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The Dollar as the World’s Reserve Currency

Dennis Torigoe explores the role of the US dollar as the world’s reserve currency and the implications of Modern Monetary Theory in shaping the global economy.

| Dennis Torigoe |

The US dollar is in a privileged position in the world as the global reserve currency which dominates international trade and commerce. As the world’s reserve currency, the US can continue to print as many dollars as it needs, run massive balance of trade deficits and use it to buy the world’s goods, basically swapping our paper for their raw materials and labor. The US can continue to increase its internal and trade deficits as long as it retains this world reserve currency status.

The bottom line: The dollar as the world’s reserve currency has been both an economic blessing and a curse on the workers and people of color in the US.  The US dollar’s role as the hegemonic reserve currency allows the US to deficit spend massively on the military and wars of aggression, while funding certain reforms to quell domestic resistance through targeted programs paid for by massive deficit spending.  At the same time the US dollar is used to plunder developing countries through high interest loans( by its de facto control of the IMF and the World Bank),  to attack other countries’ sovereign currencies and engage in unequal trade with developing countries.

The dollar as the world’s reserve currency has led to the gutting of domestic industry as US corporations, riding on the massive amounts of dollars printed by the US, drive for higher profits through outsourcing manufacturing and with them factory jobs to cheaper producers in Asia and elsewhere.  This has directly contributed to deindustrialization, structural unemployment and widespread suffering for a large swath of the American people.

Not only does the US control the creation of the dollar as the world’s reserve currency, it also controls the mechanism which allows another country to use the US dollar in trade or finance, the SWIFT trade clearing system.  Through it, it has attacked countries like Iran and Venezuela though enforcing trade sanctions and caused untold suffering to the people of those countries,

The reserve currency status of the dollar allows the US to import cheap manufactured goods from other countries, particularly China, while paying for it in dollar-denominated paper or bonds. The US balance of trade deficit has soared, especially since the 1990s, as they give us real goods and we give them paper.

This cheap goods vs. paper payment has contributed to inflation being almost nonexistent, till now, from the 1990s to 2020.

Given the history of the imperialist wars, the plunder through unequal trade and economic and political aggression against the developing countries, the US owes reparations to much of the developing world which have to be repaid over time.  In our view, the only way to repay these historic debts and to raise the standard of living within the US is through unleashing massive postindustrial gains in productivity through a top to bottom reform of the present economic system.

However, we do recognize that replacing the US dollar as a reserve currency will perhaps take decades. In the interim, a Green New Deal-like program could be pivotal in accelerating the fight against climate change and the US’s advance in a post-industrial world.  However, the feasibility of such massive spending assumes the reserve currency status of the US dollar and the US’s own easy access to capital markets. Do the benefits that accrue to American workers from giant government programs come at the expense of people around the world? The answer is yes, thus the US bears a special responsibility to the rest of the world to fight climate change, inequality and injustice. As starters, the US needs to join or rejoin initiatives like the 2015 Paris Agreement, COVAX, the World Health Organization and revolutionize the character of international institutions like the IMF, World Bank, Bank for International Settlements, and the UN.

At the same time, we should seek first to promote alternatives to the US dollar’s reserve currency status and more equitable control of the world’s financial, trading and banking networks.

Commentary:

The US Dollar as the Global Reserve Currency: Is Modern Monetary Theory Only Good for Modern Imperialism?

When Representative Alexandria Ocasio-Cortez was asked how the potentially multi-trillion dollar Green New Deal was going to be paid for, she mentioned Modern Monetary Theory (MMT).  Coming into wider public view since then, it has become the answer for some on the political left to the question of how to pay for any major program proposed, from Medicare for All to Guaranteed Annual Income.

So what is this theory and how does it work, who benefits and who actually pays for what it promises?  We think it is usable by a superpower with hegemonic financial power through the use of the US dollar as the world reserve currency, benefiting the ruling class financially and politically.  It is paid for by the developing countries and their citizens forced to use the US dollar in trade and finance. And while it may give short term benefits to US workers, it creates an unsustainable global economy and prolongs the rule of the monopoly capitalists.

