Exorbitant Dollar Privilege

1. How the US Dollar Replaced Gold

2. Of Debt, Debt and Exorbitant Privilege

3. Looking for reasons to be worried?

4. How the U.S. Has Weaponized the Dollar


Part 2 Dollar Privilege Predictions

 

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Yalta Was About Money

 

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How the US Dollar Replaced Gold

1) US WW 2 foodstuffs and arms to the Axis grew the  economy and moved most Axis gold to the U.S.  2) Gold was valued at $35 per ounce and after the war, other currencies were a little undervalued in terms of gold. This  allowed countries to sell natural resources and the few goods they produced to the large U.S. market at low prices. 3) U.S. manufactures didn't mind because England, France, Germany and Japan had lost much of their industrial base and produced little for export. With little world competition U.S. exporters had Oligopoly power. This power allowed U.S. exports to be priced at a relatively high price resulting in high profits for US companies and high salaries for workers.  4) US loaned dollars to exporting nations which were returned for high quality U.S. manufactured goods plus private and public financial assets. 5) Eventually the Marshal Plan added even more dollars into the world currency system which also flowed back to the US. And only the U.S. could print dollars. This was acceptable as long as the US could convert dollars to gold at  $35 per ounce. This dollar exchange standard worked for two decade.

2. The value of the convertible dollars became problematic during the 1960's because of these US deficit problems.

President Johnson's war on poverty: Job training, Direct Food Assistance and Direct Medical Assistance for about four million poor people. Specific programs include Head Start, Job Corps, Food stamps, Medicaid, Student Financial Aid.

 Vietnam War borrowing cost of $500 billion and

Countries were unhappy using the U.S. dollar. Why?

3. The US gold reserve of $30 billion were already backing much more in existing dollars and the U.S. government refused to raise taxes to slow US economic activity, slow inflation and protect the dollar.  US inflation put international pressure on the dollar which caused massive gold outflows. This resulted in the Nixon Shock which severed the dollar link to gold and eventually creating a floating value for gold. The US thus had fiat money system. A new negotiated gold value for the was needed.

4. To cushion the shock on U.S. exporters, a 10% surtax on all imports was instituted.

Britain continued to prop up the pound against a currency market that clearly wished a lower value. Markets simply did not want Britain's prestigious value, yet successive Chancellors* fearing a sterling collapse, refused to allow it to float freely. In 1976, the Chancellor of the Exchequer called in the IMF to help arrest persistent runs on sterling. On the advice of the IMF, the Chancellor imposed austerity measures, which reduced inflation and improved economic performance. The IMF’s loan was never fully drawn. The pound recovered – but only temporarily. Against a background of rising unemployment, the famous “Winter of Discontent” of 1978 sounded the death knell for the Labor government. In 1979, the Conservatives under Margaret Thatcher won the election.  Many fear U.S. debt may cause the US dollar to have the same fate.

Japan soon increased the Yen's value against the dollar by 7% meaning the US dollar price of Japanese goods had increased by 17%. Others would be forced to follow. Eventually individual countries negotiated an increase of the dollar value of their currencies by 3% to 8% depending on their US negotiation power. The dollar price of gold was also increased by 9%. So US imports became more expensive by 12% to 17% and import prices decreased by the same amount. In 1973 the value of the weaker dollar was set at $42 and then allowed to float with other currencies. This meant Bretton Woods finally collapsed. Nixon was happy because printing dollars to pay for stuff was now allowed. No gold needed.

5. Nixon also abolished the International Monetary Fund’s international capital constraints that had allowed Arab oil producers to recycle their petrodollars into New York banks. The global ‘Petrodollar’ was born and the overseas dollar was becoming the world's currency. This massive invasion of petro dollars into the US Banking System would end up in a world economy that really didn't need them. Easy money was here to stay. Deep-Do-Do would result from international loan bad debts.

See Long Decline-the Great British pound, Plaza Accord Smithsonian Agreement

   
 

 

 

Of Dollars, Debt, and Exorbitant Privilege


Advantages of overvalued dollar for U.S. were cheap energy, cheap imports including foreign travel, low interest rates on all US debt including mortgages and cheaper foreign expansion by US companies. Disadvantage is high valued dollar hurts competitiveness of U.S. exporting companies, companies that compete with imports and anyone working for these companies.

In 2016 the US, a debtor nation brought in $180 billion more than it paid out.  China, a creditor nation paid out $50 billion more.  source

See Economic Normality 1945-2015   page 2   and World Changed and Good Jobs Disappeared 
 

On the Supply of, and Demand for, U.S. Treasury Debt

What’s good for the global economy (and for many Americans) is bad for U.S. manufacturers and their workers as their products suffered a permanent price disadvantage. For them, the global dollar is not a privilege. It’s a stubborn curse. Since 1976, the United States has not had one annual trade surplus. The New Normal of ever  increasing manufacturing wages was over, another New Normality had begun.  It’s trade deficits were not the result of poor U.S. competitiveness. In reality, our deficits were required to supply the world with a currency for international trade and investment. The many advantages of being the world's currency would continue and  politicians began looking for solutions to work force problems caused by Free Trade. Source

3. Looking for reasons to be worried?

U.S. companies are warning that currency fluctuations are weighing on their results, raising a red flag for investors heading into the thick of the second-quarter earnings season, Akane Otani reports. A weaker dollar benefits U.S. multinationals by making exports cheaper to foreign buyers and also making their overseas profits look bigger when translated back into the U.S. currency

But strong economic growth, stable inflation and the Fed's plan to gradually raise short-term interest rates is boosting the greenback. The WSJ Dollar Index, which gauges the U.S. currency against a basket of 16 others, rose to 88.63 Tuesday, its highest level in more than a year.

