The Sun Sets on U.S. Dollar Supremacy

Tuesday, October 15, 2013 6:08 AM

Interesting summary below on the probable fate of the U.S. Dollar and American hegemony. It emanates from yesterday's London Telegraph. London is a good location from which to view the matter in a calm, detached way.

I have recently finished the three volume magisterial work by Jan Morris on the British Empire entitled Pax Britannica. It confirms my long-held view that Uncle Sam is stumbling down the same steep, rocky footpath which John Bull traversed in the aftermath of the Boer War, say, from 1900 till 1950. 

The gentleman in Whitehall did not draw the appropriate and correct conclusions from that gruesome war-of-choice in South Africa against Dutch, Christian fundamentalist settlers who were there first and who wanted nothing to do with the British Empire.

The lure of imperialism in the ruling circles in London, however, could not be altered. The Pound Sterling was King. This combination of hubris and foolishness was the reason London felt compelled to get engaged in the continental conflict of 1914 which became the Great War, now known as World War I. They could not help themselves.

Nominally victorious over the Boers and then the Germans, the British were blinded to the writing on the wall. They had learned next to nothing from these two national and humanitarian disasters. The ruling elite, for lack of a better term, remained meddlers and busybodies, intent on lording it over the world, or as much of it as possible for as long as possible.

Hence, World War II, championed by the last and greatest imperialist, Winston Churchill, who was the biggest fool of them all. Not surprisingly, he retains the best press. And he wrote his own history. This has been covered briefly in «Bled Dry». England was left high and dry. Such a fate may be right around the corner for Uncle Sam, due to essentially the same reasons.


The sun is setting on dollar supremacy,

and with it, American power

By Jeremy Warner, Assistant Editor, The Telegraph

All great empires – from the Greek, to the Roman, the Spanish and the British - have at their heart a dominant means of exchange which is very much part of their political and social hegemony. Once upon a time, it was Roman coinage which was the world's pre-eminent currency. In more recent times it was the British pound. Today, it's the US dollar to which international investors flock as a safe haven for their money. Highly liquid and apparently reliable – until recently at least – nothing else comes even remotely close to the greenback's dominant position in the international monetary system.

That this position – what Giscard d'Estaing referred to as America's "exorbitant privilege" – could so casually be put at risk by politicians on Capitol Hill is an extraordinary spectacle that may be indicative of a great power already seriously on the wane.

With the pound, the fall from grace was swift. Britain emerged from the devastation of the First World War an irreparably damaged economic and military power, with crushing debts and a deeply impaired manufacturing sector.

The dollar was able quickly to usurp the pound's position. Final defeat for sterling came with Britain's decision to leave the gold standard in 1931 – an economically sensible decision but a psychological turning point for sterling from which it never recovered.

Lack of any credible alternative means it won't happen so quickly with the dollar. For all the progress of the last 30 years, China for now remains a much smaller economy than the US and in any case is nowhere near ready financially to assume such a role. As for the euro, the dollar needn't trouble itself much about this one-time pretender to the throne.

Yet rarely before has international dissatisfaction with the dollar's role as reserve currency to the world been as great as it is now. The most visible anger comes from China, with more than $3 trillion of dollar foreign exchange reserves, $1.3 trillion of them held in US Treasuries. For ordinary Chinese, it has come as a revelation to discover they own so much American debt. That they own it in a country which because of political brinkmanship may actually default has provoked understandable fury.

"It is perhaps a good time for the befuddled world to start considering building a de-Americanised world", China's official government news agency has said.

A steady erosion of trust which began with the financial crisis five years ago has reached apparent breaking point with the pantomime antics on Capitol Hill. The search for long-term alternatives to the dollar is on as never before. Regrettably, there aren't any, or not for the time being in any case. Everyone can only look on in horror as the US commits apparent economic suicide.

Such is the dollar's dominance that, to begin with at least, investors might simply have to take default on the chin. More than 60pc of global foreign exchange reserves are held in US dollars, which also account for more than 80 per cent of global foreign exchange trading.

So important is dollar liquidity in global trade that if, for instance, you wanted to sell Singapore dollars and buy South African rand, your forex dealer would first typically buy US dollars with your Singapore dollars and then use them to buy the South African rand. The dollar is the middle currency in the vast bulk of international transactions.

By the same token, US Treasuries are the very backbone of the global financial system. They are the supposed "risk-free asset" against which everything else is benchmarked, and as such are the collateral of choice in a huge array of financial market transactions. The dollar is also the currency used to price most commodities, from oil to gold.

The dollar's hegemony is all pervasive. This has given the greenback a degree of leverage unmatched by any other reserve currency in history. If China starts to sell dollar assets, it will only weaken the dollar, undermining Chinese exports and reducing the value of its remaining portfolio of dollar assets.

I'd been part of the received wisdom that any act of US default would set off a devastating chain reaction of bankruptcies that would provoke a second global financial crisis. But David Bloom, chief currency strategist at HSBC, has convinced me that dollar hegemony might perversely act in the opposite way, at least initially.

Unlike a generalised credit event, where all instruments default at the same time, the US would initially engage in a series of little, self contained defaults, or "selective defaults", whose individual impact would probably not be that great.

Each bond has a life and coupon of its own. The missed coupon payment might therefore be regarded as not so bad – especially as this is a case of "won't pay", rather than "can't pay".

Markets see such defaults differently, with missed payments expected to be made up eventually once a political resolution is found. It's also very likely that the Federal Reserve would attempt to counter the damage in financial markets with more QE, buying up the Treasuries that investors dumped.

Furthermore, the financial uncertainty created by default would likely drive investors towards past safe havens of choice – in particular, US dollar assets. Alternative safe havens, such as Japan and Switzerland, have been rendered defunct by central bank money printing. Ironically, emerging markets are likely be more damaged by default than the US itself, with further capital flight.

Such is the degree of "exorbitant privilege" enjoyed by the dollar that it might therefore be the first currency in history to see an asset price rally on the back of a default. However, if there were repeated selective defaults, a second, less benign phase would eventually set in. Spooked markets would begin to sell off the dollar.

The consequent stronger euro and pound would have powerfully deflationary consequences for Europe. Internal demand in the US would also collapse as a result of the wrenching fiscal squeeze that would result from federal government attempts to match expenditures with tax revenues.

Dollar hegemony has long been a destabilising force at the centre of the international monetary system; it's a major part of the sharp build-up in global current account imbalances and cross border capital flows that have been at the heart of so many of the problems in the world economy. The unprecedented accumulation of dollar foreign exchange reserves has in turn caused new challenges for the US, making it more difficult to maintain fiscal and financial stability within its own borders.

Policies that may or may not be good for the US are in all probability bad for everyone else. Loose monetary policy in the US since the crisis began has induced unwanted demand and asset bubbles elsewhere in the world.

Serious alternatives to the dollar, such as a global reserve currency, are still a long way off, but the latest shenanigans on Capitol Hill have given the search for them renewed and added momentum. The US is recklessly throwing away its future.