The Dollar Is Not As Strong As It Seems

The green bill’s structural weaknesses foretell of a decline in its predominance.

Money is a symbol of power, prestige, and the influence of a nation. As economist Robert Mundell said, “Great powers have great currencies.” Since World War II, the dollar has represented the economic and military power of the United States. It even seemed that the dollar had gotten over the crisis, since it had started to increase in value. This relevant strengthening made people think that the dollar had recovered its throne. However, its structural weaknesses are more significant than people think.

The reality is that its use and presence is in decline. The numbers show it. For 10 years, the green bill has been losing weight in the official reserves of the central banks. In 2014, it dropped from the psychological barrier of 60 percent, a level lower than in the 1990s. At the start of the 21st century, the pivotal point of U.S. power, dollar holdings peaked at more than 70 percent of world reserves. One must analyze this decline with caution. It is not the first time that the dollar has lost vigor. It happened before at the end of the 1960s and at the beginning of the 1970s, when the U.S. broke with the Bretton Woods gold standard and saw its trade balance record a deficit with Europe, and above all Germany, and in the 1980s, when the Japanese emergency threatened to cast a shadow on the lights of New York.

However, on both occasions, U.S. power recovered, and the dollar was maintained as the “primus inter pares.” The dollar’s predominance was supported by the two pillars that have sustained any monetary system since the origins of money. The issuers of a currency — historically sovereign — must have both legitimacy and force to impose the use of their money. The monopolized use of violence is important to preserving the fulfillment of the order, but that violence, like printing money, cannot be arbitrary because otherwise, the system collapses. That is why it is just as necessary to have a legitimate transmitter.

The United States maintained the monopoly of violence — it was the world’s police — just as much as the legitimacy to use it as the leader nation up until the Iraq war in 2003 and the global recession of 2008, hard knocks to the two pillars that sustained the dollar’s dominance. This still persists. It’s because of this that when Lehman Brothers went bankrupt, the investors sought refuge in the greenback and not in the euro, the dollar’s rival foreign currency that has neither a centralized political authority nor military power that it exercises any right over. But it is true that the war in Iraq and the recession have damaged the image of the United States.

United States military policies in the Middle East are a failure. The region is embroiled in great instability, and with the energy revolution, it is very probable that the United States is becoming desensitized to the zone’s problems.

More importantly, in the past when there were imbalances in the monetary system, the United States could demand that its protected partners, like Germany and Japan, change their macroeconomic policies — which value their currencies, for example — in order to alleviate tensions. The U.S. could not do this with China, the new emerging power, since it does not depend on U.S. military protection. Rather, the opposite is true. China considers itself a regional economic and military power. All of this shows that “the police,” in places of importance, like the Near East, are doing a bad job, and are starting to have serious rivals in Asia.

Meanwhile, the economic crisis of 2008 has debilitated U.S. leadership, although much of Europe thinks otherwise. Over the decades, with the globalization of the financial sector, numerous crises have occurred, but they occurred on the periphery: in Mexico, Asia, Russia, Brazil and Argentina. This time, however, the crisis originated with Wall Street, the center of the system, but perhaps the most surprising thing was that the medicine that was used to attack the hemorrhage was the same one that for many years was considered counterproductive. Instead of cutting public spending, privatizing and deregulating, like the Washington consensus demanded of the peripheral countries, the United States did the complete opposite. It applied an expansionary monetary and fiscal policy, rescued the banks and the car industry, and — modestly — restricted financial regulations.

Paradoxically, this policy, although necessary in order to overcome the crisis, has damaged the legitimacy of the United States in the world. Many of the elite financiers from emerging countries think that Washington measured itself differently. This has made people question the three basic rules the United States has promoted during decades of governing the international monetary system.

Washington, supported by Brussels, has always maintained that the desirable macroeconomic framework was the full opening of capital markets, freely floating currency, and the independence of central banks. In the aftermath of the recession, these three rules are being violated, which means the United States is losing its leadership.

South Korea and Brazil have followed China and again applied capital controls. In the war of currencies, the active intervention (in the BRICS) or passive intervention (via quantitative easing in the U.S. and Japan) in the foreign exchange market is the order of the day. Even Switzerland, a country that has always followed the rules of the dollar system blindly, won’t let the Swiss franc appreciate more than $1.20 ahead of the euro. Finally, even the independence of the central banks is in question. There are many that think that the Federal Reserve, the Bank of England, and the Bank of Japan act under the pressure of their sovereigns to monetize their debts. Even the Central European Bank, the most independent of the central banks, squints at Berlin and Paris. Despite the German resistance, it is likely that in 2015, the eurozone will enter fully into the war of currencies with quantitative expansion to further depreciate the euro.

All of this confirms that the military and economic power of the United States is weakening, and one can see this in the instability of the monetary system. This is not to say that the dollar’s dominance is going to disappear. Like on other occasions, U.S. power can recuperate. The United States has enormous strongholds, and if quantitative easing, a risky experiment, does not create another recession, its credibility could recover, but the most likely outcome is that we will continue to see a slow decline in the dollar’s dominance, and new competitors will surge onto the market, like a stronger euro and Chinese yuan. For some, a multipolar system is more stable than the current system since it would generate greater competence and efficiency. History, however, says otherwise. Periods of interregnum are not stable, unless, of course, the different powers reach an agreement that makes everyone happy.