The bottom line: the US dollar’s role as the hegemonic reserve currency allows the US to spend massively on the military and wars of aggression, while funding certain reforms to quell domestic resistance through targeted programs and to continue to use the US dollar to plunder third world countries and engage in unequal trade.

It is one currency, one system.  They are interconnected. Given the history of the imperialist wars, the plunder through unequal trade and economic and political aggression against the developing countries, the US owes reparations to much of the developing world which have to be repaid over time.  In our view, the only way to repay these historic debts and to raise the standard of living within the US is through unleashing massive postindustrial gains in productivity through a top to bottom reform of the present economic system.

However, we do recognize that replacing the US dollar as a reserve currency will perhaps take decades.  In the interim, a Green New Deal-like program could be pivotal in accelerating the fight against climate change and the US’s advance in a post-industrial world.  However, the feasibility of such massive spending assumes the reserve currency status of the US dollar and the US’s own easy access to capital markets. Do the benefits that accrue to American workers from giant government programs come at the expense of people around the world?  As we show below, the answer is yes, and if so then the US bears a special responsibility to the rest of the world to fight climate change, inequality and injustice. As starters, the US needs to join or rejoin initiatives like the 2015 Paris Agreement, COVAX, the World Health Organization and revolutionize the character of international institutions like the IMF, World Bank, Bank for International Settlements, and the UN.

At the same time, we should seek and promote alternatives to the US dollar’s reserve currency status and more equitable control of the world’s banking networks.

Secular Stagnation Takes Hold in the US Economy

We believe that the US economy is in a period of what Lawrence Summers, the Harvard economist, calls secular stagnation.  He cites a number of factors pointing in this direction.

First of all, there has been a decrease in market-based investment demand overall, driven by a shrinking working age population which drives down investment in housing, consumer demand and production equipment.  Also driving down investment has been the lower cost and higher productivity afforded by the technology revolution.  He also argues that increased monopoly power in the US has stifled investment, as well as the refusal of the politicians to fund major infrastructure projects.  The net result has been that infrastructure spending is now one half of what it once was,

The other aspect driving secular stagnation has been the increased savings taking place in the economy.  Much more of the country’s income and wealth is going to the top economic earners, driving up the prices of assets like stocks and real estate, not into productive investments.  Moreover, because of the traumatic experience of the Great Recession of the 2009, people are themselves saving more as a cushion and banks have tightened lending rules, excluding many from purchasing homes and opening businesses.  Of course, the coronavirus pandemic has greatly increased all these factors.

What Is Modern Monetary Theory?

Modern Monetary Theory has been around for a while.  In her recent book The Deficit Myth, Stephanie Kelton, a leading proponent, cites her colleague Wynne Godley who in the late1990’s as a major inspiration for her thinking.  Basically, MMT argues that the government (in the US case, the Federal Reserve) can issue as much money to enable the Federal Government to spend as much money as it wants up to the point where economic demand in the economy outstrips the available supply of goods and services, at which point inflation and higher interest rates set in.  For a country with a sovereign currency, meaning it issues and controls its own currency, MMT believes that it can create money and the government can spend money as long as the goods and services exist for it to buy in its specific currency.

One of the major distinctions made by MMT is that unlike households and private businesses, a government with a sovereign currency does not need to balance its expenses with its revenues.  The government, as the creator and controller of the currency, can print as much money as it wants to pay off its bills.  But this means that governments without control over the currency with which they borrow or trade must use the US dollar to trade or pay off debts denominated in dollars or held by US-controlled institutions.  They are like households.  They need to get US dollars to pay off these bills.

How Does the US Ruling Class Use the Dollar as the Global Reserve Currency to Plunder the Rest of the World?

The countries that have the ability to follow MMT’s policies are the advanced capitalist countries of the world, with the US by far the most powerful.  Like households and businesses, the rest of the world has to get (through trade or borrowing) and use the major currencies of the West, mainly the US dollar but also the euro, the yen, the pound, and to a smaller extent China’s yuan, to engage in trade and finance with the US and major trading nations of Europe, Japan and China.  As we shall see, not only does the US control the creation of the dollar as the world’s reserve currency, it also controls the mechanism which allows another country to use the US dollar in trade or finance. (Unlike the US, the European countries that share the euro are a work in progress. While they share a single currency and a central bank that issues that currency, spending decisions are still made, within limits, by their individual governments.)

