The world has changed, and the US dollar is losing support as the international measure of value and means of exchange. The governor of the Bank of England recently outlined the reasons in favour of ending international dollar dominance. He also outlined his preferred replacement system.
The UK is a deeply integrated subordinate and ally of the US. The international power politics of its state actors are closely tied to the efficacy and capacity of the US system as a whole. Furthermore, London is one of the planet’s dominant financial capitals, and its highly organised financial sector boasts numerous advantages over its peers.
The UK central bank governor, Mike Carney, likely spoke in favour of a transition away from the dollar simply because the change seems inevitable: so best to get ahead of it.
This subject of political and monetary multipolarity was discussed at this August’s annual meeting of central bankers and economists. The Jackson Hole Symposium is held in the US and it helps coordinate the efforts of related state institutions in order to influence the international economy. The event was backgrounded by bets being placed on the possibility of recession in the near future.
The attendees were under special observation because of slowing manufacturing production the world over, declining trade, trade war between the US and China, because the instability caused by the broad and persistent use of US sanctions such as in the case of Iran, and because the outline of a new multipolar world is being constructed in the face of declining US hegemony.
Importantly and worryingly for capitalists, average profits are in a long period of decline. As profits drop, investments have followed. Why invest in productive activity when that generates less and less profits and when the economic and political future is uncertain?
The chairperson of the US central bank (aka the Federal Reserve), Jerome Powell had this to say during the symposium of his peers: “The global growth outlook has been deteriorating since the middle of last year. Trade policy uncertainty seems to be playing a role in the global slowdown and in weak manufacturing and capital spending in the United States”. Weak investments predate the trade war, and there seems ample empirical evidence <!–citation–> of falling profits and investments triggering the 2008 recession. So, even though trade wars and barriers can exacerbate the situation, they can’t exactly be held up as singular cause.
As a response to weak economic growth, a good deal of capital is being stored in what many capitalists and state actors consider safer holdings, such as government bonds and gold. Government bonds are deemed safe because they’re backed by states that can bring to bear their concentrated power and potential revenues in order to guarantee the bonds. There is no equality of strength between states so it should be understood that certain bonds are favoured while others are deemed risky.
Central bank attendees to the annual meeting in Wyoming include the US Federal Reserve, the UK’s Bank of England, and Germany’s Bundesbank. Such institutions oversee the international financial system. They set the interest rates at which they lend and receive funds, and they exert influence by deciding how much they lend to whom.1 They are key instruments of state regulation over the economy and its corresponding social relations, even though in many contemporary cases they may be distanced from the government and are often largely representative of a more direct lever of capitalist management.
Fear of a looming recession at a time of long economic turmoil and a changing world order have accentuated conflicts among the ruling class.
US president Donald Trump’s recent complaint about the practices of his country’s central bank – the Federal Reserve – should be seen in this context. He tweeted that the Fed is not acting according to his desired plan – specifically that:
As usual, the Fed did NOTHING! It is incredible that they can “speak” without knowing or asking what I am doing […]
The 23 August thread called out chairperson Jerome Powell, comparing his actions to those of the Chinese leader with which there is a trade war under way:
…My only question is, who is our bigger enemy, Jay Powel or Chairman Xi.
The far more consequential speech, however, was given by Mark Carney at the central bankers meeting. Here are excerpts from the official transcript, important enough to quote at length:
A small number of national currencies dominate international exchanges. However, one currency is paramount. “Dominant currency pricing refers to the widespread use of a single currency – the US dollar – in trade invoicing, in place of the currency of either the producer or the importer. Import prices will therefore depend on changes in the bilateral exchange rate between the local and the dominant currency, rather than that between the local and producer currency”.2
“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”. The exchange of goods and services between international trading partners are handled in such a way that “global trade volumes are heavily influenced by the strength of the US dollar”. This is especially a problem for weak currencies, meaning national currencies that don’t belong to the world’s most powerful countries, because they’re less able to bridge the gap in currency prices during a time of rapid change in dollar exchange pricing.3
Furthermore,
As well as being the dominant currency for the invoicing and settling of international trade, the US dollar is the currency of choice for securities issuance and holdings, and reserves of the official sector. Two-thirds of both global securities issuance and official foreign-exchange reserves are denominated in dollars. The same proportion of EME foreign currency external debt is denominated in dollars and the dollar serves as the monetary anchor in countries accounting for two thirds of global GDP. [EME stands for Emerging Market Economy, meaning countries below the top tier of per capita income. Includes places like China, India, Brazil, Mexico, etc.]
The US dollar’s widespread use in trade invoicing and its increasing prominence in global banking and finance are mutually reinforcing. With large volumes of trade being invoiced and paid for in dollars, it makes sense to hold dollar-denominated assets. Increased demand for dollar assets lowers their return, creating an incentive for firms to borrow in dollars. The liquidity and safety properties encourage this further. In turn, companies with dollar-denominated liabilities have an incentive to invoice in dollars, to reduce the currency mismatch between their revenues and liabilities. More dollar issuance by non-financial companies and more dollar funding for local banks makes it wise for central banks to accumulate some dollar reserves.
