The dollar in a world gone MAD (Mercantilism, Autarky, Dirigisme)
“The owl of Minerva only spreads its wings at dusk.” Fancy talk from the German idealist philosopher Hegel. When describing history nowadays, we might just say we are only wise after the event. With the question of the future of the US dollar however, it being 2023 and all, two very distinct camps seem to have formed in the public debate, each certain of being correct. In the red corner is the ‘dollar is toast’ brigade, in the blue corner the ‘dollar forever’ gang. Is there any room for grey areas in this discussion?
Even dollar champions must admit something is afoot, and the apparent pace of change is increasing. Chinese premier Xi Jinping’s recent visit to Moscow revealed a clear policy of promoting the yuan for trade settlement, while Russia itself, in the person of the Commissioner for Integration and Macroeconomics for the Eurasian Economic Union (EAEU) Sergey Glazyev, is working on a proposal for a new commodity-backed international settlement currency.
Elsewhere, a political shift against the use of the dollar for global trade is clearly in progress, although as might be expected, rhetoric and reality don’t always go hand in hand. The Kingdom of Saudi Arabia is increasingly open to settlement of oil trades in currencies other than the dollar. French oil company Total has just completed its first liquid natural gas transaction in yuan 1, While the Brazilian President Lula is now openly calling for developing countries to settle trade in their own currencies rather than the US dollar 2.
For the dollar, there is the short story and the long story. In the wake of Russia’s invasion of the Ukraine last year, the seizing of Russian foreign-reserve assets by the US, the UK and the EU clearly acted as a catalyst event for those countries with large US dollar reserves who feel concerned that America may at some stage deem them to be bad hombres and seize their reserves.
It is this weaponisation of the dollar rather than a particular concern about current American inflation or fiscal policy which likely explains historically high gold purchases in the past year by global central banks, particularly those in the developing world. Data from the World Gold Council suggests that central banks picked up in 2023 from where they left off last year, buying 125 tonnes of gold in January and February alone. But buying gold doesn’t mean the end of the dollar, especially as the currency of choice for international trade settlement. That may be Russia’s plan at some stage, but it’s clearly still in an embryonic state.
In the long term, it’s necessary to differentiate between currency (the money of a particular country) and a monetary system, especially the one promoted by the dominant global economic and military power. The birth of the nineteenth century gold standard to the backdrop of British free-trade policy and of the US petrodollar system offer some interesting parallels with respect to this.
After dispatching the French at the Battle of Waterloo in 1815, Britain ended its emergency war financing with a return to gold in 1817. This acted as a strong form of monetary tightening, particularly in the context of the usual post-conflict economic slump as government spending declined. With poor harvests to boot, serious social unrest spread, culminating amongst other things in the Peterloo massacre in Manchester in 1819.
Yet from this unpromising start, the British focus on free trade and gold as the sole monetary asset to promote it gradually spread throughout the nineteenth century. With a massive 5-billion franc indemnity from France after winning the Franco-Prussian War in 1871, the new German Empire ditched silver by 1873. In the same year, the US abandoned monetary silver to focus exclusively on gold, and the French-led Latin Monetary Union drifted down the same path in the following years. The ensuing period of the classical gold standard which lasted until the start of the First World War was one of monetary stability, trade expansion, economic growth and globalisation. Sounds familiar?
Given the incipient loss of faith in US political institutions following the assassination of JFK in 1963 and the Watergate scandal a decade later, the social dislocation of the civil-rights movement and the gut-wrenching divisions caused by the Vietnam War, not to mention the US default when it ended the gold convertibility of the dollar in 1971, the backdrop to Henry Kissinger’s trip to Saudi Arabia in 1974 couldn’t have been less auspicious.
Yet from this trip in which the US Secretary of State brokered a deal in which the US would offer protection to the Saudi Kingdom in return for the latter buying US Treasuries with its oil profits, the petrodollar was born. Following the collapse of the Soviet Union in the early 1990s and with China admitted to the World Trade Organisation in 2000, the second age of globalisation was born, and the dollar was its currency of trade as the pound had been during the pre-1914 era.
