In a widely circulated and quoted article “Dollar Hegemony has to go” in the Asia Times, American analyst Henry C.K. Liu described how the US maintains its pre-eminent position in the global economy through the dollar.
Liu says that, it is an economics-textbook myth that foreign-exchange rates are determined by supply and demand based on market fundamentals. Economics tends to ignore socio-political factors that shape market fundamentals that affect supply and demand. The strength of the US Dollar is a vivid example to strengthen this argument.
The current international finance architecture is based on the US dollar as the dominant reserve currency, which now accounts for 65.7 % of global currency reserves, up from 51 per cent a couple of decades ago. Yet in 2006, the US share of global exports (US$ 1.14 trillion out of a world total of $ 13.7 trillion) was only 8.3 % and its share of global imports ($1.96 trillion out of a world total of $ 12.09 trillion) was 16.2 %.
DOLLAR BECOMES A FIAT CURRENCY
Towards the end of World War II, an agreement was reached at the Bretton Woods Conference that each country would adopt a monetary policy that maintained the exchange rate of its currency within a fixed value – plus or minus one per cent – in terms of gold. It was intended as a fund to support stability of currencies and trade of the post-war European allied countries. At that time Washington held the vast bulk of world gold reserves and expected to lend dollars to rebuild Europe. In 1971 US President Richard Nixon took the dollar off the gold standard and the dollar thus became a fiat currency (The term “fiat” money is used to distinguish such money from representative money, which is pegged or fixed to a quantity or mass of precious metal).
The power of the US dollar is not realistic because of the huge US current-account deficits and the status of the US as the leading debtor nation. The US national debt as of August 3, 2008 was $ 9.591 trillion against a gross domestic product (GDP) of $ 13.84 trillion. And yet the world trade is now a game in which the US mints unlimited dollars (as it is a fiat currency and need not be balanced by gold assets) while the rest of the world produces things that dollars can buy. The world’s interlinked economies no longer trade to capture a comparative advantage; they compete in exports to capture the much needed dollars to service dollar-denominated foreign debts (World Bank and IMF) 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 dollar that in turn forces the world’s central banks to acquire and hold more dollar reserves, making it stronger. This phenomenon can be termed as dollar hegemony.
OIL TO THE RESCUE
Dollar hegemony is also helped by the fact that critical commodities, most notably oil, are denominated in dollars. It is the most ingenious way for the US to make the rest of the world to believe and have faith in the paper dollar. The US viciously bullied OPEC the oil exporting cartel to sell oil for dollars only. Now countries had to keep dollars to buy much needed oil. Everyone accepts dollars because dollars can buy oil. The recycling of petrodollars is the price the US has extracted from oil-producing countries for US tolerance of the oil-exporting cartel. The Quantity Theory of Money is clearly at work. US assets are not growing at a pace on par with the growth of the quantity of dollars. US companies still represent 36 per cent of global market capitalisation.
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 essentially owns the world’s oil for free. And the more the US prints greenbacks, the higher the price of US assets will rise. Thus a strong-dollar policy gives the US a double win.
RACE TO THE BOTTOM
A strong-dollar policy is in the US national interest because it keeps US inflation low through low-cost imports and it makes US assets expensive for foreign investors. This arrangement, which former Federal Reserve Board chairman Alan Greenspan proudly called US financial hegemony in congressional testimony, has kept the US economy booming in the face of recurrent financial crises in the rest of the world. It has distorted globalisation into a “race to the bottom” process of exploiting the lowest labour costs and the highest environmental abuse worldwide to produce exports to US markets in a quest for the almighty dollar, which is not backed by gold nor economic fundamentals.
The adverse effect of this type of globalisation on the developing economies is obvious. It robs them of the meagre fruits of their exports and keeps their domestic economies starved for capital, as all surplus dollars must be reinvested in US treasuries to prevent the collapse of their own domestic currencies. The adverse impact of this kind of globalisation on the US economy is also becoming clear. In order to act as consumer of last resort for the whole world, the US economy has been pushed into a debt bubble that thrives on conspicuous consumption and fraudulent accounting. The unsustainable and irrational rise of US equity prices, unsupported by revenue or profit, has merely been a devaluation of the dollar.
THE ROAD AHEAD
The world economy, through technological progress and non-regulated markets, has entered a stage of overcapacity in which the management of aggregate demand is the obvious solution. Yet we have a situation in which the people producing the goods cannot afford to buy them and the people receiving the profit from goods production cannot consume more of these goods. The recent global food crisis is a classic example of this premise, wherein the food prices are touching the sky and yet we have farmers suffering from economic woes and committing suicides. Economics devoid of moral principles with everyone trying to outwit each other and trying to achieve ends without any consideration to the means employed will only result in a rat race towards disaster. A paradigm shift in economic thought, principles and fundamentals is the order of the day. Islam has a way out of this economic mess. Let’s free ourselves from this Dollar Raj.