A Crisis to Shatter the World

Saturday, 11/10/2007 10:59

If the US won’t swap Dollars for gold, the rest of the world will just have to make the exchange itself…

THE PRESIDENT of FRANCE went to Washington this week. He spoke to Congress en Français and told the United States to stop dumping Dollars on the rest of the world, risking a global financial crisis.

Zut alors! Sounds just like old times…

The Dollar cannot remain solely the problem of others,” said Nicholas Sarkozy before a joint session of Congress on Wednesday. He was riffing on the (infamous) joke made by John Connally, Treasury Secretary to Richard Nixon in the early ’70s.

Connally had told the world that the Dollar was America’s currency “but your problem.” Au contraire, replied Monsieur le President this week.

If we’re not careful,” Sarkozy went on – apparently using “we” to mean both himself and the US Congress – “monetary disarray could morph into economic war. We would all be its victims.”

Ooh la la! Did Sarkozy need to take a little Dutch courage before speaking his mind to US legislators and wonks? (As the Belgian news anchor in this clip from June’s G8 summit puts it, M.Sarkozy only ever drinks lots of water.) Telling the US to take responsibility for its actions – and its currency – is a gambit for only the brave.

It weighs heavy with history, too. “What the United States owes to foreign countries it pays – at least in part – with Dollars that it can simply issue if it chooses to,” barked French president Charles de Gaulle in a landmark press conference of Feb. 1965.

“This unilateral facility contributes to the gradual disappearance of the idea that the Dollar is an impartial and international trade medium, whereas it is in fact a credit instrument reserved for one state only.”

De Gaulle did more than simply grumble and gripe, however. Unlike Nicholas Sarkozy, he still had the chance to exchange his dollars for a real, tangible asset – physical gold bullion – at the Federal Reserve.

Gold “does not change in nature,” de Gaulle reminded the world in that 1965 speech. “[Gold] can be made either into bars, ingots, or coins…has no nationality [and] is considered, in all places and at all times, the immutable and fiduciary value par excellence.”

How to collect and hoard this paragon of assets? Back in the 1950s and ’60s, world governments could simply tip up at the Fed, tap on the “Gold Window”, and swap their unwanted dollars for gold.

So that is exactly what de Gaulle did.

Starting in 1958, he ordered the Banque de France to increase the rate at which it converted new Dollar reserves into bullion; in 1965 alone, he sent the French navy across the Atlantic to pick up $150-million worth of gold; come 1967 the proportion of French national reserves held in gold had risen from 71.4% to 91.9%. The European average stood at a mere 78.1% at the time.

“The international monetary system is functioning poorly,” said Georges Pompidou, the French prime minister, that year, “because it gives advantages to countries with a reserve currency.

   “These countries can afford inflation without paying for it.”

In 1968, de Gaulle then pulled out of the London “Gold Pool” – the government-run cartel that actively worked to suppress the Gold Price, capping it in line with the official $35 per ounce ordained by the US government. Three years later, and with gold being air-lifted from Fort Knox to New York to meet foreign demands for payment in gold, Richard Nixon put a stop to de Gaulle’s game. He stopped paying gold altogether.

De Gaulle called the Dollar “America’s exorbitant privilege“, repeating a phrase of his favorite economist, Jacques Rueff. This privilege gave the United States exclusive rights to print the Dollar, the world’s “reserve currency”, and force it on everyone else in payment of debt. Under the post-war Bretton Woods Agreement of 1946, the Dollar could not be refused.

Indeed, alongside gold – with which the Dollar was utterly interchangeable until 1971 – the US currency was real money, ready cash, the very thing itself. Everything else paled next to the imperial Dollar. Everything except gold.

And today?

Printing a $100 bill is almost costless to the US government,” as Thomas Palley, a Washington-based economist wrote last year, “but foreigners must give more than $100 of resources to get the bill.

“That’s a tidy profit for US taxpayers.”

This profit – paid in oil from Arabia…children’s toys from China…and vacations in Europe‘s crumbling capital cities – has surged since the Unites States closed that “Gold Window” at the Fed, and ceased paying anything in return for its dollars.

Now the world must accept the Dollar and nothing else besides. So far, so good. But the scam will only work up until the moment that it doesn’t.

“The US trade deficit unexpectedly narrowed in Sept.,” reported Bloomberg on Friday, as “customers abroad snapped up American products from cotton to semiconductors, offsetting the deepening housing recession that is eroding consumer confidence.

