillary Clinton was the establishment favorite, and why she seemed so sure that she deserved to be the next president? She did the leg work to save the economic empire, of course she deserved it! The most amazing aspect of all this is that she was almost fully backed by liberals, people who would tell you in a heartbeat that the American empire is evil and that America is only rich by oppressing poor non-white nations. This says all you need to know about (a) her shrew skills as a politician, (b) the willingness of our media to shield the public from reality, and (c) the high level of immunity liberals have to cognitive dissonance. (Not all liberals though. Jill Stein frequently called Clinton out on Twitter for it). She won the popular vote, and she did it by saying one thing and doing another, which was easily discoverable for anyone with any sort of intellectual curiosity. I ranted at length repeatedly about Libya in my blog and facebook page and not many seemed too concerned. This has just puzzled me to no end, and has eroded any faith I had that the American people are capable of self-government.

Russia

Russia supplies nearly all of Europe's gas, and is the only oil-exporting regional power. If any one nation has the power to undermine the US economic order, it is Russia. Currently the US political and media establishment are pushing heavily for Russia confrontation. Ostensibly the reason is the Russians may have attempted to influence the election. Of all the unmitigated gall! This is entirely ridiculous. I won't get into it here, but you can read the Saker's take on it if you like.

What are they really upset about? Le's walk this back a ways.
  • The US establishment is furious that Russia stood up against them and frankly humiliated them in Syria. They had expected their favorite foot soldier to breeze into office, but instead the election went to the man they spent a year vilifying and who has shown interest in resuming friendly Russian relations.
  • Russia intervened in Syria because they saw the US empire as creating more harm than good. In particular, they were lied to about US intentions in Libya.
  • The US had issued economic sanctions on Russia in response to Russian actions in Ukraine, in particular their annexation of Crimea. 
  • The Russians took action in Ukraine after western meddling in Ukranian politics, as well as overtures from NATO to states in the former Soviet bloc. The Russian actions generally had the support of the people in the regions they operated, as the majority are ethnic Russian and view the Ukranian government as an ultra-nationalist Nazi regime.
  • The US empire began pushing on Russia's home turf, I suspect, in response to Russia's decision to sell oil outside the dollar markets.
The question is what will happen now with Trump elected? Some say they are trying to push for war with Russia before the inauguration and that the transfer of power will be suspended. That's not a totally hare-brained prediction. I have every reason to believe that's what they would do, if they could get away with it. But that might very likely trigger a civil war in the US, which would not bode well for the dollar they're trying to protect.

People said the same thing about Bush, that he would implement martial law to hold on to power, because Obama was going to undo all their work in the Middle East. But neither happened. And despite basically campaigning on the notion that he would not be a neocon, the establishment did not oppose Obama, and he in fact carried on the work of the Bush administration. Clearly there was signaling somewhere to let the establishment know the dollar empire was not in danger. Could it be that Trump also, despite his campaign rhetoric, will fall in line to the establishment orthodoxy? Well the same signaling certainly hasn't happened with Trump, or we wouldn't be witnessing this foaming-at-the-mouth obsessive diatribe levied against him. He may pivot at any time, but at this point it is clear he poses a real threat to the project of American global hegemony.

I suspect they'll hand over power, and do everything in their power to sabotage him, assault his reputation, and get someone back into office who can continue their work. The bigger question is, what will happen to the reserve status of the dollar under Trump?

Conclusion

And there you have it. The American path to war almost always begins with a threat to the dollar's monopoly on the trade of energy commodities. American foreign actions are much less confusing when you look at them this way. The thing that gets me is that, I'm always opposed to the American empire. I've never voted for a presidential candidate who wasn't effectively an anti-empire candidate. The lies, the inconsistencies, they drive me bananas. But if the government was actually forthright about it's intentions and actions, I might actually be compelled to support them. I understand the benefit of a global currency for trade. I appreciate the benefits of a Pax Americana, and that there are costs involved in maintaining that. Hell, I'm pretty nationalistic. I'd be on board with straight up invading Saudi Arabia and saying, "we're going to take this oil because you're a backwards & brutal dictatorship and we are an advanced civilization that sends scientific probes into the far reaches of the solar system." Fine by me. Give it to me straight; I can handle it. The electorate as a whole, cannot, so these kinds of public policy decisions are always decided through the illusion of some humanitarian issue. The decisions to defend the dollar reserve status may well be in the best interest of Americans, and they generally support those actions, even though they don't realize it.

No comments:

Post a Comment