The Weakening Dollar*

The Weakening Dollar

Who says the Dollar is weakening? That’s not possible. The Dollar is the world’s preeminent currency, its Reserve Currency, the cornerstone of global commerce. The US Dollar is the very definition of “money” …, and the facts show that it’s only been getting stronger, its value increasing for the past 12 years. The Dollar is higher now than it’s been almost any time since 2003. There’s no way it could be weakening.

And, yet, … it is. That’s the goal President Trump has set out to achieve … and is working to achieve. The Dollar is weakening because the foundations of its value are being eroded, slowly, almost imperceptibly, much like ocean waves wear away the shoreline, wave by wave. Although the consequences of that erosion aren’t readily apparent, their effects gradually will become clear, although the outcome of erosion more often comes as a sudden surprise. There is, after all, a natural human tendency to ignore the bit-by-bit chipping away that takes a number of years, with a final outcome that is unpredictable in any event. Unfortunately, the problem with erosion is that, unless it’s addressed, the ground upon which a structure, or a Reserve Currency, is built … collapses.

So it is with the US Dollar.

President Trump has repeatedly declared a goal of his Administration to be a weaker US Dollar. That’s not a good idea. For Trump, it’s all about, and only about, the U.S. trade deficit, which has expanded significantly over the past ~20 years. He’s made it a priority for his Administration to reduce it … and to do so with every one of America’s trading partners. He believes that his “America First” policies and confrontations with trading partners – through sanctions, tariff wars and otherwise – will shrink the trade deficit, create jobs, and strengthen national security. He also believes that, if the US Dollar is worth less relative to other currencies, foreigners will be more likely to buy more American goods and thereby boost U.S. manufacturing.

That’s not correct.

Consumers spend and import more when the Dollar is strong and goods are cheap … and higher U.S. interest rates have made foreigners eager investors in U.S. businesses and markets – cheaper goods and strong foreign investment in the U.S. are good things. A strong U.S. economy – which is another good thing – necessarily increases the trade deficit. The strong Dollar has made the U.S. the wellspring of global liquidity, which drives up demand everywhere, enhances the importance and profitability of U.S. businesses, and entrenches the Dollar as the world’s Reserve Currency … requiring other countries to add US Dollars to their reserves – which is a further good thing. This, in turn, creates massive demand for U.S. financial assets, including U.S. government securities … precisely what America needs to fund its enormous budget deficits. The good things keep coming! This means that the U.S. is able to finance its high consumption at a low cost, which further boosts both Americans’ demand by lowering prices and increasing productivity … and America’s wealth – even more good things! Each relies on the others in a self-reinforcing cycle. The strength of the Dollar anchors it as the world’s Reserve Currency … and the status of the US Dollar as the world’s Reserve Currency is what anchors the American economy. It’s a virtuous circle in which the Dollar is the most significant contributor to America’s economic greatness. It comprises 62{29ea29b64b10057f61377b2c087cd5b7537a0cd24da4295a308b0bf589469f35} of global central bank reserves; 65{29ea29b64b10057f61377b2c087cd5b7537a0cd24da4295a308b0bf589469f35} of physical Dollars are used outside the U.S.; 90{29ea29b64b10057f61377b2c087cd5b7537a0cd24da4295a308b0bf589469f35} of foreign exchange trading involves the US Dollar; and one-third of the world’s Gross Domestic Product is generated by countries that peg their currencies to the US Dollar. The reason the U.S. economy remains the world’s strongest is because its currency is the world’s strongest.

Weakening it therefore is not a good idea.

No prior American President has advocated a weaker Dollar …, for precisely these reasons. As part of his campaign to weaken the Dollar, Trump not only has pressured the Fed for lower interest rates, he also has been raising tariff barriers and sanctioning foreign companies, presenting currency devaluation as part of a war between trading nations. With the dominant U.S. economy as a global magnet for goods and services, and with U.S. government securities paying higher interest rates than all other fiscally-stable developed countries, the Dollar naturally has been the world’s strongest, most-attractive, most-used currency … and that’s why it has been the world’s strongest currency and retained its status as the Reserve Currency.