“Exports have reached a record for each of the past seven months, the longest surge since 2000,” the newswire goes on, which “may help explain why the Bush administration has suggested it’s comfortable with the Dollar’s drop. It has declined in all but one of the past five years, even as officials say they support a ‘strong’ Dollar.”

What Bloomberg misses, however, is the surge in US import prices right alongside. They rose 9.2% year-on-year in October, the Dept. of Labor said on Friday, up from the 5.2% rate of import inflation seen a month earlier.

Yes, the surge in oil price must account for a big chunk of that rise – and the surge in world oil prices may do more than reflect Dollar weakness alone. The “Peak Oil” theory is starting to make headlines here in London. Not since the Club of Rome forecast a crisis in the global economy in 1972 have fears of an energy crunch become so widespread.

But if you – an oil producing nation – were concerned that one day soon your wells might run dry, wouldn’t you want to get top dollar for the barrels you were selling today? Especially if the very Dollar itself was increasingly losing its value?

“At the end of 2006, China’s foreign exchange reserves were $1,066 billion, or 40% of China’s GDP,” notes Edwin Truman in a new paper for the Peterson Institute. “In 1992, reserves were $19.4 billion, 4% of GDP. They crossed the $100 billion line in 1996, the $200 billion line in 2001, and the $500 billion line in 2004.”

What to do with all those dollars? “If all countries holding dollars came to request, sooner or later, conversion into gold,” warned Charles de Gaulle in 1965, “even though such a widespread move may never come to pass…[it] would probably shatter the whole world.

“We have every reason to wish that every step be taken in due time to avoid it,” the French president advised. But the step chosen by Washington – rescinding the right of all other nation-states to exchange their dollars for gold – only allowed the flood of dollars to push higher.

Nixon’s quick-fix brought such a crisis of confidence by the end of the ’70s, Gold Prices shot above $800 per ounce – and it took double-digit interest rates to prop up the greenback and restore the world’s faith in America’s paper promises.

The real crisis, however – the crisis built into the very system that allows the US to print money which no one else can refuse in payment – was it merely delayed and deferred? Are we now facing the final endgame in America’s post-war monetary dominance?

If these sovereign wealth funds – owned by national governments, remember – cannot tip up at the Fed and swap their greenbacks for gold, they can still exchange them for other assets. BCA Research in Montreal thinks that “sovereign wealth funds” owned by Asian and Arabian governments will control some $13 trillion by 2017 – “an amount equivalent to the current market value of the S&P500 companies.”

And if China doesn’t want to buy the S&P500 – and if Congress won’t allow Arab companies to buy up domestic US assets, such as port facilities – then the sovereign wealth funds will simply swap their dollars for African copper mines, Latin American oil supplies, Australian wheat…anything with real, intrinsic value.

They might just choose to Buy Gold as well. After all, it remains – “in all places and at all times…the immutable and fiduciary value par excellence,” as a French president once put it.

Charles de Gaulle also warned that the crisis brought about by a rush for the exits – out of the Dollar – might just “shatter the world”. It came close in January 1980. Are we getting even closer today?

 

Adrian Ash is director of research at BullionVault, the physical gold and silver market for private investors online. Formerly head of editorial at London’s top publisher of private-investment advice, he was City correspondent for The Daily Reckoning from 2003 to 2008, and is now a regular contributor to many leading analysis sites including Forbes and a regular guest on BBC national and international radio and television news. Adrian’s views on the gold market have been sought by the Financial Times and Economist magazine in London; CNBC, Bloomberg and TheStreet.com in New York; Germany’s Der Stern; Italy’s Il Sole 24 Ore, and many other respected finance publications.

See the full archive of Adrian Ash articles on GoldNews.

Please Note: All articles published here are to inform your thinking, not lead it. Only you can decide the best place for your money, and any decision you make will put your money at risk. Information or data included here may have already been overtaken by events – and must be verified elsewhere – should you choose to act on it. Please review our Terms & Conditions for accessing Gold News.