When the post-war Bretton Woods monetary settlement saw the dollar replace the pound as the world’s main trading currency, there was little to doubt about American supremacy. American GDP was 50% of the global total, while the US held 20,083 tonnes of an estimated 33,300 tonnes of the world’s gold reserves3. While its share of GDP had fallen by 1990, the US was at that point the world's sole military-fiscal super power, and the dollar reigned supreme.
US GDP is now 24% of the global total, while the dollar forms about 60% of global monetary reserves, down from about 70% a decade ago. The switch has been from dollars to the currencies of smaller nations (Canada, Australia, S Korea and so on) rather than to the yuan or the euro. The trend in dollar usage has been lower, but that doesn’t mean the dollar is dead. The economies of America and Imperial Germany overtook the UK in the 1890s, but the dollar only really superceded the pound in the 1950s as the functional reserve and trading currency.
If one can draw a valid conclusion from just two examples (the pound and the dollar), then it is that a single dominant global currency backed by policies lending themselves to free trade clearly promotes globalisation, but that global conflict tends to push that process into reverse.
For 1914 and the pound read 2022 and the dollar? If the pundits are to be believed, then the type of global conflict that beckons (or that has actually started) isn’t just one of trenches and barbed wire like the First World War, but a multi-level conflict fought through proxy wars as well as economically, especially over resources, as well as technologically and in cyber-space.
If this cold war is a China vs the US affair, then the monetary analysis is fairly easy. China has a closed capital account and a current-account surplus. The US runs a large current-account deficit and a capital-account surplus, allowing foreigners to get their hands on dollars, and this is the essential mechanism which makes the dollar the global reserve and trading currency - the ability of foreigners to get hold of dollars. There are suggestions that people can trade in yuan and then convert these yuan balances to gold on the Shanghai Gold Exchange, but it is unclear whether this process is structurally robust enough or liquid enough to replace the dollar. Until China changes its economic policies therefore, the yuan can’t really rival the dollar in a meaningful way.
What would a multi-polar world which rejects free trade and globalisation look like? The opposite of free trade is mercantilism, a view that sees world trade as a zero-sum game where exports must dominate imports with a view to increasing the wealth of a country at the expense of one’s neighbours. This denies the principle expounded by David Ricardo of economic progress through relative advantage in production, and leads to sub-optimal growth through an over-reliance on potentially uncompetitive domestic industries, a policy which falls under the umbrella of autarky or self-reliance. Such economies tend to have heavy-handed government involvement in guiding private-sector investment, interrupting the process of successful industrial specialisation which Adam Smith rightly highlighted as a key driver in wealth creation. Rather than free enterprise you have state-controlled planning or dirigisme.
The question therefore isn’t so much one about predicting if and when the dollar will be toppled, but looking at the sort of world that might exist if the economic system that has characterised the dollar era is challenged. If it is to be a world characterised by MAD (mercantilism, autarky, and dirigisme), then one would expect it to be one increasingly characterised by trade tariffs, capital controls, and potentially credit controls.
Thanks to President Trump’s trade war on China, the world is now reacquainted with trade tariffs. Capital and credit controls are however policy tools of the era before we had floating currencies and the free movement of capital, and investors may find themselves becoming familiar with them once again, especially if this new cold war between east and west lasts.
The entire modern financial system is based on the free movement of capital and the ability to create credit without any real restriction. A fracturing of the dollar hegemony and the emergence of a multi-polar world, particularly one in which governments are trying to rid themselves of excessive amounts of debt, may start to look suspiciously like the 1940s or 1950s. The financial world might look very different - there weren’t many hedge funds back then.
Jan van der Made, ‘Petrodollar’ at risk as TotalEnegies sells LNG to China in Yuan, RFI News, 31/03/2023.
Joe Leahy, Hudson Lockett, Lula urges end to dollar dominance in international trade, Financial Times, 14/04/2023.
St Louis Federal Reserve, Gold Reserves of Central Banks and Governments and States, 1945-1960, stlouisfed.org.