How the US has Plundered the World - The Dollar Hegemony

This article is first in a series in which I will go into the reasons behind the current predicament of the global economy, for the benefit of my friends who are only now beginning to pay attention to what's happening.

The topic of this post was an inspiration from a recent news item in Reuters quoting an article published in the Chinese state newspaper People's Daily. Finally the world is waking up to the US's scam.

The biggest reason behind the current collapse in the world economy is the unstable and heavily mismanaged reserve currency system used for trade throughout the world - the US Dollar. So why is the supposedly most advanced and powerful nation on earth "mismanaging" its currency? Well, as we'll see, it's managed quite well from the perspective of those benefiting the most from it, i.e., the elite in the US economic and power structure, but mismanaged from the perspective of almost everybody else in the world. The mismanagement stems from the regime of irredeemable currency - a topic requiring a whole another blog post(s) by itself. Here I will talk about the historical context in which the dollar became irredeemable, i.e., delinked from Gold, and how this allowed the US to manipulate the currency to its significant advantage - a free lunch to US at the expense of the rest of the world.

Henry C K Liu of Asia Times has done a splendid job of explaining how it all happened and the mechanism of the dollar "hegemony" in this article "PART 2: The US-China trade imbalance". I am posting only the relevant part here, but the entire article is worth a read:

In 1950, the United States imported US$11.4 billion of goods and services and exported $12.7 billion, for a foreign-trade total of $24.1 billion, constituting a mere 7.3% of a gross domestic product (GDP) of $329 billion. There was no trade with China because of a Cold War embargo by the US. The US trade deficit for 1950 was $1.3 billion, which came to an insignificant 0.4% of GDP. It was an amount the US could easily sustain as World War II had left the country the richest and most productive economy in a war-torn world.

Also, at that time the US was the world's only creditor nation, with a gold-backed dollar serving as a reserve currency for international trade as mandated by the Bretton Woods international finance architectural regime. The gold-backed dollar with fixed exchange rates ensured that war debts incurred by US allies would be duly paid back without dilution. Thus a US trade deficit was quite necessary for restoring a world economy severely damaged by war. And the dollars that the surplus trading economies received were returned to the US to pay for war debts but not to buy US assets, as foreign-exchange and capital controls were the order of the time. The minor payments imbalance was paid with a transfer of gold holdings between the trading economies. There was no foreign-exchange market beyond government exchange windows. In that arrangement, dollar hegemony was not a serious problem, as cross-border flow of funds were strictly controlled by all governments and the US was obliged to redeem dollars with gold.

The end of the Cold War in 1991 enabled the globalization of deregulated financial markets to allow cross-border flows of funds to be executed electronically with no restrictions for most economies. Since then, a huge foreign-exchange market has grown to more than $2 trillion of daily volume around the benchmark of a fiat US dollar. The reserve-currency status of the dollar has not been based on gold since 1971, but only on US geopolitical prowess, which managed to force all key commodities to be denominated in dollars. Finance globalization since 1991 has allowed the US to become the world's biggest debtor nation, with the largest trade and fiscal deficits, financed by a fiat dollar that continues to serve as a key reserve currency for not only international trade but, more important, for international finance.

Imbalance of payments and debt bubble:

Dollar hegemony emerged after 1991 to allow the US to neutralize persistent trade and fiscal deficits that otherwise would lead to an imbalance of payments between it and its trading partners by erasing the payments imbalance from its trade deficit with a US capital-account surplus.

Separate from the trade deficit, the US fiscal deficit is financed by the Federal Reserve's monetary-easing policies to increase the money supply, causing an asset-price bubble that can absorb the rising debt without altering the debt-equity ratio, causing de facto but stealth inflation, renamed as "growth". This phantom growth is touted by neo-liberal economists as the reason foreign investment is attracted to US assets. What dollar hegemony does is to transform the dollar-denominated payments imbalance of the United States into a dollar-denominated debt bubble in the US economy. Holders of US debt and assets are rewarded with high nominal returns provided by a high growth rate reflecting rising asset prices denominated in money that constantly loses purchasing power.