A Multipolar Reserve Currrency: US Dollar Alternatives

14:58
if you’re looking ahead of the elections
15:00
do you think that the outcome of the
15:01
elections either way
15:03
would influence foreign policy going
15:05
forward and as a result
15:07
foreign countries decisions to hold more
15:09
or less gold
15:11
absolutely i mean we’re working on a
15:13
report right now
15:15
on the implications of the election for
15:17
for gold and precious metals
15:19
uh and you have like four different
15:22
scenarios on how things
15:23
shake out but definitely i mean you know
15:26
this
15:27
administration has um
15:30
excelled in its ability to reduce the us
15:34
stature around the world
15:36
and to create hostile relationships with
15:39
countries around the world
15:41
it’s had a negative effect on cpm group
15:43
because
15:44
there are people who don’t want to deal
15:46
with u.s companies
15:49
and and so i think a change in the
15:51
administration
15:53
while it wouldn’t be a 180 degrees turn
15:55
because
15:56
there are people in the democratic party
15:58
including joe biden
15:59
who will probably retake retain would
16:02
retain
16:03
some sort of hostile posture toward
16:06
china
16:06
it may be less hostile than the current
16:09
one and it may be less hostile toward
16:11
canada
16:12
and and other countries around the world
16:15
so you should see
16:17
if you saw a change in the
16:18
administration and a change in the
16:20
senate
16:20
you should see some improvement in the
16:23
u.s relations with
16:25
the rest of the world but there’s been a
16:27
tremendous amount of damage
16:30
done to the u.s stature globally
16:34
and it’s probably not going to get
16:36
changed by one
16:37
by a change of government for four years
16:40
do you think the us dollar then going
16:42
forward could lose its status as a de
16:45
facto reserve currency of the world
16:47
because you see another currency
16:49
challenging that status
16:51
as i said the part of the problem is
16:53
that the u.s owes the world so much
16:55
it owns it we have 62 percent of
16:58
monetary reserves
17:01
the u.s dollar will lose its stature
17:04
as the reserve currency in the future
17:08
the future may be 50 years from now and
17:12
it is it not it is reversible
17:15
this could not happen if the u.s
17:18
government got its act together but i
17:19
have
17:20
no hopes for that well if the u.s if the
17:23
u.s loses that status
17:24
who’s what’s going to take over who or
17:26
what well i was getting to that
17:28
as i said earlier most central banks in
17:31
the world
17:32
see as an ideal a multi-polar
17:36
international currency regime they
17:38
understand that it will take
17:40
decades to get there because of the
17:42
imbalance and liquidity between the
17:44
dollar and
17:44
all of the other currencies in the world
17:47
yeah
17:48
62 percent of their money of their forex
17:51
is in dollars that means that there’s
17:53
only 38 percent and everything else
17:55
they have to slowly make that transition
17:58
away
17:59
no government wants to see
18:02
its currency replace the dollar as the
18:05
reserve currency
18:06
what they’d like to see is a multi-polar
18:09
international currency regime
18:11
where people are free and companies and
18:14
governments are free
18:15
and there’s sufficient liquidity in
18:17
non-dollar currencies
18:19
that you can own and hold a portion of
18:22
your wealth
18:24
in those other currencies a greater
18:26
proportion of it
18:27
no one like if you talk to the chinese
18:29
central bankers if you talk to
18:31
other central bankers in around the
18:34
world
18:34
no one expects the dollar to disappear
18:37
as a
18:38
quote de facto reserve currency
18:41
but they‘d like to see it disappear as
18:43
the de facto current
18:45
reserve currency but they’re fully aware
18:48
that this is something that’s going to
18:50
take decades to execute
18:52
if it can be done okay you brought up
18:55
china i’m surprised to see that china
18:57
was relatively low on the list
18:59
when you’re talking about their
19:00
percentage of foreign reserves
19:02
in gold holdings it’s only four percent
19:04
of the foreign reserves in gold
19:06
are you surprised at how low that number
19:08
is
19:09
no um i’m not surprised i
19:12
i should ask you why you’re surprised
19:14
that it’s high
19:15
but you know china that should the
19:18
people’s bank of china for
19:20
decades had a view that gold was a small
19:22
and insignificant portion of its
19:24
monetary reserves
19:26
it changed that view in 2015 at a time
19:29
when it rolled out
19:30
a massive acceleration of
19:33
its efforts to make the rmb
19:37
more of an international currency it’s
19:39
still not you know fully convertible
19:41
but they expanded the daily trading
19:43
ranges and they expanded the longer term
19:45
trading ranges that they found
19:47
acceptable on the rmb
19:49
they started encouraging rmb
19:52
bonds offshore being issued offshore
19:56
and they said okay we’re adding some
19:59
gold to our reserves and we’re going to
20:01
continue to buy gold because
20:02
we see gold as a small but significant
20:05
part of our monetary reserve policy
20:08
going forward
20:08
now this was in 2015 and it’s very
20:11
important to understand that that was
20:13
after 2008 and 2009 when the u.s
20:16
treasury
20:17
basically stuffed everybody else and
20:20
protected
20:21
the bankers or the executives at the
20:23
banks uh
20:24
in the us and and so this was a direct
20:27
reaction
20:28
to the inappropriate behavior that the
20:31
us
20:32
treasury had during the financial the
20:34
global financial crisis
20:36
uh and and the chinese central bank
20:39
basically said we have to accelerate our
20:41
effort
20:42
to help move toward that multi-polar
20:45
currency
20:46
regime that we all would like to see in
20:48
the long run
20:50
uh and so they started adding their goal
20:52
if you go back to 2015
20:54
they probably had about 1.1 1.3 percent
20:58
of their reserves in gold so the fact
21:01
that it’s up to four percent
21:02
and the fact that they have like three
21:04
trillion dollars of dollar reserve
21:06
of of foreign exchange reserves means
21:08
that it’s going to be a slow transition
21:10
as they add gold to it and as i said
21:12
they’re very price sensitive
21:14
they pulled out of buying gold for about
21:16
15 months a few years ago
21:18
then they came back and they were buying
21:20
but then they pulled back at the end of
21:22
2019
21:23
and they haven’t reappeared they said
21:25
you know in the past they said
21:27
we’ll buy gold below a thousand when
21:29
gold went over a thousand they
21:31
didn’t buy any gold for several years
21:33
then they increased their threshold
21:35
and they knew they were buying uh and
21:37
then when the price started rising this
21:39
year they said no
21:40
you know we’re going to wait finally
21:41
jeff with everything that’s happened
21:43
this year and in particular with the um
21:46
central bank activity or slowdown of
21:48
central bank buying activity
21:49
do you think the run-up of gold prices
21:52
to two thousand dollars
21:53
all-time highs has made sense to you do
21:55
you think valuations are
21:57
correct as they should be right now yeah
22:00
i think they are
22:01
uh you know obviously the trend of the
22:04
next year or two is going to depend on
22:06
several things the outcome of the us
22:08
elections for the senate as well as the
22:10
presidency
22:11
brexit is coming up the pandemic which
22:14
is getting worse in europe now and is
22:16
expected to get much worse in the united
22:18
states
22:18
there are a lot of negative factors
22:20
there uh that fully support the idea of
22:23
a two thousand dollar
22:24
gold price now i wouldn’t be surprised
22:27
to see the price of gold
22:28
spike up higher on a short-term basis uh
22:31
then maybe plateau depending on what
22:33
happens politically
22:35
uh but we expect higher prices later
22:37
like
22:38
2023 2025 because
22:41
none of these things are being solved
22:43
would you have a long-term price target
22:45
in mind
22:47
we’re looking at a gold price that is
22:50
very significantly higher than it is
22:53
today
22:54
all right perfect jeff jeff i want to
22:57
thank you so much for uh speaking with
22:58
me today that was a fascinating talk
23:00
thank you for your time thank you for
23:02
your time
23:03
and thank you for watching kiko news
23:05
we’ll have much more coverage for you
23:06
at the denver gold form stay tuned
23:34
you