Given the widespread dominance of the dollar in cross border claims, it is not surprising that developments in the US economy, by affecting the dollar exchange rate, can have large spillover effects to the rest of the world via asset markets. […] the global financial cycle is a dollar cycle.
In part, that arises because movements in the US dollar significantly affect the real burden of debt for those companies (especially in EMEs) that have borrowed unhedged in dollars, and tend to reduce the dollar value of companies’ collateral. Both result in tighter credit conditions and, in the extreme, defaults.
Fluctuations in the dollar also significantly affect the risk appetite of global investors. […] For EMEs, this manifests in volatile capital flows that amplify domestic imbalances and leave them more vulnerable to foreign shocks.4
Even when EMEs have supposedly done everything right, they can still be battered by the dollar financial system.
But unfortunately for EMEs, all else is not equal. Their efforts have not been sufficient because of the consequences of the growing asymmetry between the importance of the US dollar in the global financial system and the increasingly multi-polar nature of global economic activity.5
The advanced economies of powerful countries also have to deal with the complications of the dollar system. They’re heavily impacted by it despite the US decline in the face of rising multipolarity.
Monetary policy and financial stability shocks in advanced economies have become more prevalent and more potent, increasing the importance of “push” factors in driving capital flows. Bank research suggests that the spillover from tightening in US monetary policy to foreign GDP is now twice its 1990-2004 average, despite the US’s rapidly declining share of global GDP. Financial instability in advanced economies also causes capital to retrench from EMEs to ‘safe havens’, as it did during the 2008 financial crisis and the 2011 euro-area crisis […] Connally’s dictum “our dollar, your problem” has broadened to “any of our problems is your problem”.6
The problematic interrelationship, the details of which are in the full speech document, means that EMEs have to bear particular troubles of a different order than their more powerful counterparts.
EMEs are forced to compromise their monetary sovereignty, temporarily diverting monetary policy away from targeting domestic output and inflation and instead using it to try to stabilise capital flows.
While this strategy is the best EMEs can do given the current structure of the international monetary financial system, outcomes for them are a distant second best when compared to those advanced economies that are less exposed to international financial spillovers.7
Carney publicly states that in the short term policymakers have to make the best of the system such as it is.8 In the medium term, reform the system. In the long term, he says the financial system should be restructured by “changing the game” to match the new multipolar world. He suggests a sunset for the US dollar as the global reserve currency. “That won’t be easy” he says, and “Transitions between global reserve currencies are rare events given the strong complementarities between the international functions of money, which serve to reinforce the position of the dominant currency”.9 The last time such a change took place was the transition from the UK’s pound sterling to the US dollar.
Carney’s proposal for a long term solution: “While the rise of the Renminbi may over time provide a second best solution to the current problems with the IMFS, first best would be to build a multipolar system”.10
He leans into a publicly regulated international currency based on a basket of national ones.
The Bank of England and other regulators have been clear that unlike in social media, for which standards and regulations are only now being developed after the technologies have been adopted by billions of users, the terms of engagement for any new systemic private payments system must be in force well in advance of any launch.
As a consequence, it is an open question whether such a new Synthetic Hegemonic Currency (SHC) would be best provided by the public sector, perhaps through a network of central bank digital currencies.
Even if the initial variants of the idea prove wanting, the concept is intriguing. It is worth considering how an SHC in the IMFS could support better global outcomes, given the scale of the challenges of the current IMFS and the risks in transition to a new hegemonic reserve currency like the Renminbi.
An SHC could dampen the domineering influence of the US dollar on global trade. If the share of trade invoiced in SHC were to rise, shocks in the US would have less potent spillovers through exchange rates, and trade would become less synchronised across countries. By the same token, global trade would become more sensitive to changes in conditions in the countries of the other currencies in the basket backing the SHC.
The dollar’s influence on global financial conditions could similarly decline if a financial architecture developed around the new SHC and it displaced the dollar’s dominance in credit markets.11
The question on the mind of some policymakers is not if but when will the dollar system be replaced? How will that take place, what could replace it, and how turbulent will be the period of change? The dollar system is a fibre in the fabric of the world order, backed not only by economic power (of which it was explained the US is losing), but also by political and military might.
References
[1] Tony Norfield, The City: London and the Global Power of Finance, Verso, 2017.
[2] Found in a footnote. Mark Carney, The Growing Challenges for Monetary Policy in the Current International Monetary and Financial System: Speech by Mark Carney at Jackson Hole Economic Symposium, Bank of England, 23 August 2019, p. 6.
[3] Mark Carney, pp. 6-7.
[4] Mark Carney, p. 7.
[5] Mark Carney, p. 8.
[6] Mark Carney, p. 8.
[7] Mark Carney, p. 8.
[8] Mark Carney, pp. 9-13.
[9] Mark Carney, p. 13.
[10] Mark Carney, p. 14.
[11] Mark Carney, p. 15.
