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The author is a contributing editor for the FT and writes the Chartbook newsletter.
The dollar is the currency of America and also the currency of the world. Although the United States accounts for approximately 15.5 percent of the world's GDP (PPP), the dollar is involved in 88 percent of all international monetary transactions. Approximately 58 percent of the world's foreign exchange reserves are held in U.S. currency.
The economics of this lopsided situation are murky. The dollar's foreign exchange reserves support the U.S. current account deficit, favoring U.S. importers and creating markets for the rest of the world, but also tilting the U.S. economy away from traded goods. There is. The global spread of the dollar makes the Federal Reserve the world's central bank at will. The ubiquity of the dollar also gives the American state enormous power. US financial sanctions are a commercial death sentence.
In an increasingly multipolar and hostile world, how long will this strange hybrid of punitive conflict and commercial cooperation last?
Some in Washington worry that the United States will overuse sanctions tools, undermining confidence in the dollar and, by extension, in the United States' own sources of power. But a far more comprehensive threat to the status quo comes from the workings of the monetary system itself.
The global dollar system works best when dollars are plentiful, U.S. interest rates are low, and other currencies are rising. Easy access to dollars stimulates economic activity around the world. Currently, the configuration is reversed. A strong recovery in the US economy has forced the Federal Reserve to raise interest rates, causing the dollar to appreciate and putting stress on dollar businesses around the world.
Although this is unpleasant, it does not by itself cause any systemic concern. Financial elites around the world know how to deal with the pressure of a strong dollar. The European Central Bank and the Bank of Japan plan to adjust interest rate settings. Major central banks in emerging markets have strong powers to intervene to manage depreciation.
But this facade of calm could crumble if exchange rate fluctuations are large enough and U.S. interest rates remain high for an extended period of time. The dollar issue may even enter the political realm. It is no surprise that the government of Brazilian President Luiz Inacio Lula da Silva continues to talk about the BRICS establishing an alternative currency to the dollar. In some corners of the global economy, the recent rise in interest rates is causing serious damage. Lending to the world's poorest countries reversed in 2023, a recent equity survey commissioned by the G20 showed. The IMF and World Bank were unable to compensate. The need for structural reform is clear.
But where a strong dollar policy matters most is at the heart of the system: the United States itself.
The Biden administration has chosen not to take issue with the sharp rise in the dollar, viewing it as a sign of a strong economic recovery in the United States. Donald Trump shows no such restraint.
As someone who lived through the American crisis era of the 1970s and early 1980s, Trump has crudely nationalist views on trade and exchange rates. For him, a strong dollar “kills” the United States and benefits China. President Trump's aide Robert Lighthizer supports the use of tariffs to force a concerted devaluation of the dollar. There is even talk in Trump's circles of subordinating the Federal Reserve to the Oval Office in order to force lower interest rates.
First under the Trump administration and then the Biden administration, U.S. policymakers have fused industrial policy, trade policy, green energy, and geopolitics into a strong nationalist formula. Add a monetary system to the mix and you have a truly explosive cocktail. A comprehensive devaluation of the dollar to revive American manufacturing would politicize the global monetary system in ways that go far beyond surgical strikes through financial sanctions.
Of course, there's a possibility that Trump won't win. Even if he did, no one knows whether he is serious about economic policy. In his first term, he was restrained by the so-called adults in the room. But the general lesson is that America's own politics and economics, not China or Russia, will determine the dollar system's future.
The United States established the dollar system at Bretton Woods in 1944. President Richard Nixon first broke this standard in his early 1970s. In the wake of the 2008 financial crisis, the United States ushered in a new era of quantitative easing. The question in 2024 is whether the ongoing crisis in American democracy is about to spill over into the entire global economy.