What are the ingredients which Suggest a Financial Crisis?

@RaoulGMI identified the following factors contributing to a crisis, before Coronavirus:

  1. Stocks: Largest Equity Bubble of All Time: (Pension Crisis & Buyback Bubble)
  2. Demographics:
    • Largest Retiree Wave, all wanting to sell stocks and bonds at the same time
    • Millennials are too poor and indebted (make 20% less than parents)
  3. Corporate Credit: Largest Credit Bubble of All Time
    • ($10 Trillion + Off balance Sheet = 75% of GDP)
  4. Student Loan Bubble:
    • $1.6 Trillion
  5. Auto Loan Bubble
    • ($1.2 Trillion)
  6. Indexation Bubble
  7. ETF/Market Structure Bubble
  8. Foreign Borrowings (Dollar Standard Bubble)
  9. Monetary Policy Bubble (The Central Bank Bubble)
  10. EU Banking Crisis
  11. A Trade War:
    • The Trade Wars “shattered” supply chains
  12. Coronavirus
    • Largest Supply & Demand Shocks of all Time

 

Big Picture:

Central Banks have been fighting for the last 20 years:

  • Full Scale Debt Deflation and a Solvency Crisis

Turns into:

  • A loss of confidence in the Dollar Standard and the Entire Financial Architecture

(page 29-30)

Peter Schiff VS Brent Johnson: The Future Of The US Dollar

In this video from VRIC 2020 Peter Schiff and Brent Johnson debate about the future of the fiat money specifically US Dollar and the gold standard.

