Global Reserve Curse

Does it actually benefit the US to manage the Global Reserve Currency?

It's often taken as a given that the country in possession of the global reserve currency (GRC) is in a privileged position. On the surface, it seems obvious that having the ability to print the currency that everyone else uses is all upside. In particular, the difference in cost to the GRC holder to mint one unit and the cost of the goods that one unit procures is referred to as seigniorage — a kind of tax levied on the rest of the world for the privilege of doing business with the issuing country. This is so offensive to those under this regime that the French minister of finance under Charles de Gaulle, Valéry Giscard d'Estaing criticized this elevated status for the US dollar as an 'exhorbitant privilege'.

But it's not all upside for the owner of the GRC. In order to supply the world with the liquidity to run their economies, the issuing country almost by definition has to run a current account deficit (they need to buy from others more than they sell to others.) That pushes new dollars into the global economy which other countries can then use to buy oil, food, and the other necessities for their countries. Since there is no bank for all of these huge sums of outstanding balances of dollars, it also lowers borrowing rates for the US government as those dollars return home in the form of purchases of US treasurys creating a sort of virtuous circle. But this dynamic of needing to have a negative current account has consequences and the some of the externalities are borne by Americans.

In order to maximize their take when dealing with the GRC issuer, other countries depress the value of their currencies. This keeps their exports to the issuer artificially cheap which means residents of the issuing country enjoy low cost imported goods. Think TVs from South Korea or cars from Japan. The benefit to the exporting country is that the dollars they get for their exports translate into more units of their local currencies. Their exporting businesses thrive in local currency terms compared to nonexporters. At first blush this dynamic sounds like pure win for both countries until you consider what this has done to the domestic economy of the US over time. The US used to be a manufacturing powerhouse. Having its manufacturing base largely untouched by the destruction of the World Wars, the US had a powerful economy when the rest of the world needed to rebuild. We were able to manufacture and supply the rest of the world with many of the things the US now imports. Over time, the manufacturing sectors of the US economy were out competed by artificially cheaper goods from other countries. Domestic US businesses moved their manufacturing bases from the American heartland to China, Mexico, and elsewhere. The once thriving American middle class was hollowed out during the period from the 1950s through the 1990s creating the Rust Belt and other forms of wealth transfer away from middle class Americans.

It's popular to speak in deferential terms about the era of Paul Volcker and how he 'broke the back of inflation' through unpopular but effective interest rate increases effected by restricting the money supply in the 1980s. One of the underappreciated downsides of this muscular central intervention was the persistent appreciation in the exchange rate of the dollar versus other currencies as foreign investors flooded into high interest bearing US instruments. This accelerated the degradation of American manufacturing because the price of US exports rose in concert with the rise in the dollar sending domestic manufacturers into bankruptcy. A knock on effect of the flood of foreign money into the US drove the stock market into the bubble that ended in 2001 and by then the US manufacturing sector and middle class had been reduced to a mere shadow of its former self.

The US services, financial, and tech sectors throve during this period due to the low cost of capital, exacerbating wealth inequality while the interior of the country struggled with low wages and even more insidious decay like inflation and the opioid crisis. This is a perfect stew in which populism can grow as resentment of the once thriving and now degraded middle class watches as coastal elites grow ever richer. Shrewd populist politicians have plugged into this latent angst. Phenomena like what Demetri Kofinas refers to as financial nihilism are also byproducts of the sense that there is no way to thrive simply by working hard so you may as well yolo your life savings into lottery-ticket-like stock options in the hopes that one will hit and you might be able to buy a house. Without such a windfall, many people who didn't participate in the recent booms in small subsets of the economy are stuck in a kind of economic purgatory.

The unfairness of this dynamic is not lost on those in America's heartland. There is no fair balance point on the continuum of 'I get the benefits' and 'you bear the costs' which is the engine of inequality that has resulted in the current rise in populism. Reversing this political trend will require us to reverse the economic trend. The reshoring of manufacturing will go some way to reverse this dynamic but much of the reshoring will likely place the manufacturing in friendly low cost jurisdictions outside the US, so called 'friendshoring', which could leave the American middle out of the picture even in a newly reconfigured world economy.