The Dollar Underpins American Power. Rivals Are Building Workarounds. 5/19

U.S. friends and foes, looking to buck American control over international trade, are developing alternative systems. The catalyst was the Trump administration’s decision to again impose trade sanctions on Iran, Justin Scheck and Bradley Hope report.

  • The U.K., Germany and France are fine-tuning a system to enable trade with Iran without using dollars.
  • India wasn’t happy either. It began using a similar alternative system in November.
  • China and Russia are striking deals to trade with yuan and rubles instead of dollars.
  • Global trade runs on dollars and resulting clout has long made allies and enemies vulnerable to U.S. trade sanctions. Dollar’s dominance will continues but recent reactions to Trump may diminish the U.S.’s power to impose its policies.

China’s Currency Catch-22

Exorbitant Privileges Continues because the dollar has not faced any significant competition from  the Japanese Yen, English Pound , Euro, and Chinese Renminbi because of their weak economies and weak government in relation to US. The Special Drawing Rights (SDR) system of the International Monetary Fund has not gained traction. For now, no alternatives exist. Current system is unsustainable according to those experts believing the system favors the United States too much. Alternatives will emerge to correct imbalance existing since the 1971 Nixon shock. Source

But Rivals Have a Way to Go

\

Readings

Positive Dollar Privilege Prediction

China, Russia poised to ditch US dollar for
direct payment system in bid to limit sanctions fallout 11/22/18

Advantages and Disadvantages of Exchange Rate Systems

Exorbitant Privilege: The Rise and Fall of the Dollar
85 min video by author Professor Barry Eichengreen

The Dollar’s Privilege Is a Terrible Thing to Waste
Steven Englander, Bloomberg View

Dollar Privilege Prediction 3/24/18

" How Tax Reform Will Net the U.S. Big Returns"

In 1971, Nixon suspended convertibility of the dollar to gold, effectively ending the Bretton Woods system.
But even after this, Dollar Privilege Continued.

Tyranny of the US Dollar?

Loss of U.S. economic dominance has  been aided by Trump's lowering our place as Leader of the Free World. This when the U.S. dollar continues its dominate role as does American Exceptionalism.

The European Central Bank the dollar makes up two-thirds of both international debt and global reserves. Oil and gold have long been priced in dollars. Iran, North Korea, and Russia and other developing are terror stricken by the loss of dollar needed to finance the global payments system.

The dollar hegemony may be weakening. Political leaders are pushing back. Paying for European goods bought from European  companies should be in Euros, not dollars. China recently challenged the dollar supremacy with a  Yuan-based oil futures contract Russia all but eliminated her US  dollar based investments  because she perceived wreaking dollar.

 

Upsetting US Actions

 Pressuring non-US companies trading with Tehran.

 Editor's Note: While most of this by political Trump's posturing and return posturing by our economic adversaries. Foreign leaders posturing began when de Gaulle threw a fit. See Russia, China Rivals or Adversaries?

 

International Monetary System (%)

 

 

 
 

The Dollar May Be Knocked off Its Pedestal

America’s competitors, friend and foe, have opportunities to challenge the U.S. currency.
 

The consensus answer of no is too complacent.

Developments in foreign-exchange markets during the past 18 months point toward dedollarization.

1. Chinese “petroyuan” crude-oil futures, launched last year in Shanghai, now sits right behind Brent and West Texas Intermediate in trade volume.

2. The world’s central banks bought more gold last year than at any time since President Nixon took the U.S. off the gold standard in 1971.

3. Markets recently learned that China added gold to its reserves for the fifth month in a row.

4. U.K., France and Germany created a new payment-processing system to permit payments to Iran.

5. Russia shifted $100 billion of dollar-denominated reserves into Chinese yuan, Euros and Japanese yen, as it did last year.

Presidents Obama and Trump increase in sanction is the immediate cause of dedollarization.

1. Braking US sanctions on Iran and Cuba cost French bank BNP Paribas a $8.9 billion US Justice Department fine in 2014
plus a one-year suspension in use of US international banking system.

2.  European Commission President said: “It is absurd that European companies buy European planes in dollars instead of Euros.”

3. As America buys less international crude oil and the Chinese buys more, oil exporters may begin to accept other currencies. Oil companies in Russia, Iran and Venezuela have already begun accepting yuan. Were Saudi Arabia to join them, the effects could be substantial.