Peter Schiff believes the US market has never been as overvalued and over priced. And one of the major warning signs is we blew up the private equity market. This decades dot.com bubble is the private equity market destruction. This destruction will lead to the decline of the US dollar and eventually a remonetization of gold as the dollar loses its place as the Worlds Reserve Currency.

Peter Schiff’s theory is that Central Bankers around the world are under the false impression that a cheap currency is a good thing because it allows them to export more to the United States. However, the US is broke and can never pay for what it’s buying.

And since America is the largest debtor nation in the world and have more debt than other major countries combined and manufacturing is such a small portion of the US economy, there is a complete dependency on foreign goods.

And Relative to Wealth producing components of GDP no other country on earth has as much debt as the United States.

Add in contingency guarantees such as bank accounts, pensions, brokerage accounts that the US government is committed to funding despite the lack of money to pay for these things.

Combine all of this together and there is the potential for a currency crisis the likes the world has never seen. Schiff thinks this because there is an unrealistic level of belief for the US Dollar.

Schiff thinks the dollar will perform worse than other fiat currencies around the world and that we’re going to remonetize gold as the central asset.

Brent Johnson ultimately believes the same ending but with a different theory on how it will all go down.

Brent’s theory is that MMT is that the government will spend more money into existence and the central banks will want to control of the monetary policy. And that the dollar will go up and people will continue borrowing and buying which will ultimately lead to a massive currency crisis.

Every country in the world has over leveraged their economy and Brent Johnson believes that Central Bankers in every country are making the same bad bets across the world.

Brent Johnson makes note of The Plaza accord and that it was put in place in 1986 to artificially weaken the dollar against the other worlds Fiats because it was too strong. He argues that the dollar will be the the worlds central currency until fiat fails.

Schiff’s theory is “Money Is Nothing” and the value is the production and real goods that a country has. Money just lets you divvy up whats been produced. The wealth of the nation is the productive capacity of that nation.

Schiff also believes that in order to have a strong country you need:
*Factories
*Skilled Workers
*Production

Which are things that the US severely lacks and will pay a massive price for the over dependence on countries that do have these things.

The Canadian economy will benefit from a resource and precious metals boom that will help the Canadian dollar.

Schiff on inflation: Inflation initially pushes up asset prices before consumer prices.

Brent believes that digital currencies could be the future of money and likely will be implemented by most countries in the near future.

Brent and Peter agree that The Gold Standard will happen after a general loss of confidence in fiat currency.

Schiff explains MMT Modern Monetary Theory as the practice of taking Quantitative easing to the extreme. Printing Money without creating prosperity. Democrats will rely on the central bank to fund their spending agenda.

Repo rates have spiked to 9% – the market wants rates higher but Americans have so much debt and American can’t afford to service the debt. And international banks have been accessing the FED repo market to a greater extent than the US domestic markets. Repo rates spiking shows a demand for funding from the US dollars.

Americans have so much debt that the US government has to keep rates low other

Marin Katusa postulates that the highest risk lies in the credit market with debt in triple BBB

Trump’s Trade Levers Test Long-Term U.S. Alliances

President’s threats against Mexico and others can work in the short run, but global rules could be strained

President Trump’s threat to hit Mexico with tariffs over immigration is the latest and most dramatic step in the weaponization of international economic levers.

In the short run, these moves may serve the U.S. interest. But in the long run, they could do the opposite, by emboldening everyone to ignore international conventions and rules that reserved tariffs and sanctions for specific purposes. The U.S. may also find its “soft power,” the ability to get other countries to cooperate out of shared mutual interest rather than threat, diminished.

Mr. Trump is not the first president to use trade levers to achieve unrelated goals. Congress has granted the president authority to do so in successive statutes, starting with the Trading with the Enemy Act of 1917. These laws enabled Presidents Roosevelt to declare a bank holiday in 1933, Nixon to impose a 10% tariff on foreign imports and Reagan to sanction Nicaragua.