Cryptocurrencies are a direct response to the violation of the trust in institutions that has resulted from this dynamic. Bitcoin was born after the Great Financial Crisis in 2008 by Millenials and GenZs who were disaffected by this widening gyre and were trying to escape the system by building a parallel one in the hopes that it would be more fair. The bitcoin whitepaper reads like a manifesto and, at its heart, is predicated on the idea that trust, having eroded, should not be restored but replaced with trustless mechanisms. It seems to accept axiomatically that the need to actually trust systems, institutions, or each other is the problem and proposes bitcoin as the solution. The word 'trust' appears 13 times in the whitepaper, each time as something to be minimized or circumvented. Folks like Ben Hunt of Epsilon Theory disagree. Rather than try to obviate the need for trust, they assert that the goal should be to reestablish trust starting with trust in each other and building back up to trust in our institutions.

John Maynard Keynes lost the argument with Harry Dexter White regarding whether a neutral reserve asset (bancor) should be used instead of the dollar. The SDR exists but without a deep and liquid debt market denominated in SDR, it stands as a useless artifact of Bretton Woods.

The GRC isn't just the dollar itself but it is also a delicate international dance between dollars, treasurys, and oil. It could be said that the dollar shares its GRC status with oil because it is the international trade of oil in USD, the so-called petrodollar, that grants the dollar its intrinsic exchange rate and bestows its quasi hard-money status. Treasurys could be thought of as dollars at rest, an international bank account, so to speak. Dollars themselves are only in play when value is in motion. Oil, then, is motion as value and is the final benchmark by which the dollar is measured. It’s a kind of holy trinity of dollar-oil-treasurys that is maintained in equilibrium by US Treasury, The US Federal Reserve, and OPEC+, and seems to be why Saudi Arabia can get away with literal murder without incurring US sanctions. Everything in the US geopolitical calculus seems to be subordinate to maintaining the dollar as the GRC.

In order to address the domestic inequality and existential angst that is driving populist movements and threatening the rule-of-law which supports the dollar as GRC, we might actually counterintuitively benefit from supporting a move away from the dollar as GRC. If we keep going in the political direction we're heading, we may lose the GRC anyway as civil society continues to break down in the US which may eventually push foreign money elsewhere. If that is inevitable, then we would benefit from proactively managing the transition rather than having it imposed upon us. Revenge is a b*tch and you can count on our international adversaries to take their pound of flesh in the form of reparations if the US is forced out of its global imperial role, unceremoniously.

Losing the GRC will naturally remove the ability to use the dollar as a weapon through sanctions and will effectively end the Pax Americana, if there ever really was such a thing. The world would return to an explicitly multipolar stance which would need to find a new equilibrium. Finding that new equilibrium will likely take a bumpy course so it would behoove the US to attempt to proactively manage the transition if it is indeed inevitable as I think it might be. The alternative is probably war. As Michael Kao points out in his recent conversation with Grant Williams, "in Weimar, it wasn't until France invaded the Ruhr valley that confidence in the [deutsche] mark fell off a cliff." Does the US have its equivalent of the Ruhr valley and if so are we actively working to prevent or minimize an incursion? Regardless, Kao is right that the catalyst that could crater confidence in the dollar and send the US into an economic and social tailspin is probably a geopolitical one.

National power is predicated on domestic social stability which has been slowly eroding in the US ever since the dignitaries closed the books at Bretton Woods. We're now in the late stages of the breakdown of social structures that being stewards of the GRC has caused. We can either attempt to hold on to the power, privilege, and concomitant domestic discord that that represents or we can let go gracefully and in a manner of our choosing in the hopes of rebuilding the middle class which is the foundation of our once vibrant democracy. Either way, the US is likely heading toward a new international posture where we no longer call all the shots. If we head into that new playground as a bully, we can expect an uncomfortable reckoning. We could also head in to that new circumstance as a leader and peacemaker. Do we have leaders who can stand up to domestic opposition to lead America into that new international posture?

Because I disagree with him on basically everything else, I’m slightly uncomfortable that I essentially agree with newly appointed CEA chair, Jared Bernstein who in 2014 penned an op ed calling for an end to 'king dollar'. But we essentially agree that, while it was extremely beneficial during the early decades after the Bretton Woods agreement in 1944, managing the world’s reserve currency no longer serves the American economy nor the American people as a whole and we should voluntarily relinquish it for the sake of domestic peace as well as overall international prosperity.