Assuming that the Trump Administration succeeds in weakening the US Dollar, what might happen?

U.S. Treasury bills, notes and bonds – America’s government-issued debt – are the world’s favorites. They also are the world’s most abundant – the supply of America’s Federal debt (excluding its State and private debt, which also are enormous) now stands at over $23 trillion. Because the interest rate on U.S. government debt is higher than the rate on every other developed country’s debt, and because the US Dollar is exceptionally stable, U.S. Treasury securities are the favorite of foreign investors. What might happen to those investors and to their belief in the stability of U.S. government debt … and to their belief in the value of the US Dollar that led them to purchase that debt … if its value were to start sliding? What if faith in the stability of the US Dollar were to be called into question? If the demand for U.S. government debt should decline, the interest rate on that debt would have to increase in order to attract investors. Increased interest on U.S. government debt would increase the amount of U.S. government debt that would need to be issued to pay that interest …, which would continue in a vicious circle. That clearly would not be in America’s best interest. Among other things, a self-reinforcing increasing national debt cycle would undercut the Dollar’s Reserve Currency status.

America’s enemies well understand the power of the Dollar’s Reserve Currency status. So do its once-close friends, including France, Germany, Britain … and others. They view America’s efforts to leverage its monetary, financial, economic and currency advantages as an abuse-of-Dollar-power, and its desire to weaken the Dollar as currency manipulation that will damage their economies and the global economy. Where they once merely complained about America’s leveraging of its Reserve Currency status, friends and foes alike now are experimenting with undercutting the US Dollar – they are working separately and together towards global “de-Dollarization.”

America derives a very substantial amount of its Dollar leverage from the universal reliance on SWIFT, the global payments system. The SWIFT system controls the wire transfer of Dollars – an essential component in international commerce. SWIFT has been amazingly useful to the U.S. government in enforcing trade sanctions, particularly against Iran and Russia. Europe – which has not supported America’s renunciation of the 2015 Iran accord – has been working with Iran to forge an alternative payments system, called INSTEX, that would skirt American sanctions. Any successful alternative to SWIFT would deal a major blow to America … and to the US Dollar. That’s the goal. In her declaration of policy for 2019-2024, Ursula von der Leyen, the new President of the European Commission, said “I want to strengthen the international role of the Euro” and thereby weaken the Dollar. Her predecessor, Jean-Claude Juncker, called the Dollar’s dominance in European energy trade an “aberration.” Although these are merely words, America’s ongoing “America First” trade sanctions and tariffs are pressing America’s allies to take action. They are beginning to do so.

When it comes to action, Russia leads the pack. Since 2018 it has been dumping its Dollar reserves and replacing them with gold. “We aren’t aiming to ditch the Dollar,” according to Vladimir Putin. “The Dollar is ditching us.” Most of Russia’s energy exports no longer are being denominated in Dollars, and Russia views energy trade as merely a first step in a process intended to undermine Dollar hegemony. Rosneft has switched to the Euro and Surgutneftegas currently prices in Dollars but has a clause in its contracts allowing it to unilaterally switch to Euros, and Gazprom is now pricing its natural gas solely in Rubles. Russia’s ambassador to China, Andrey Denisov, has emphasized that Russia and China are working together to increase bilateral trade in Rubles and Yuan and thereby reduce their reliance on the Dollar. As an initial step, they have agreed to a barter exchange of Russian oil for Chinese Yuan, a transaction having a value of $400 billion. Denisov has emphasized the eroding changing international trade environment: “Both China and Russia are dissatisfied that almost everything in international payments is based on American dollars. We need more self-sufficiency.… When I say ÔÇÿwe,’ I mean not only Russia and China, but a wide range of economies.” Russia-China barter arrangements include the newly-opened Power of Siberia pipeline. Despite American sanctions and political pressure, Russia also is completing arrangements with Germany for Euro payments for gas shipments through the Nord Stream 2 pipeline and with Turkey for gas shipments through the TurkStream pipeline. Vladimir Putin has been a consistent critic of US Dollar hegemony: “The world economy is entering a period of trade wars and growing protectionismÔÇöovert and indirect…. Deep changes require adaptation of international financial organizations, reconsidering the role of the dollar, which after it became the international reserve currency, turned into the tool of pressure [by the United States] on the rest of the world …. [Thus,] trust in the US dollar is falling…. States that previously advocated the principles of freedom of trade, fair and open competition, started speaking the language of trade wars and sanctions, blatant economic raiding, arm twisting, intimidation, eliminating competitors by so-called non-market methods.” China’s leader, Xi Jinping, has seconded Putin’s condemnation of America’s “increasing anti-globalism and hegemony.”