But Mr. Trump’s trade maneuvers have been different in several ways. First, the extent is unprecedented: Last year, he used national-security justifications to impose tariffs on steel and aluminum imports, even from allies, and is threatening the same with autos. He then doubled tariffs on Turkish steel to force that country to release an American pastor. He has imposed new sanctions that would severely penalize any foreign or U.S. company that does business with Iran. A new order barring U.S. companies from doing business with China’s Huawei Technologies Co. because it could be a conduit for spying is ensnaring foreign companies as well.

“There’s nobody like this in the last century,” said Gary Hufbauer, a trade expert at the Peterson Institute for International Economics.

Second, the president has used these powers to achieve narrow goals with little connection to the economic imbalances or national-security threats for which they were intended. In 1985, Mr. Reagan imposed sanctions on Nicaragua using the International Emergency Economic Powers Act of 1977, the same authority Mr. Trump invoked for his tariffs on Mexico. But the U.S. regarded Nicaragua as a hostile client-state of the Soviet Union. Similarly, Mr. Reagan imposed sanctions on construction of a natural-gas pipeline from the Soviet Union to Western Europe for fear it would make American allies vulnerable to Soviet economic blackmail.

Mr. Trump’s actions don’t flow from an overarching geostrategic vision: His tariffs on imports of steel, aluminum and, potentially, autos are designed primarily to shore up favored domestic industries. His threat toward Mexico came because he says it hasn’t done enough to stem the flow of Central American asylum seekers traveling north to the U.S. border. And while his tariffs on China and his sanctions on Huawei superficially resemble Mr. Reagan’s efforts to contain the Soviet Union, Mr. Trump’s calculus is more transactional. He has suggested, for example, that the case against Huawei, which U.S. officials say is motivated by national security, might be dropped as part of a trade deal.

In the near term, these tactics can work. His assumption that other countries will prioritize retaining access to the U.S. market has generally proved correct. Mexico has so far been restrained in responding to his tariff threat. Though U.S. allies haven’t joined its sanctions on Iran—designed to halt all its nuclear activity and support for Syria’s government and groups the U.S. considers terrorists—the threat of American penalties has dissuaded their companies from resuming business there. As a result, Iran’s economy is cratering. Similarly, several Western European companies have suspended business with Huawei even as their governments don’t view it as the threat the U.S. does.

Yet in the long term, these actions, with other trends, likely will weaken ties between the U.S. and its allies and the security and leverage all derive from acting together.

The Pew Research Center has found a growing share of Republican voters, like Mr. Trump, are skeptical that openness to the world or deference to allies serve U.S. interests. And many countries are moving in a similar direction. Nationalists now govern India, Israel, Brazil, the Philippines, Poland, Hungary and Italy, and Chinese President Xi Jinping espouses a more bellicose, China-first agenda than his predecessors. Because they define national interest in the same transactional terms as Mr. Trump, they are more likely to defy the U.S. if it suits their immediate needs. The Philippines, for example, has courted Chinese investment, and Italy has welcomed Huawei. Despite Mr. Trump’s personal fondness for Indian Prime Minister Narendra Modi, India has sought to circumvent the U.S. crackdown on trade with Iran, while the U.S., unhappy with Indian protectionism, has withdrawn tariff preferences from India.

Even countries still ideologically allied with the U.S. will question the value of doing deals if, as with Mexico, they fail to prevent unilateral punishment for nontrade matters.

“As Trump shreds international trust in the U.S., friendly countries have to start preparing Plan Bs: alternatives to relying on America,” said Robert Zoellick, the U.S. trade representative under George W. Bush and later World Bank president. “This shift won’t occur overnight, but the erosion is increasing rapidly, and the negative dynamic weakens U.S. influence.”

The Iran sanctions are an early sign of this diminished leverage. Other countries, tired of how the U.S. uses the dollar’s role in global payments to enforce unilateral sanctions, are devising workarounds. The U.K., Germany and France are building an alternative payments system for dealing with Iran, which has meanwhile begun expanding its stockpile of enriched uranium.

The political trends weakening U.S. leverage with the world are compounded by economic trends. Since 1985, the U.S. share of global gross domestic product has shrunk to 24% from 35%, while China’s has grown to 16% from 3%. This means other countries have less to gain by cooperating with the U.S. and more to lose from antagonizing China.