The US dollar is in a privileged position in the world as the global reserve currency.  After World War II, the US was the world’s most powerful military and economic power. At the post war Bretton Woods Conference, the major allied powers and other signers agreed to the US dollar as the world’s reserve currency, then pegged at US$35 to an ounce of gold.

The Conference also created the International Monetary Fund, which was to stabilize currencies vis-a-vis the US dollar through loans and the World Bank which was to help develop international trade and finance.  Both were de facto controlled by the United States in its position as the biggest contributor of financial support, with US dollars, a currency that it created and distributed as its sovereign currency.

The US Dollar as the World’s Currency for Buying Oil Shores Up its Dominance

In the 1950s and 1960s, as the world’s economic and military superpower, the US dominated the world economy in trade, finance and manufacturing. Importantly, it also dominated the trade in the world’s most traded commodity – oil.  As the US dollar was the reserve currency in the world, almost all oil produced and exported had to be bought with US dollars. This worked until the US stagflation crisis (economic stagnation AND inflation at the same time) in the early 1970s when the US unilaterally pulled out of the gold standard of US$35 being exchangeable for one ounce of gold.  With US inflation and the dollar’s devaluation — its value “floating” depending on supply and demand — the oil-exporting countries of the Middle East lost purchasing power. They rebelled with the 1979 OPEC boycott by oil producing countries, refusing to ship oil to the West, which made the price of oil quadruple, from a fixed price of US$4 a barrel to US$12 a barrel in a matter of months.  With US dollars now gushing out of the US and Europe to the oil producers in OPEC, a new agreement was signed.  In 1979, the US-Saudi Arabia Joint Agreement on Economic Cooperation, in which Saudi Arabia, the biggest oil exporter, agreed to take only US dollars for its oil and to funnel them back into the US.  This again strengthened the US dollar’s hegemony on the world economic, trade and financial scene.

Since then, the US dollar has kept its position as the only truly world currency, though it is being potentially challenged by the euro and less so by China’s yuan. (On a secular basis, the shift away from fossil fuels, including oil, and the rise of digital currencies, especially sovereign-state-supported ones, pose challenges to the US dollar’s dominance in world trade and finance.)

The US Dollar Hegemony Helps Keep Wages Down Here and Oppress Low Wage Labor Overseas

The new millennium has brought historically low inflation to the United States, especially compared with the decades since the 1970s, as can be seen by the chart below.

At the same time, the US balance of trade deficit soared, especially since the 1990s, or as MMT author Kelton says, they give us goods and we give them paper.  What happened in that period?  The US started importing massive amounts of goods from the rest of the world, particularly China.  While the US has historically exploited cheap overseas labor and raw materials, from the banana plantations of Central and South America to the sewing factories in the Caribbean and Asia, now the US was buying manufactured goods from a fast-growing Chinese economy. At least one study shows that this had the effect of dampening price inflation.  This was especially true after the period of the Great Recession of 2008-2010, when the US economy was recovering.  According to A New York Federal Reserve staff report showing the impact on trade on US prices:

Lower Chinese export prices due to WTO entry reduce the U.S. manufacturing price index by 4.9 percent, while greater Chinese export variety reduce the index by 2.6 percent. The sum of these two values indicates that the total WTO effect on the U.S. price index is 0.076, that is the U.S. manufacturing price index was 7.6 percent lower in 2006 relative to 2000 due to China joining the WTO. Note that this fall is after correcting for any overall inflation in domestic and import prices that is common across industries in the constructed U.S. price index, since common trends would be absorbed by the constant term in (33).

So we interpret this 7.6 percent fall in prices as the real impact on U.S. manufacturing prices relative to inflation. Since manufacturing is only a fraction of the U.S. economy, this seemingly large effect is notably smaller than the aggregate 6.7 percent long-run U.S. welfare increase that Caliendo et al. (2015) estimate from the 2000-2007 China trade shock.

