We’ve been writing about dedollarisation here for some time.
Russia and much of the world have been seeking to dedollarise for a while. In the wake of the Russian military operation in Ukraine, one of the outcomes of countersanctions by Russia against the US and the rest of the west is them being forced to use the Russian Rouble to buy oil and gas.
This does something Russia has wanted to do for a while: reduce US dollar hegemony.
When it comes to what we often call dollar hegemony one can get all technical (and often wrong) or we can make things much more simple.
I prefer simple.
So, here’s what dollar hegemony means in simple (and accurate within limits) terms.
Some necessary assumptions:
- 1) Inflation is a general increase in prices within an economy. Economists differ in the following, but my training is that inflation is a decrease in the value of a currency.
- 2) If there is no increase in the amount of currency in circulation within an economy and there is no increase in productivity then there can be no inflation. Inflation is based on the supply of money within an economy.
- 3) If productivity increases (output of the economy per unit labour) at the same rate as the supply of money then there will be no inflation.
As we know, the money supply in the United States has been growing, and the rate of growth has been accelerating hugely in recent years, but even 20 years ago we could see that the money supply was growing faster than productivity was rising. (Increase money supply by 10% per year and productivity by 7% per year and the result will be 3% inflation.)
The US in various forms recognised the issue. It was why the US came off the gold standard and closed the gold window.
The only way to keep inflation lower than would be expected when productivity does not increase to match is to move money out of the national economy to ‘some other place’. There are tricks that can be employed, but they are short-term and limited in scope.
Clever people in the USA understood the issue. Moving off the gold standard solved the problem of having to pay out ever more dollars per unit of gold but only gave a very short respite. So, the clever people came up with a cunning plan. They came up with a way to permanently export US dollars from the national economy to the rest of the world. The plan was to tie the dollar to Saudi Arabian oil.
The Saudis got stuff in return, but they agreed to not sell oil in Riyals (Saudi currency) but in dollars. So, every country that wanted to buy Saudi oil needed to buy (import) US dollars which limited the number of dollars in circulation in the US national economy. This, in turn, kept inflation at bay – of course, not entirely!
Of course, over time, the dollar became ever more the default currency, after all, every nation had huge bundles of dollars sitting in central bank accounts and this made the process of keeping domestic inflation even more effective.
I will not go into the macroeconomic effect of this process on the global economy, but it has been huge!
OK, so that’s the WHY of dollar hegemony. There are hundreds of entire books written on the topic so please do not criticise me on any point that is generalised for simplicity and brevity!
Dollar hegemony is akin to a drug for the US economy. As soon as one stops taking the drug, the withdrawal effects are painful and possibly fatal!
Every time a barrel of oil is paid for in a currency other than the dollar, those dollars end up, with some delay, back in the US national economy. Each of those dollars serves to increase the money supply within the economy and, from our assumptions, we know that this results in inflation.
The only way to keep those dollars away from the US economy is to keep international purchasing payments in dollars.
I will ignore the fact that even for the exported dollars (often called petrodollars) there are limits because stability depends upon continued economic growth worldwide to ensure that more and more dollars are used in international trade.
The United States is fully aware of the need to keep exported dollars away from the national economy. It has been the cause of wars and regime change. However, it could be seen a couple of decades ago that the process of dollar export was finite. At some point, the export would slow. The slowing of dollar export is good enough to wreck the US national economy. As long as there is less demand for exported dollars than the production of dollars then inflation starts to rear its head.
So, today, what is happening?
I described the current events in respect of US and EU sanctions on Russia as a black swan event – an unpredicted, but a not unpredictable event that causes a rapid and unforeseen change.
For nations to attack another country’s central bank is almost unprecedented (and illegal) and only legal during times of declared war upon the target country. It has happened before, but only to relatively impotent nations and economies such as Afghanistan, Iran, and Venezuela.
This attack is on an economy that is key to the global economy. This has been noticed. Russia has been forced to move away from the dollar as a unit of account for its imports and exports. This has the effect of causing dollars to be repatriated to the United States’ national economy driving inflation (with some delay).
Worse than that are the secondary effects. Dollar hegemony depends upon the United States keeping its promises to pay the bearer on demand. Demonstrating that this promise can be broken due to political will means that trust in the dollar and the issuing central bank is inevitably reduced.
When trust reduces, the tendency to use the currency is reduced. Over time (months or years – possibly weeks), countries that do not have significant economic ties to Russia will make choices about how to hold their reserves. They may not entirely stop using the dollar, but a reduction is a reduction.