World trade is now a game in which the US produces dollars by fiat and the rest of the world produces things that fiat dollars can buy. The world's interlinked economies no longer trade to capture a comparative advantage; they compete in exports to capture dollars needed to service dollar-denominated foreign debts and to accumulate dollar reserves to sustain the exchange value of their domestic currencies.

To prevent speculative and manipulative attacks on their currencies, the world's central banks must acquire and hold dollar reserves in corresponding amounts to their currencies in circulation. The higher the market pressure to devalue a particular currency, the more dollar reserves its central bank must hold. This creates a built-in support for a strong US dollar that in turn forces the world's central banks to acquire and hold more dollar reserves, making it even stronger. This phenomenon is known as dollar hegemony, which is created by the geopolitically constructed peculiarity that critical commodities, most notably oil, are denominated in US dollars. Everyone accepts dollars because dollars can buy oil. The recycling of petrodollars is the price the United States has extracted from oil-producing countries for US tolerance of the oil-exporting cartel since 1973.

Ironically, as oil-producing economies benefited from a suddenly rise in the price of oil denominated in dollars, they developed a need to preserve the value of the dollar. Thus three conditions brought about dollar hegemony in the 1990s:
#In 1971, US president Richard Nixon abandoned the Bretton Woods regime and suspended the dollar's peg to gold as US fiscal deficits from overseas spending caused a massive drain in US gold holdings (The US basically defaulted on its gold payment obligations to the rest of the world - GG).
# Oil was denominated in dollars after the 1973 Middle East oil crisis, followed by other key commodities.
# Deregulated global financial markets began to emerge in 1991 after the Cold War, making the cross-border flow of funds routine.

A general relaxation of capital and foreign-exchange control in the context of free-floating exchange rates made speculative attacks on currencies regular occurrences. All central banks have since been forced to hold more dollar reserves than they otherwise need to ward off sudden speculative attacks on their currencies in financial markets. And dollar reserves by definition can only be invested in US assets. Thus dollar hegemony prevents the exporting nations from spending domestically the dollars they earn from the US trade deficit and forces them to finance the US capital account surplus, thus shipping real wealth to the United States in exchange for the privilege of financing US debt to further develop the US economy.

The US capital-account surplus in turn finances the US trade deficit. Moreover, any asset, regardless of location, that is denominated in dollars is a US asset in essence. When oil is denominated in dollars through US state action and the dollar is a fiat currency, the US in essence owns the world's oil for free. And the Quantity Theory of Money dictates that the more the US prints greenbacks, the higher the price of US assets will rise. And by neo-classical definition, a rise in asset value is not inflation as long as wages lag behind. Thus a strong-dollar policy gives the United States a double win while workers everywhere, including those in the US itself, are handed a double loss.

Through dollar hegemony, the US, unlike many Third World nations with similar trade and fiscal deficits, has been granted immunity from associated penalties of payments imbalance by having its trade deficit finance its capital-account surplus. But instead of reforming the fundamental structure of the US economy that creates such trade and fiscal deficits, many in the United States are seeking painless yet pointless solutions to a non-existent payments imbalance by engaging in irrational disputes over the issue of currency exchange rates of its trading partners, first Japan and Germany decades ago, and now China.

On top of this monetary scam, the US wants to push the exchange rate of the dollar further down to erode the value of the massive dollar holdings of its trading partners, as the exchange rate of the dollar affects only those who live, operate in or visit non-dollar economies. Because the Fed can print fiat dollars at will under a dollar-hegemonic regime, a dollar-denominated US trade deficit does not present a balance-of-payments problem for the United States, as it does all other countries that cannot print dollars. Thus a US trade deficit, being not a balance-of-payments problem, cannot be cured through manipulation of the exchange rate of the dollar. The solution has to come from reducing wage disparity between the two trading economies.

So basically, after it stopped being Gold-backed in 1971, the dollar effectively became "oil-backed" - oil the USA did not own, as opposed to the Gold it did (really, though, it came to be "backed" by any commodity that was traded in dollars) which allowed it to maintain it's status as the world's reserve currency. This biggest single factor has allowed the US to maintain its supremacy (read Empire) over the rest of the world and usurp all the resources in the process, alongwith stealing (purchasing power) from workers everywhere.