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Signs of the diminution of US power have been proliferating since the crisis. Geopolitically, revolutions in Tunisia and Egypt signalled that the US’s lid on Middle Eastern popular aspirations was blown off.
The western intervention in Libya went ahead only with Russian and Chinese consent and without US leadership. And today the US fights shy of George Bush Jr style unilateral action against the erstwhile ‘axis of evil’ – Iran, Syria and North Korea – while, back at the ranch, its astronomical defence spending faces sequestration.
Signs of decline are less clear on other chief front of US power. The US dollar’s mixed fortunes have attracted considerable attention since 2008. Every upturn allegedly signals its continuing world role and downturns lead to questions about that role and debates about the future of the international monetary system.
Xiaochuan Zhou, governor of China’s Central Bank, for instance, proposed replacing the dollar with a ‘super-sovereign’ currency like the one John Maynard Keynes outlined during the war-time negotiations at Bretton Woods. Though the US rejected it then, the idea re-emerges punctually when the dollar runs into trouble as it so frequently does. This time, however, it is unlikely to go away.
Few are today aware of the impending end of the dollar’s world role largely because it is surrounded by obfuscations. Two are particularly relevant for the BRICS and emerging economies.
One is the notion of US hegemony which implies that the dollar can only be displaced by a new more powerful ‘hegemon’ able and willing to internationalise its currency.Questions about China’s relative strength and the alleged difficulties of internationalising the yuan are ‘Exhibit A and B’ here. Secondly, we are told that there the BRICs, pre-eminently China, will not abandon the dollar because of their large dollar reserves. These obfuscations prevent clarity on developments to come.
The idea of US ‘hegemony’ is old and deeply entrenched. Whether or not the US is considered still ‘hegemonic’, the idea that it once was is practically an article of faith. The reality is otherwise. True, the world dominance of the world’s first industrial country, the UK, was inevitable and sterling served as the world’s currency in the 19th century. True also that US policy-makers sought to emulate such dominance in the 20th century and lacking formal colonies they settled for making the dollar the world’s currency.
However, what is less well-known is that 20th century conditions made even this impossible. Without colonial surpluses to export to provide the world dollar liquidity stably, the US resorted to providing it through balance of payments deficits.
These were subject to the ‘Triffin Dilemma”: though necessary to provide liquidity, they drove down the dollar’s value. And after 1973, maintaining the dollar’s world role required generating successive dollar-denominated and US-centered financializations – excesses of financial activity unrelated to productive or commercial activity – which inflated international capital flows to ever higher levels.
Initially the economic damage these short-term financial flows wreaked could be externalised and the world witnessed an increase in financial crises, culminating in the East Asian Financial Crisis in 1997-8.
However, with the stock market and housing bubbles of the late 1990s and 2000s, the financialization now rested on damaging asset bubbles at home. After the housing bubble burst no new financialization has emerged to cover up the underlying economic rot and to give the dollar another reprieve, however, temporary. After their massive collapse in 2008, international capital flows recovered to only 40 per cent of their peak before declining again.
Despite the series of financializations that propped it up, the dollar has trended downwards since currencies were first floated in 1973. It rose only twice, albeit spectacularly, with the recession-inducing Volcker Shock in the early 1980s and the stock market bubble of the late 1990s. The housing bubble, by contrast, could only moderate its decline.
Since then, the perennial problems of US debt and deficits have grown a lot worse. The massive bailout of US financial institutions has added to US debt. The even more massive Quantitative Easing (QE) programme has created more unwanted dollars. Though both were justified as necessary for recovery, they have worked only to strengthen the financial sector while the austerity it demands has made US recovery more difficult.No wonder dissatisfaction with the dollar as a reserve currency among the emerging economies, which had been growing throughout the 2000s, has sharpened. It has brought the dollar’s share of world reserves from 71 per cent in 1999, the peak of the stock market bubble, to about 62 per cent in 2012, despite the massive increase in reserve accumulation since the 1997-8 East Asian Financial Crisis and the US’s historic refusal to allow the creation of alternative reserve assets.
US efforts to retain centrality in the international monetary system face great obstacles. If the dollar retains a large role in foreign currency transactions today, it is mainly because US financial institutions, more handsomely bailed out than any other by far, are the chief parties to them as they resume international speculation.
However, such financialization is unlikely to prop up the dollar’s world role anymore. The BRICS economies are already less financialized and their financial sectors are less internationalised. They embarked on both in the 1990s believing that increased financialization and liberalisation would bring much-needed international investment.
However, they were disappointed as capital outflows (mostly to the US) far outpaced inflows and the capital that did flow in was dominated by unproductive crisis-inducing short term capital not productive long-term Foreign Direct Investment.
Since the 2008 financial crisis, capital controls against short-term capital flows have been implemented by many BRICS and emerging economies. Their capital inflows and outflows are dominated by FDI. They are also fashioning devices to sidestep the dollar’s use such as bilateral trade agreements using local currencies, currency swap and reserve pooling agreements.
For the moment, the Eurozone crisis, the sheer weight of US financial institutions and the ongoing US stock market bubble are holding up the dollar. They cannot do so for long and questions about the shape of the international monetary system are bound to re-emerge.
When they do, the dollar-style internationalisation of other currencies will not prove to be the solution. As the Chinese are all too aware, that would incur the same problems that attended the dollar’s world role to date. Coordinated international action to create a super-sovereign currency is both ideal and difficult. The default is a multiple reserve currency scenario with greater regulation of international capital flows by home governments and other countries as well as reduction of reserves through their efficient use.