If U.S. tariffs, real and threatened, shrink trade and investment flows, that would further diminish economic incentives to cooperate, while also weakening the constituencies in other countries favoring openness and integration with the U.S.

But that argument can’t be applied to other countries targeted by Mr. Trump. Aaron Tornell, a Mexican-born economist at the University of California, Los Angeles, noted that since the 1980s, Mexico has turned away from left-wing isolationism toward liberalized markets and closer cooperation with the U.S. on trade and security issues such as narcotics. Advocates in Mexico of this integration argued American presidents and big business would prevent the U.S. from using its enhanced leverage to punish Mexico.

Mr. Trump’s policies could “destroy the political foundations of a country that has been following liberal economic policies for the last 30 years and give more power to those who want to be like Venezuela,” Mr. Tornell said.

The Risks in Overusing America’s Big Economic Weapon

Alienated nations will be moved over time to establish alternatives to the U.S.’s systems and markets

But there is a real underlying risk that by deploying and using its economic weaponry so frequently the U.S. will, in the long run, drive others, friend and foe alike, away from its economic orbit. “These are not zero-cost options,” says Robert Hormats, former under secretary of state for economic affairs and an adviser on international economics for presidents going back to Richard Nixon.

Imposing tariffs on China and other nations trying to send their goods to the U.S. not only raises the prices of those products for Americans, it also gives targeted nations an incentive to develop markets, and long-term trade ties, in other countries.

At the same time, those foreign nations can retaliate by cutting purchases of American goods, or by slapping retaliatory tariffs of their own on American products, making them less competitive, as China has just announced it will do. The Chinese may find other countries to provide, say, wheat and soybeans, and in doing so develop lasting, non-American trade ties.

If the U.S. develops a reputation as an unreliable supplier, countries will turn to our competitors, and, when sanctions end, earlier supply chains will be difficult to restore,” says Mr. Hormats.

.. Similarly, there is a danger the U.S. is providing both allies and adversaries an incentive to find ways around using the American financial system as the wiring for international commerce.

For now, there are few alternatives to using American banks for clearing international transactions. As a result, enemies find they can be shut out of much international commerce by crossing the U.S. and being slapped with American sanctions.

But it isn’t just enemies. Friends also know their companies can be isolated if they don’t heed American wishes to shut down commerce in countries on the American black list. The risk of losing access to the financial system is a powerful motivator.

Yet overuse of this threat could compel other counties—including the very allies whose cooperation the U.S. seeks in applying financial pressure to the bad guys—to find alternatives to using dollars and American banks. Mr. Hormats notes that this “is not easy to do now, given the dollar’s pre-eminent role, but over time such overuse could eat away at the dollar’s role and hence U.S. leverage.

Indeed, there are signs that others are seeking alternatives to the dollar and the American-led financial network. The European Union is trying to set up its own payment system to allow oil companies and businesses to continue trading with Iran despite American sanctions. China has made clear it would be happy to lead a different international finance system and use its currency as an alternative to the dollar.

Similarly, 11 Pacific Rim allies have moved ahead with their own new trade bloc after the U.S. pulled out of the Trans Pacific Partnership trade deal.

America remains the big kid on the economic block, but it isn’t the only one. The danger is that it could come to be seen as the bully who tries to intimidate the other kids once too often, persuading them to join together to find ways around him.

 

The Fed and the Professor Standard

The central bank needs new voices that will speak up for a stable dollar, which leads to prosperity.

Real income for America’s bottom 90% reached an all-time high in 1999, and at the time Pew Research found that 81% of Americans agreed that free enterprise was a major reason for the country’s success in the 20th century. By June 2015, however, Gallup reported 47% would vote for a socialist.

What happened? Real income for the bottom 90%, as measured for the World Top Incomes Database, declined after 1999 and never rebounded. Two terms each of Republican and Democratic administrations failed to end this stagnation, which says all you need to know about why Donald Trump was elected president. Now wages are rising at robust rates—above 3% a year—thanks to cuts in taxes and regulation, with the largest wage increases going to low-wage workers. And the Federal Reserve has been itching to raise interest rates.

The Fed still operates on the “professor standard,” enshrined with Bill Clinton’s nominations of pure academics. Their textbooks say strong economic growth, particularly strong wage growth, causes inflation, which Fed policy should temper. Both the Bush and Obama administrations perpetuated the professor standard, and both presided over incom

Ending that stagnation is one goal that unites the political spectrum. But do we really expect that to happen under the professor standard? The academics’ favorite tool, the Phillips curve, tells them wage growth that is too strong can cause an outbreak of 1970s-style inflation, as former Fed Chair Janet Yellen alluded in her 2010 Senate confirmation hearing.