President Xi has much to complain about American policies …, and the US Dollar. The Trump Administration’s trade and sanctions policies have targeted China and its tech firms, and not only the highly-publicized Huawei. Sanctioned Chinese companies include premier artificial intelligence firms SenseTime Group Ltd, Megvii Technology Ltd., Hikvision and Yixin Science and Technology Co. The Trump Administration also has threatened to block New York Stock Exchange and NASDAQ listings by Chinese firms …, a two-edged sword that could weaken America’s preeminence as the world’s financial capital, a boon to Chinese efforts to create alternatives for the trading of commodities in Shanghai, Dalian and Singapore and for trading equities in Shanghai, Shenzhen and Hong Kong. America’s actions also have accelerated China’s efforts to create its own payments and settlements structure in an effort to circumvent US Dollar hegemony. China reportedly is urging India, Russia and others to explore using China’s internal Yuan payments system, CIPS, to sidestep SWIFT.

TLR addressed the risks to the US Dollar caused by America’s sanctions and trade policies in “Be Careful What You Wish For.” Others are now beginning to focus on the weakening of the US Dollar. The erosion therefore has become noticeable …, and that’s important. The US Dollar is today’s the very definition of “money” …, and “money” is the grease that lubricates America’s and the world’s economy.

What makes the US Dollar “money”? And what has made the US Dollar the world’s Reserve Currency?

In order to be “money,” a currency must be (1) widely used, (2) accepted in transactions from one person to another, and (3) a store of measurable value. The US Dollar has been precisely that. It’s been the world’s go-to medium-of-exchange for every possible good and service. Although aspirational, the Chinese Yuan is not “money.” Nor is the Russian Ruble or the Venezuelan Bolivar … even though they too are currencies. Crypto-currencies, such as Bitcoin and Ether, aren’t “money” either. They may or may not turn out to be a store of value, but they aren’t widely accepted and few people use them for the purchase of goods or services. Gold and silver also are not “money.” They are stores of measurable value, but are not widely-used or accepted in day-to-day commerce. Today, only the US Dollar is worldwide “money.” The Dollar is widely used, accepted in transactions involving the transfer of goods and services, and is a store of measurable value. And, yet, Dollars have no intrinsic worth. They are, after all, only pieces of paper. They have no permanence – anyone can put a match to them. The Dollar hasn’t been around for very long either, having had a relatively short run as the world’s Reserve Currency. Throughout human history a variety of currencies that appeared sound have become worthless disappeared. Remember the Deutschmark? How about the heavily debased Roman Antoninianus? It used to be that the value of currencies was backed by something having intrinsic value, like gold bullion, but that’s not the case today. Fort Knox holds only a small fraction of Dollar value. What therefore gives the Dollar value? Why do people continue to put their trust in it?

The value of a fiat currency like the Dollar – that is, government-issued paper that is not fully backed by a physical commodity – is based on faith the belief that the government backing it is legitimate, that it keeps its word, that it will continue to pursue sound fiscal policies, and that its political and military strategies will be supportive of its currency.

