Article by : Gaurav Kumar
In the recent years world politics has moved from far left to far right. With increasing nationalism, comes protectionist policies. Brexit can be a live example. Situation is aggravated with the election of US president Donald Trump. Although, Brexit was not such a big issue for the rest of the world, election of US president is; as US directly or indirectly controls/influences the world economy.
The question arises is why US has so much influence on world’s financial system?
The answer does not lie in trade, research or competitiveness but lies in single term “DOLLAR“. After world war II, major European countries were facing financial crisis. As European governments exhausted their gold reserves and borrowed heavily from USA to pay for war materials, USA accumulated huge amount of gold. This reserve gave USA significant political and economic powers following the war. We saw Bretten Woods agreements which further regulated the economic dominance of dollar with international monetary system based on fixed exchange rates. It valued the dollar at $35 per ounce of gold and rest of the economies pegged their currencies with dollar. This was the turning point in world financial system in which dominance of gold ended and dollar began.
With the currencies pegged in dollars and increase in US exports, rest of the countries needed more and more dollars to buy American goods and for rebuilding the infrastructure what was lost in the war.
Huge demand resulted in dollar shortage.
Among the big economies, USA was the only one which could have financed the infrastructure developments in Europe. As expected we saw the European recovery plan in 1948 also called as “Marshal Plan” -giving dollars to European countries to purchase imports needed to rebuild their economies. With the rebuilding of European economies, their exports increased and they didn’t need any further “marshal like” plan. For Japan too, USA came with “Dodge plan” in 1949 which was similar to Marshal plan but for Japan rather than Europe.
With the implementation of Marshal and Dodge plans, came new challenges. Dollar spread around the world exceeded the US gold reserves. USA had two choices, Either curtail the free availability of dollar leading to reduction in US exports or making dollar available without backing with gold. US federal reserves increased money supply by 340% during 1947 to 1971.
During 1971, US spent excessively on US-Vietnam war. With the election of President Nixon, it chose the second option and an executive order was passed in 1971, unilaterally terminating the rights of foreign European banks to convert dollars into gold.
He said, “We must protect the position of the American dollar as pillar of monetary stability around the world… I am determined that the American dollar must never again be hostage in the hands of the international speculators. This became known as the Nixon Shock and marked the dollar’s transition from the gold standard to a fiat currency.
With the making of dollar as international reserve, US is less likely to run out of dollars and face balance of payment crisis, But this position comes at a huge cost: American government is more likely to forego fiscal expansionary policies to maintain confidence in dollar.
Petrodollar and Petrodollar recycling
With the end of Bretton Woods agreement, USA went from being an oil exporter to importer. OPEC began discussing viability of pricing of oil trades based on a basket of currencies. This threatened American military and monetary supremacy (the two pillars of American empire). President Nixon’s administration had huge influence on Saudi Empire and began discussions to Price oil sales only in dollars.
The pricing of oil in dollars had indirect benefits for USA, as the surplus generated by the oil exporting countries was reinvested in USA only. This reinvestment in US government securities, bonds and purchase of US weapons came to be known as Petrodollar Recycling. With the increase in dollar use, US increased military bases in middle eastern countries to protect them from enemy neighbours. The fee for the “protection” further increased the process of Petrodollar recycling.
This process makes it possible for western banks of developed countries, International lending institutions and Arab banks to lend dollars to less developed economies. Developed countries of Europe, Japan and the United states buy oil from the Oil Exporting countries. Further, less developed countries pay for oil import, goods and services from the money borrowed from these western banks and the International lending institutions. The process of Petrodollar recycling is complete when Oil exporting countries again deposit their dollars in these western commercial banks in the form of cash and investments.
It is easy to observe that this led to win-win situation for both western countries and Arab nations.
Why is Dollar in threat?
Even though Europe and Asia saw huge economic growth, dollar dominance continued. In fact countries which exported goods and services to USA and Europe, continued to buy more dollars and US securities to maintain their exchange rates for exports. This led to further spread of dollar. Countries like China, USA, Russia, South Korea, Saudi Arabia, India hold more than 10 trillion dollars of US treasuries and bonds. After 2008 financial crisis, USA went for Quantitative easing by supplying 800 billion dollars to global dollar supply. If dollar was not accepted as a “global currency”, it would not have been possible to go for such quantitative easing policy. So, any threat to dollar dominance is a direct threat to US influence and military.
US spends more than 600 billion dollars on its military which is more than the military budget of next 10 countries combined. So, no country has the courage or military might to challenge US domination.
The only way someone can challenge USA is by challenging dollar. Some countries like Libya and Iraq tried to challenge US dollar and trade in gold. We all know how this ended. They soon saw “democracy” coming.
Due to complete control on world financial institutions, USA enjoyed as sole super power of the world. Those countries who refused to dance as per the tunes of USA saw sanctions. Due to economic sanctions Iran was unable to trade in dollars. Those companies which tried to help Iran by surpassing dollars were sanctioned further. This huge influence comes due to “dollar” domination.
Rise of china
China saw double-digit growth for three decades and surpassed US economy in ppp terms. Its foreign reserves is more than 4 trillion dollars. China and India’s dollar demand added more dollars in the global supply than US did.
China is building big infrastructure projects throughout the world under OBOR (one belt one road) umbrella. This is reducing US and its allies influence significantly. Russia, China and Iran started using their domestic currencies for trade among them. China wants to promote Yuan as an alternate currency for global trade, reserve and for the countries participating in OBOR.
BRICS countries introduced New development bank to trade in their local currencies and bypass dollar. Venezuela recently introduced cryptocurrency backed by its oil reserves for trade to surpass US sanctions. This seems to be motivated by China. Pakistan also allowed Yuan to be used as freely convertible currency for trade through CPEC corridor.
My point is no country can challenge USA militarily, and thus, China is attacking dollar and promoting Yuan as an alternative.
Since China surpassed US as the largest importer of crude oil in the world, it has introduced PetroYuan challenging Petrodollar. China has been buying oil fields in Russia and is also planning investing in Aramco’s IPO which is to be introduced later this year. According to some reports, China plans to use Yuan for future crude oil trade. Being the largest buyer of crude oil in the world, most of the oil exporting nations will probably bow down to Chinese pressure. If Petroyuan becomes successful, it will be huge blow to the dollar. As I explained above, if dollar goes down US goes down. Even the european banks and world’s financial institutions will go down and China will create an alternative for every US institution.
I doubt US will allow this. They will oppose it at any cost, even if it means war.
Recently we saw Trump pressurizing China by going for trade war. Russian diplomats were expelled from US and Britain. Economic sanctions for Iran is on the way. Pakistan is pressurised by financial institutions like IMF and organisations like FATF. Last week US blocked Americans from investing in Venezuelan cryptocurrency. Many European nations are planning to boycott Russian olympics. Yesterday US banned 7 Pakistani firms citing dangers of nuclear proliferation.
Whatever happens, US won’t allow any challenge to its dollar dominated financial system. If dollar fails, US falls. Dollar is a Fiat currency backed by nothing but trust that US will secure it at any cost. US will go to any extent to protect this, even if it leads to world war III.