In a period of increasing impoverishment of US workers, this meant that their real wages were buffered by this lowered inflation and thus kept their standard of living from declining even more.  The fact that most of the imports from China are consumer goods and consumer spending makes up 2/3 of our economy means that the standard of living of people in the US is increasingly dependent on the continuation of US dollar hegemony. We are using massive amounts of printed dollars to keep the goods coming.  If there ever was a sudden stop to this, our living standards could fall precipitously.  As quoted by Siddiqui, Paul Samuelson expressed his deep concern about this:

More than a decade ago, Krugman (2007: 437) noted, “The United States has a remarkably large current account deficit, both in absolute terms and as a share of GDP. At the moment the country is not having any difficulty attracting capital inflows sufficient to finance this deficit, but many observers nonetheless find that deficit worrisome. This worriers see an ominous resemblance between the current U.S. situation and that of developing countries that also went through periods during which capital flows easily financed large current deficits, then experienced ‘sudden stops’ in which capital inflows abruptly ceased, the currency plunged, and the economy experienced a major setback.”

The Walmart’s and Amazons depend on the much lower paid labor making manufactured goods from China and the developing countries as an inherent part of their business models.  This was another way that the ruling class kept pressure for wage increases down and capitalist profits higher.  The other way was US companies offshoring production of things like sophisticated electronics at a fraction of the cost of what it would be to produce in the US.  The Apple iPhone is a prime example of this,

And how does the United States pay for this massive trade deficit?  As MMT says, we get real goods, we send them paper.  Basically by printing money that the world is obliged to take as payment. China now has over a trillion dollars of US Treasury notes that it has accumulated in trade with the US, about 7% of the total foreign-held US government debt.

US Global Trade Deficit 1950-2018

Thus the US ruling class continues to reap the profits of exploiting cheap labor from the developing countries in both raw materials and in manufactured goods because of its position as the creator of the world reserve currency.

The Cycle of US Interest Rates and Currency Attacks on Developing Countries 

Federal Funds Rate 1950-2019

In 2007 Joseph Stiglitz wrote an article titled “The Asian Crisis 10 Years Later” in The Guardian, explaining the Asian Financial Crisis which began in 1997.  In it, he laid out the timeline of the crisis:

In July 1997, the Thai Baht plummeted. Soon after, the crisis spread to Indonesia and Korea, then to Malaysia. In a little more than a year, the Asian crisis had become a global financial crisis, with the crash of Russia’s ruble and Brazil’s real.

In that year, George Soros’ hedge fund, the Quantum Fund, bet heavily against the Thai baht, which had recently dissolved its peg to the US dollar. Thailand did this after the dollar strengthened, and Thailand was caught in deteriorating terms of trade and thus an inability to pay the massive loans it had denominated in dollars. That was like blood in the water to the hedge fund sharks and other currency speculators to attack the Thai baht, betting that it would quickly devalue against the dollar.  George Soros’ fund’s $1 billion bet, in fact, wasn’t the biggest of the attackers. Julian Roberts’ Tiger Fund hedge fund bet $3 billion against it.  The attacks continued through the next two years.

What were the general conditions causing this financial crisis? As Stiglitz puts it, “[B]efore the 1997 crisis, there had been rapid increases in capital flows from developed to developing countries – a six-fold increase in six years. Afterwards, capital flows to developing countries stagnated.”   He went on to say, “Indeed, the two most important lessons of the crisis have not been absorbed. The first is that capital market liberalisation – opening up developing countries’ financial markets to surges in short-term ‘hot’ money – is dangerous. The only two major developing countries to be spared a crisis were India and China, both of which had resisted capital market liberalisation. Yet today, both are under pressure to liberalise.”

We think that the cycles of interest rates play a major part in the recurring financial crises. When US interest rates decline and a weaker dollar follows, US companies use the cheap money to buy up assets in these countries and US banks push dollar-denominated loans to them.  Then the crisis hits and the foreign investments become “hot money” and flows out of the country.  At the same time, Western banks stop lending and the economic crisis intensifies in developing countries.

Korea’s experience with the 1997 Asian financial crisis is an example of Western predatory attacks against a weakening currency leading to the attempts at an economic takeover of its most valuable assets.  Korea was  forced to borrow from the IMF to cover foreign loan repayments for its major industrial companies, the Chaebol.  Among other demands, the IMF demanded that Korea “open up” its financial markets to foreign investment, allowing 55% foreign ownership of its companies (Korea dropped limits altogether), which would mean foreign, primarily U.S., control of Korea’s companies.

