When investment guru Ray Dalio and leading economist Jeffrey Sachs both warn of the coming unravelling of US monetary hegemony, the world listens. But are we really only a few years from the US dollar’s requiem?
America’s current fiscal position, Dalio argues, is unsustainable and a looming entitlement crisis (health care and pension liabilities) could trigger a “flight to gold”.
Rational investors, the argument goes, will soon realise that the only way for America not to default on its ballooning debt would be to inflate it by printing dollars, thus accelerating the long-term depreciation of its currency and encouraging investors to opt for alternative assets. Sooner or later, US monetary hegemony would be over.
Meanwhile, Sachs argues that the dollar’s centrality will decline as the share of the US economy in global GDP is falling. In addition, President Donald Trump’s draconian application of economic sanctions has created a counter-coalition, spearheaded by China and Russia but also tacitly supported by the EU, to “de-dollarise” the global economy.
Lastly, Sachs argues, the US has been the source of global economic instability because of its neo-liberal deregulation agenda, and this has undercut its credibility as an enlightened guardian of the global monetary order.
Yet, there are strong factors in support of sustained US dollar hegemony.
The share of the US economy has indeed declined from the all-time high of almost 50 per cent in the immediate post-World-War-II period but the dollar’s centrality has not faltered. In the years since the implementation of the euro, often seen as a candidate to replace the US dollar, the greenback’s status has remained unchallenged.
A crisis of US institutions may provoke a run on the dollar, and this crisis can only come from the top
Moreover, the premise that America’s share of the global economy will continue to decline is not a law of nature. As Michael Beckley has marvellously theorised in his latest book, Unrivalled, convergence theory which sees poor nations growing faster than rich nations remains underspecified and past success of developing nations does not guarantee future performance. With sound demographics and an innovative ecosystem, the US may retain its global economic share.
To be sure, China has defied the “China collapse” pundits and could soon reach high-income status, yet serious structural problems – including a real estate bubble and dominance of the state-owned enterprises – could undermine Beijing’s innovation-led growth.
But even a China growing solidly will hardly match America’s post-World War II share of global GDP. If the renminbi is to replace the US dollar then its power must spring from other dimensions, such as a sustained current account deficit creating a net export of renminbi, a liquid bond market, abolition of capital controls and, most importantly, the rule of law. China is far from establishing most of those conditions.
If not the renminbi, then why not the euro? Without a fiscal union in the euro zone, structural pressures between the centre and periphery could crush the currency. The economic and social conditions in Italy, Greece and Spain remain poor.
Even in Germany, whose competitiveness has been massively boosted by the euro’s shadow devaluation, pensioners remain gravely dissatisfied with the European Central Bank’s low-interest-rate policy, which affects pension fund returns. In essence, the euro’s survival past the next economic crisis is not guaranteed.
Lastly, why not gold? Simply because the gold market is small compared to the capital markets and this is something that Dalio himself has acknowledged as a major impediment for gold to replace the dollar.
That brings us back to the US dollar. Sachs is right to argue that the United States has been culpable for the crisis of global capitalism but even during the great recession of 2007, which originated in America, capital did not run away from the US but towards it.
It seems almost paradoxical, yet this is not only because the US has – by far – the world’s most liquid bond market, but mostly because investors trust the US system: its rule of law, protection of property rights and the independence of technocratic institutions.
Thus, a crisis of US institutions may provoke a run on the dollar, and this crisis can only come from the top. Here’s how it may unfold.
Since the end of the Bretton Woods system in 1971, the US dollar has been a fiat currency; that is, its value is not backed by gold reserves but solely by markets’ trust in its credibility.
For most of the post-Bretton-Woods’ era, the US has “inflated its debt” by printing excess dollars – the so-called exorbitant privilege. Yet America has, at the same time, remained an inexorable source of innovation and attracted the world’s best and brightest.
Here’s where Trump steps in. His massive tax cuts to reward his campaign financiers has led to a huge deterioration in the US’ fiscal position. To sustain GDP growth built on an unsustainable fiscal expansion, Trump has repeatedly urged the Federal Reserve to cut interest rates, to try to “normalise” the debt-to-GDP ratio by inflating asset prices, in what looks like “Ponzi macroeconomics”.
To preserve this status quo, Trump may attempt to drastically intervene in the Fed decision-making, which could spark a political crisis leading to a loss of confidence and ultimately provoke a run on the dollar.
The unravelling of US monetary hegemony will thus not begin in Beijing or Frankfurt but in Washington. If, however, the US manages to preserve the independence of its institutions, then to paraphrase former Treasury secretary John Connally, the dollar will remain “America’s currency but the world’s problem”. As long as the US institutions hold the line, the requiem for the dollar may be premature.
Vasilis Trigkas is an Onassis Scholar and research fellow in the Belt & Road Strategy Centre at Tsinghua University