I have a different perspective. The professor standard doesn’t work, and the Fed needs new voices to argue for an approach that does.

The 1980s and 1990s brought prosperity across the board. This success was driven by a voting bloc of Fed governors, such as Wayne Angell and Manley Johnson, who favored a stable dollar and were able to swing the consensus. The dollar is a unit of measure—like the foot or the ounce—and keeping units of measure stable is critical to the functioning of a complex economy. The result of their stable-dollar policy was prosperity.

.. Since the Federal Reserve Act of 1913, there have been three distinct periods of sustained dollar stability:

  • 1922-29,
  • 1947-70 and
  • 1983-99.

During these periods, real growth of gross domestic product averaged 3.9% a year and real income growth for the bottom 90% averaged 2.2%, according to calculations done by Rich Lowrie, senior economic adviser to my 2012 presidential campaign. During distinct periods of sustained dollar volatility—in 1913-21, 1930-46, 1971-82 and 2000-15, real GDP growth averaged only 1.9% and real income for the bottom 90% declined by an average of 1.3% annually.

The prosperity of the 1980s and 1990s gave way to stagnation precisely because dollar stability gave way to volatility. Blame the professor standard. Demand for dollars is determined globally on a real-time basis, but the Fed has preferred to look largely at domestic lagging indicators in determining supply. The frequent resulting mismatches cause dollar volatility, which the professor standard then dismisses as transitory.

America’s future prosperity, and especially the end to income stagnation, depends on getting this distinction right. The Fed has the tools to stabilize the dollar. The open-market desk can buy bonds to counter a downward trend in commodity prices and sell bonds to arrest an upward trend, resulting in ongoing stability in the dollar’s commodity value. The only thing missing are voices like Messrs. Angell’s and Johnson’s to advocate for it. If confirmed by the Senate as a Fed governor, I will speak up for dollar stability.

Last September the professor standard led Fed governors to pick up the pace of quantitative tightening and stick to its plan of rate hikes. Never mind that commodity prices were falling, meaning the dollar’s commodity value was rising, a market signal of deflationary pressure. Meanwhile, the forward outlook for industrial production and retail sales indicated signs of slowing rates of growth. This combination of slowing growth and a rising dollar is a deflationary slowdown. These are the worst conditions under which to raise interest rates, yet that’s what happened, not once but twice, presumably because wage growth was deemed “too strong.”

Markets rightly sent the Fed a strong signal to back off, prompting three subsequent dovish pivots. If the Fed listens to markets after the fact, why not listen to them before?

This mistake is not new. Had the Fed responded appropriately to the dollar’s commodity value at the turn of this century, it wouldn’t have tightened the U.S. economy into the 2000 deflationary slowdown, and technology speculation would have resolved itself without taking down the entire economy.

Had the Fed reacted to the dollar’s commodity value coming out of that recession, it wouldn’t have inflated the real-estate bubble, which led to the 2008 financial crisis. After June 2008, the dollar’s skyrocketing commodity value was screaming that there was a sudden, huge, global scramble for dollar-based liquidity. Unfortunately, the market’s cry fell on deaf ears, apparently because the signal hadn’t yet registered in the Fed’s lagging employment and consumer-price indicators. This deflationary pressure ignited the financial inferno that began in September 2008, yet the Fed didn’t begin quantitative easing to put out their fire until that December.

If Congress responds only after a crisis, the Fed’s record indicates it listens to markets only after enough damage has already been inflicted. The results of that policy look even worse in contrast: Show me a financial crisis that happened in America while the dollar’s commodity value was stable.

We need new voices at the Fed that understand stable money and know how to interpret important market signals—and that means breaking the professor standard. Monocultures tend to be fragile, but is the Fed so closed off that it can’t handle challenges to its models or the assumptions that feed them? So fragile it can’t consider that the economy is driven by production, not consumption, and that the dollar’s commodity value is important to the real investment that fuels production? I hope not.

The best way to achieve full employment, price stability, economic growth strong enough to solve our fiscal problems, and sustained income growth for the striving majority is for the Fed to stabilize the dollar. The professor standard will not challenge itself—that much has been proved. That’s why my voice is needed at the Fed.