The U.S. Dollar: A Victim of Its Own Success
America’s most powerful weapon of war does not shoot, fly or explode. It’s not a submarine, plane, tank or laser. America’s most powerful strategic weapon today is the dollar.
The U.S. uses the dollar strategically to reward friends and punish enemies. The use of the dollar as a weapon is not limited to trade wars and currency wars, although the dollar is used tactically in those disputes. The dollar is much more powerful than that.
The dollar can be used for regime change by creating hyperinflation, bank runs and domestic dissent in countries targeted by the U.S. The U.S. can depose the governments of its adversaries, or at least blunt their policies without firing a shot.
Before turning to specific tactics, consider the following. The dollar constitutes about 60% of global reserves, 80% of global payments and almost 100% of global oil transactions. European banks that make dollar-denominated loans to customers have to borrow dollars to fund those liabilities.
Those banks do their borrowing in the eurodollar deposit market, or with dollar-denominated commercial paper or notes. Being based in Switzerland or Germany does not allow you to escape from the dollar’s dominance.
The U.S. not only controls the dollar itself. It controls the dollar payments system. This consists of the Treasury’s digital ledger of holders of U.S. debt, the Fedwire payments system among U.S. Fed member banks and the Clearing House Association (successor to the New York Clearing House and proprietor of CHIPS, the Clearing House Interbank Payments System) composed of the largest U.S. banks.
A dollar payment going from a bank in Shanghai to another bank in Sydney runs through one of these U.S.-controlled payments systems.
In short, the dollar is the oxygen supply for world commerce and the U.S. can cut off your oxygen whenever it wants.
The list of ways in which the dollar can be weaponized is extensive. The International Emergency Economic Powers Act of 1977, IEEPA, gives the president of the United States dictatorial power to freeze and seize assets and block payments.
The Treasury’s Office of Foreign Assets Control, OFAC, maintains a blacklist of individuals and companies with whom financial intermediaries, such as banks and credit card companies, are forbidden to transact. Individuals on the OFAC list are like dead men walking when it comes to travel and business.
The Committee on Foreign Investment in the United States, CFIUS, can block any foreign acquisition of a U.S. company on national security grounds.
This list of financial weapons goes on, but you get the idea. The U.S. uses the dollar to force its enemies into fronts, crude barter or the black market if they want to do business.
Examples of the U.S. employing these financial weapons are ubiquitous. The U.S. slapped sanctions on Russia after the 2014 annexation of Crimea and invasion of Eastern Ukraine. The U.S. waged a full-scale financial war with Iran from 2011–13 that resulted in bank runs, hyperinflation, local currency devaluation and social unrest.
The U.S. was pushing Iran to the brink of regime change in 2013 when President Obama declared a truce to pursue what became the Joint Comprehensive Plan of Action, JCPOA, or the Iran nuclear deal. President Trump has now ended that deal and the financial war with Iran has resumed where it left off in 2013, but tougher than ever.
The U.S. is slapping stiff Section 301 penalties on China for theft of intellectual property. Other obvious victims of U.S. financial weapons are North Korea, Syria, Cuba and Venezuela.
The actions described above did not arise in the normal course of trade and finance. The Russian, Iranian and other sanctions noted are explicitly geopolitical, while the Chinese sanctions are geostrategic to the extent the U.S. and China are vying for technological supremacy in the 21st century.
None of these sanctions would be effective or even possible without the use of the dollar and the dollar payments system.
Yet for every action there is a reaction. America’s adversaries realize how vulnerable they are to dollar-based sanctions. In the short run, they have to grin and bear it. They’re fully invested in the dollar both in their reserves and in the desire of their largest companies like Gazprom (Russia) and Huawei (China) to become major global players.
Transacting on the world stage means transacting in dollars.
And dollar-based sanctions are a powerful financial weapon for the U.S. But our adversaries and so-called allies are not standing still. They are already envisioning a world where the dollar is not the major reserve and trade currency.
In the longer run, Russia, China, Iran, Turkey and others are working flat-out to invent and implement nondollar transactional currencies and independent payments systems.
Russia has begun a major research and development effort in the area of distributed ledger technology (also known as “blockchain”) so that financial transactions can be processed and verified without reliance on Western-controlled banks.
This will not involve dead-end cryptocurrencies like bitcoin but entirely new utility tokens and cryptos. Imagine something like a putincoin and you’ll be on the right track.
China is pushing its trade counterparties to accept Chinese yuan as payment for goods and services. The yuan is a small part of global payments today (about 2%) but the yuan may get a boost as the U.S. sanctions on Iran kick in.
China is Iran’s biggest customer for oil, and if U.S. sanctions prohibit dollar payments for Iranian oil, then Iran and China may have no choice but to transact in yuan.
The International Monetary Fund, IMF, has already announced efforts to put its world money, the special drawing right, SDR, on a distributed ledger. This would make the SDR a global cryptocurrency for settling balance of payments transactions among China, Russia and other IMF members, also without reliance on the dollar payments system.
Alongside the new money in cryptocurrencies, there is the oldest form of money, which is gold. The use of gold is the ideal way to avoid U.S. financial warfare.
Gold is physical so it cannot be hacked. It is completely fungible (an element, atomic number 79) so it cannot be traced. Gold can be transported in sealed containers on airplanes so movements cannot be identified through wire transfer message traffic or satellite surveillance.
There is good evidence that Iran currently pays for North Korean weapons technology with gold, and good reason to expect that future Chinese payments for Iranian oil will be made at least partly in gold.
Imagine a three-way trade in which North Korea sells weapons to Iran, Iran sells oil to China and China sells food to North Korea. All of these transactions can be recorded on a blockchain and netted out on a quarterly basis with the net settlement payment made in gold shipped to the party with the net balance due. That’s a glimpse of what a future nondollar payments system looks like.
Finally, look at the evidence presented in Chart 1 below. This shows Russia’s reserve position from 2013–18. The reserve position collapsed from $540 billion to $350 billion as a result of the oil price crash beginning in late 2014. (And query whether the oil price collapse itself was engineered by the U.S. in retaliation for Russia’s annexation of Crimea).
Since early 2015, Russia has rebuilt its reserve position under the patient stewardship of Russian Central Bank head Elvira Nabiullina. Russian reserves are now back up to $460 billion and rising steadily.
Yet there’s one huge difference between Russian reserves in 2014 and those reserves today. That difference is gold. During the reserve collapse in 2014, Russia sold U.S. dollar assets as needed to maintain liquidity, but it never stopped buying gold.
Russian gold reserves rose from 1,275 tons in mid-2015 (near the reserve low) to 1,909 tons at the end of April 2018. That’s a 50% increase in gold reserves in less than three years. Using current market prices, the Russia gold hoard is worth about $90 billion, or 20% of Russia’s global reserve position.
Why would a country put 20% of its reserves into gold unless it expected gold to be a major part of the international monetary system in the future? It wouldn’t. Russia not only expects gold to be part of the system, it is in strong position to make that happen by working with China, Turkey and Iran in what I call the new “Axis of Gold.”
The bottom line is that the weaponized dollar will soon be a victim of its own success. While the U.S. was bullying the world with dollars, the world was quietly preparing a new nondollar system. The U.S. wanted diplomatic and military clout and it got it with the dollar.
But as the saying goes, “Be careful what you wish for.”
Wise investors will prepare now for a new nondollar payments system. You may not be able to buy crypto SDRs (yet), but you can certainly own gold, and you should.
for The Daily Reckoning