This created a negative cycle. Each dollar repatriated to the US national economy adds to inflation within the economy. As inflation increases the number of dollars required to make a purchase increases. That makes the dollar less safe to hold over time and so central banks and governments will reduce their dollar holdings again. Round and round it goes, getting faster at each turn.
In time the devaluation of the dollar and increasing interest rates (which are a product of the value and risk of holding the currency) increase making it harder for the US to take out new and repay old loans. This reduces the spending that the US can undertake – and guess which is just about the most costly part of the US economy? The military!
The US armed forces are the tool sued to enforce dollar hegemony. Without an enforcer, states will make their own free choices in their own best interests.
The shocking thing is that there are plenty of people in the USA who know all this. But the elected government chose to shatter the state’s responsibility to ensure the good performance of the dollar. The sanctions imposed upon Russia have made the very tool that will hasten the end of dollar hegemony.
To repeat once again, this is a very highly simplified account of affairs. There are many complicating factors but if you think of dollar hegemony as being the main mechanism that enables the USA to have relatively low inflation and a standard of living that is not commensurate with its real economy then you will not be off the mark.
You guys sanctioned yourselves by ignoring the advice and protestations of the experts in the various related fields who were not given input into the damaging political decisions.
When I was first writing about dedollarisation and failure of the dollar, I was suggesting that the process was under some form of management by other major economies and possibly even with the tacit agreement with the US Federal Reserve.
The reason for that was the manner in which the process, which was visible, was being managed. Of course I have no proof of this, only empirical observation supported by trained knowledge.
The last thing any economy needs is an unmanaged and chaotic end for the US Dollar dominance. That would occur if central banks chose to dump their dollar assets – cash, treasuries, bonds and other instruments.
It was possible to see a slow downward trend in holdings (with some deviation). Some countries were fastidious about maintaining a dollar peg, even to the detriment of their own national economies (China) and also using cash holdings to buy US-based assets. All activities that supported the idea that the US decline was being managed from outside the United States.
A few years ago, it seemed that any US cooperation came to an end. But the slow overall process continued. China and Russia had no interest in tanking the US economy because the likely outcome would be war as the US sought to gamble big on global domination before the opportunity was lost.
Right now, I think we are at that point. The US is lashing out against ‘the world’ the EU is suffering terribly – the desired outcome. Russia is supposed to be suffering – except for autarky and a very strong economy driven by leadership in many commodity and technical areas. On a side note, I wonder where Russia would be if they had not needed to focus on defence technologies and rebuilding the armed forces almost from the ground up.
Russia is isolating itself from the coming storm and moving toward a hard rouble backed by commodities and energy. China is taking a slightly different direction. India is keen to go along with Russia and whatever China does and all, along with other Eurasian economies, are already well along with an alternative synthetic currency.
Being the global reserve currency (dollar hegemony) is not a magic bullet for an underproductive economy! So nobody wants to take it on – hence a synthetic global (or at least Eurasian) currency.
I also think that Russia and China, along with, possibly, some other states are at about the ‘bugger it’ stage and may now be willing to cut the US loose and damn the short term economic and military cost. Russia has been working toward autarky for almost 20 years.
Oddly, many other countries seem not to have noticed what Russia has achieved (economy smaller than Italy? What are these USAian experts smoking?)
China cannot be an autarky but has been working assiduously on its supply networks to attain independence from the USA. And here again, the US shot themselves in the foot. I mean, what exactly did the US leadership think would happen when they tried to cut China off from the goods and services it needs?
The only thing that could happen is that China would replace those goods and services in the home market. They built up land-based logistics networks, building relationships in Asia, Africa, Eurasia and even Europe.
My only conclusion here is that the USAian leadership was unable to understand the Chinese context, seeing everything in terms of what similar action would bring to the USA. And, yes for the USA it’d be disastrous due to the hollowing out of US manufacturing through providing perverse incentives that made it impossible for manufacturers to remain in the USA. US-based businesses were forced to offshore manufacturing. I saw this first-hand when I was studying at Fudan University, possibly the foremost economics centre of excellence in the field in China.
We were taught and shown what was going to happen in the USA. Those guys knew it. This was back in 2001. To be honest, it was blindingly obvious when one reframed the issues away from a US-centric perspective.
Andrew Wilson writing about de-dollarisation from the RUA discussion forums.