As one report in 2009 stated in Korea’s attempt to instill anti-takeover poison pill measures:

Domestic M&A laws have been loosened since the 1997-98 Asian financial crisis, and in 2006 activist investor Carl Icahn and hedge fund Steel Partners floated the idea of buying tobacco monopoly KT&G…in what would have been South Korea’s first unsolicited foreign takeover bid, but no official tender offer was filed.

In 2003, SK Group, parent of top mobile carrier SK Telecom…and refiner SK Energy…, clashed with Sovereign Asset Management, which unsuccessfully sought to remove its chairman.

Those cases raised a red flag to unfriendly takeover attempts and led listed companies, including Samsung and POSCO, to spend $55 billion defending their management as of end-January.

“Our country has made hostile M&A attacks easy by removing a ceiling on foreign stock investments, but it has not had any means to prevent hostile M&A,” the justice ministry said in a statement on Monday.

The US Dollar and the SWIFT International Settlement System: Weaponizing the Dollar

On November 5, 2018 Al Jazeera ran the following headline: US Treasury Secretary Steven Mnuchin told reporters that SWIFT could get slapped with sanctions if it provides services to Iranian banks blacklisted by Washington.

The article continued:

The Belgium-based Society for Worldwide Interbank Financial Communications (SWIFT) financial messaging service announced on Wednesday it was suspending access for some Iranian banks “in the interest of the stability and integrity of the wider global financial system.”

What was this about?  Another way the US uses its hegemonic position as the world’s reserve currency is its weaponization of the currency clearing system used in global trade.  Today SWIFT (the Belgium-based Society for Worldwide Interbank Financial Communications) system dominates the international trade payments system, which of course is heavily based on the US dollar,

As a whole, the US dollar is by far the currency of world trade transactions.  As Kalim Siddiqui wrote in his 2018 article “The U.S. Dollar and the World Economy: A Critical Review”:

the U.S. dollar makes up nearly 63% of central banks’ reserve currency holdings, against 17% for the euro and 2% for the yen (Siddiqui 2018a, World Bank 2017).

In the foreign exchange market, 90% of forex trading involves the U.S. dollar. At present, nearly 40% of the world’s debt is issued in the U.S.dollars (World Bank 2017, Willett and Chiu 2012).

SWIFT is basically a financial messaging system that allows its member banks to conduct payment settlements between international trade buyers and sellers,  According to Al Jazeera, the member-owned cooperative connects more than 11,000 banks, financial institutions and corporations in more than 200 countries and territories around the world.  It continues:

Think of SWIFT as the central nervous system of international financial transactions. The messaging platform enables financial institutions to send, receive and track information about financial transactions in a secure and standardised way that facilitates the smooth flow of funds across borders.

When the Trump administration wanted to punish Iran with sanctions, it used the US’ role as the world’s issuer of reserve currency as one of the ways to enforce it.  Al Jazeera states,

Countries cut off from SWIFT can be crippled financially because money transfer information can’t be forwarded to its banks.  When a country’s banks are cut off from SWIFT, it can’t pay for imports and can’t receive payment for exports… In March 2012, SWIFT agreed to not forward messages to any Iranian bank or individual that had been blacklisted by the EU. As a result, Iran’s oil exports plunged from around 2.5 million bpd in 2011 to around one million bpd by 2014.  The 2012 SWIFT ban was widely seen as instrumental in bringing Iran to the negotiating table which led to the 2015 Iran-nuclear deal.  When Iranian banks were reconnected to SWIFT following the 2015 Iran-nuclear deal, oil exports increased again.

While SWIFT is not owned by the US, it defies the wishes of the superpower at its own peril.  Al Jazeera states:

…There could be consequences if it resists US pressure to cut off Iran again. Richard Goldberg, senior adviser at the Foundation for Defense of Democracies, a think-tank, argued in this blog that in 2012, Congress authorised any president to impose sanctions on SWIFT’s board of directors (which includes executives from some of the world’s biggest banks) if it refused to disconnect Iranian banks blacklisted by Washington. 

As can be seen, the US can impose its will on SWIFT and use it as a financial weapon against its intended targets.