4. Political polarization, continuing tax cuts and an expanding federal safety net mean increased U.S. fiscal and current account deficits which  are a good leading indicator, with a two-year lag, of dollar weakness.

By the early 1970's, the pound sterling, once the world's proximate reserve currency, accounted for just under a third of global sovereign reserves. By the end of that turbulent decade, it was less than 1/20th.

Persistent talk of a shift away from the dollar began in the 1970s, but habitual dollar use remains high—everywhere. Nevertheless, the emergence of a genuinely multi-polar world, [which America First will accelerate] means the coming market cycle is likely to be different. The U.S. dollar may finally be knocked off its pedestal.

Mr. Mahtani is a strategist at Investec Asset Management

 

How the U.S.

Has Weaponized the Dollar

 

Satyajit DasBloomberg News

 

"(Bloomberg Opinion) -- Convinced of an existential threat from competitors, America is weaponizing the dollar to preserve its global economic and geopolitical position.

History

While the U.S. accounts for about 20 percent of the world’s economic output, more than half of all global currency reserves and trade is in dollars. This is the result of the 1944 Bretton Woods agreement, the effect of which was enhanced when the link between the dollar and gold ended in the 1971 Nixon shock, allowing America to control the supply of the currency.

The dollar’s pivotal role — an “exorbitant privilege,” in the term coined by then French Finance Minister Valéry Giscard d'Estaing in 1965 — allows the U.S. easily to finance its trade and budget deficits. The nation is protected against balance-of-payments crises, because it imports and services borrowing in its own currency. American monetary policies, such as quantitative easing, can influence the value of the dollar to gain a competitive advantage.

But the real power of the dollar is its relationship with sanctions programs. Legislation such as the International Emergency Economic Powers Act, the Trading With the Enemy Act and the Patriot Act allow Washington to weaponize payment flows. The proposed Defending Elections From Threats by Establishing Redlines Act and the Defending American Security From Kremlin Aggression Act would extend that armory.

More Weapons

When combined with access it gained to data from Swift, the Society for Worldwide Interbank Financial Telecommunication’s global messaging system, the U.S. exerts unprecedented control over global economic activity.

 

 

Targets

Sanctions target persons, entities, organizations, a regime or an entire country. Secondary curbs restrict foreign corporations, financial institutions and individuals from doing business with sanctioned entities. Any dollar payment flowing through a U.S. bank or the American payments system provides the necessary nexus for the U.S. to prosecute the offender or act against its American assets.

This gives the nation extraterritorial reach over non-Americans trading with or financing a sanctioned party. The mere threat of prosecution can destabilize finances, trade and currency markets, effectively disrupting the activities of non-Americans.

The risk is real. BNP Paribas SA paid $9 billion in fines and was suspended from dollar clearing for one year for violating sanctions against Iran, Cuba and Sudan. HSBC Holdings Plc, Standard Chartered Plc, Commerzbank AG and Clearstream Banking SA have paid large fines for similar breaches.

Secondary sanctions made it difficult for United Co. Rusal to refinance dollar borrowings when global businesses, banks and exchanges were forced to stop dealing with the Russian company. Its bonds and shares plunged, even though the company sells only 14 percent of its products in the U.S., does not use American banks, and is listed in Moscow and Hong Kong. ZTE Corp., a Chinese electronics company, was hit hard by the inability to buy essential components from suppliers because of sanctions for trading with North Korea and Iran. In these cases, the entity was not in violation of laws where it was domiciled or operated, and the proscribed acts took place outside the U.S. 

The Competition

China, Russia and increasingly Europe want an alternative reserve currency system. The problem is that immediate replacement of the dollar is difficult.

First, the euro, the yen, the yuan and the ruble are not realistic options. The euro’s long-term future and stability isn’t assured, while Japan’s economy remains trapped in two decades of torpor. The Chinese and Russian political and economic systems lack transparency, and the yuan isn’t fully convertible.

Second, the required change in infrastructure is daunting. Foreign-exchange markets where the dollar is the currency of reference would have to be fundamentally restructured. Deep and liquid money markets to support a reserve currency can’t be conjured up overnight.

Third, most candidates are reluctant to take on the role of a global reserve currency because of tensions between national and global economy policy. The economist Robert Triffin pointed out that the country whose medium of exchange is the global reserve currency must meet external demand for foreign exchange. This necessitates running large trade deficits, requiring fundamental changes in the mercantilist policies of Germany, Japan and China.

Conclusion

This means that the U.S. can continue to use the dollar to help further its trade, financial and geopolitical aims, largely outside the strictures of international laws and institutions and without the need for messy, unpredictable military campaigns. As John Connally Jr., Richard Nixon’s Treasury secretary, put it in 1971: The dollar is “our currency, but your problem.”

 

To contact the author of this story: Satyajit Das at sdassydney@gmail.com

To contact the editor responsible for this story: Paul Sillitoe at psillitoe@bloomberg.net

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Satyajit Das is a former banker whose latest book is "A Banquet of Consequences." He is also the author of "Extreme Money" and "Traders, Guns & Money."

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