The U.S. for the past 75+ years has been the world’s largest and most successful economy, a Constitutional democracy that respects the Rule of Law and due process, having clear and consistent property rights that are enforceable over a realistically short timeframe, and with national and local debt within economists’ reasonable comfort-zone. It’s consequently been the destination of an outsized share of the world’s products and services, of its resources and of the fruits of other countries’ laborers … all of which necessarily have been paid-for in Dollars. The U.S. also has the world’s most powerful military – an essential element for a Reserve Currency – which it has used to ensure consistent, stable growth and governance. Other countries and their peoples have looked to the U.S. for stability and leadership and have valued the Dollar above all other currencies for that reason alone. These are what have given the US Dollar Reserve Currency status. Everything of global importance accordingly has been denominated in Dollars – including all of the world’s scarce resources and a disproportionate share of its successful businesses – and America accordingly reigns as the financial capital of the world, which means that the world’s leading banks, stock and bond markets are found in the U.S. Because of the Dollar’s dominance, Americans incur no currency conversion costs – they buy in Dollars and sell in Dollars. People in other countries therefore pay more and receive less because their goods and services are denominated in their local currencies, giving Americans a destination advantage. That has the added benefit of making America a magnet not only for goods and services, but also for labor, education and innovation.

The fact that other countries must hold Dollars in their national treasuries enables the U.S. to import goods and services and pay for them with mere pieces of paper that the U.S. Treasury simply prints. Other countries necessarily must hold Dollars while the U.S. consumes the goods and services purchased with those printed pieces of paper. They necessarily do so by buying and holding US Dollar-denominated debt instruments – U.S. Treasury securities – which has enabled the U.S. to borrow almost limitlessly, supporting America’s deficit spending. This allows Americans to buy other countries’ goods and services with an IOU having no fixed maturity – those printed Dollars are promises to pay that rely on faith in the credit of the U.S. As long as the Dollar continues as the world’s Reserve Currency, Americans will continue to enjoy these enormous advantages … and foreigners will continue to fund America’s consumption and standard of living.

Should the Dollar weaken, should it lose its dominance, its Reserve Currency status, it would compel America to resolve confront a variety of alarming issues, including its enormous overspending deficits national debt. That debt and America’s deficits alone would require a drastic reduction in government spending as well as significant tax increases. Having to self-fund its deficits and debt load would mark an end to America’s global economic hegemony, pressuring the financial ability of the U.S. to maintain military and economic competitiveness. That is a future very much to be avoided.

Americans and American politicians therefore should pray that the Dollar stays on top forever. The Trump Administration accordingly should make every effort to ensure that, rather than weaken, the US Dollar remains the strongest currency on Earth. Reducing America’s trade deficit shouldn’t be on anyone’s list and most certainly should not be a policy priority. To the contrary, preservation of Reserve Currency dominance should be a high-order priority. As former U.S. Treasury Secretary Jacob Lew warned, “[T]he plumbing is being built and tested to work around the United States. Over time as those tools are perfected, if the United States stays on a path where it is seen as going it alone … there will increasingly be alternatives that will chip away at the centrality of the United States.”

Finally (from a good friend)

Apolitical Aphorisms:

If God wanted us to vote, he would have given us candidates. ~Jay Leno~

The problem with political jokes is they get elected. ~Henry Cate, VII~

We hang the petty thieves and appoint the great ones to public office. ~Aesop~

If we got one-tenth of what was promised to us in these State of the Union speeches, there wouldn’t be any inducement to go to heaven. ~Will Rogers~

Politicians are the same all over. They promise to build a bridge even where there is no river. ~Nikita Khrushchev~

When I was a boy, I was told that anybody could become President; I’m beginning to believe it. ~Clarence Darrow~

Politicians are people who, when they see light at the end of the tunnel, go out and buy some more tunnel. ~John Quinton~

Politics is the gentle art of getting votes from the poor and campaign funds from the rich, by promising to protect each from the other. ~Oscar Ameringer~

I offer my opponents a bargain: if they will stop telling lies about us, I will stop telling the truth about them. ~Adlai Stevenson~

A politician is a fellow who will lay down your life for his country. ~Tex Guinan~

I have come to the conclusion that politics is too serious a matter to be left to the politicians. ~Charles de Gaulle~

Instead of giving a politician the keys to the city, it might be better to change the locks. ~Doug Larson~

There ought to be one day — just one — when there is open season on senators. ~Will Rogers~


*┬® Copyright 2020 by William Natbony. All rights reserved.

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