Europe Countering US Move on SWIFT

The US campaign against Iran and pulling out of the 2015 nuclear deal, however, has not been supported by the major countries of Europe, who rely on trade and imported oil from the Middle East and want the best deal they can get in buying it,  To have Iran cut off from supplying oil to them and trading with them is a major problem for them,  To counter the US move against SWIFT by banning Iran from it, the Europeans have attempted to set up a separate shadow trade settlement system.

On December 1, 2019, six European countries joined a barter system for the Iran trade.  As reported by TRT World, the Paris-based INSTEX, which has yet to enable transactions, functions as a clearing house allowing Iran to continue to sell oil and import other products or services in exchange, to avoid US sanctions.  Paris, London and Berlin on Saturday welcomed six new European countries to the INSTEX barter mechanism, which is designed to circumvent US sanctions against trade with Iran by avoiding use of the dollar.

As founding shareholders of the Instrument in Support of Trade Exchanges (INSTEX), France, Germany and the United Kingdom warmly welcome the decision taken by the governments of Belgium, Denmark, Finland, the Netherlands, Norway and Sweden, to join INSTEX as shareholders,” the three said in a joint statement. The Paris-based INSTEX functions as a clearing house allowing Iran to continue to sell oil and import other products or services in exchange.

This, in itself, is a step toward freeing the world from the US dollar hegemony that has lasted over 85 years.

8 replies on “The Dollar as the World’s Reserve Currency”

Dennis,

Many thanks for your insights here. In my continued attempts to understand the financial system, both US and global, I particularly appreciate the information about SWIFT and INTREX; clearly tools of management respectively for and against the US machine.

But where does your analysis leave us in terms of political strategy for activists? If we construe our advocacy for domestic programs–GND, M4A, reparations, free college etc.–as burdens to the developing world because they expand the money supply, what is it that we are for?
Surely you are not saying we have to wait “perhaps…decades,” until something happens that breaks US imperialism to really do constructive political work. How do your ideas about financial constraints square with Phil’s ideas about a stronger role for the government in empowering people-based institutions?

Thanks for any response you can give.

Hi, Dennis, my name is Luci Rios and I read your article. I’m very happy that Jose Calderon has referred me to this article, and I have so many questions. To be honest, I have not finished reading it. I have read the first 5 paragraphs because I’m a terribly slow reader.

1) I can see the logic that printing a large number of dollars will lead to inflation, but since the dollar is the World’s currency this large number of dollars will then be placed in reserve and thus not cause inflation is that what AOC is saying?
If so, why are the Republicans so opposed to deficit spending (of course, this is probably not true since they’re always willing to spend in the military. Which part of the ruling class are they representing?)

2) I wanted to ask also about free-trade agreements like NAFTA. Does it benefit Mexico if so what effect does the SWIFT have on Mexico and Canada?

3) One more question- why was the US so critical of China devaluating its currency and why would China want to do that?

L. Randal Wray is one of the world’s leading MMT scholars. In this short video [7:59], he explains the present context of reserve currencies in our international financial system. He acknowledges that the dollar and other highly desirable currencies allow their issuers to purchase more goods and services in global commerce than they sell, but accepts this as an inherent feature of a global system of floating fiat currencies. It is inevitable that, if states do not tax so much as to effectively eliminate private savings and investment, international savers (investors) will save in whatever currency they think is most secure (or diversify over a range of currencies), even if it’s not their own. IMO, the only way around this reality is creation of a new reserve currency by the collective, democratic decision of nation-states (revamping the Bretton Woods Agreement) and forcing all nations’ acceptance of same by imposing a global tax (an EFT tax would be easiest and most effective) in the new currency that, thereby, requires taxpayers worldwide to use and acquire the new currency. Once the currency and the tax are in place, the new currency will become the world’s dominate market and reserve currency. Obviously, the countries whose currencies are today preferable for savings (the US and China, chief among them) would have to “buy-in;” if genuine financial justice is to be achieved for the Global South and other underdeveloped nations. Once progressives gain power in the US, we can press China and other financial powers to join in the global democratization and reconstruction of the entire system. htps://www.youtube.com/watch?v=yioWPf-vud8.

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