The Dollar at the End of History
We only have true control over our domestic affairs.
Recent machinations in the world of international finance have given Francis Fukuyama’s thesis, or something resembling it, a short new lease on life. The political philosopher published The End of History and the Last Man in 1992. The book argued that history had decided that liberal democracy was the superior mode of government after the fall of the Soviet Union.
It appeared to logically follow that, moving into the future, the rest of the world would adopt this mode of government and, when the entire world had been converted, the historical process would come to a close. We would all be liberal democrats from here to eternity.
In retrospect, Fukuyama’s thesis looks both arrogant and naive. With the rise of alternative regimes in countries like Russia and China it has become clear that liberal democracy is not the logical end point of historical development. Moving into the 21st century it looks like political evolution—and perhaps, in some instances, devolution—will continue on as it always has.
The historical process, at least insofar as it applies to governmental regimes, is cyclical rather than linear. In February of 2022, in response to Russia’s invasion of Ukraine, the United States government, together with the governments of its allies, froze Russian foreign exchange reserves. In doing so, the American government started a chain reaction of events that may ultimately result in the end of U.S. dollar dominance in the world economy.
By seizing Russian foreign exchange reserves, the United States signalled to the rest of the world that U.S. dollar reserves—until then thought to be as good as gold—were only safe insofar as a country’s foreign policy was not disapproved of by the United States. Countries around the world realized that holding U.S. dollar reserves and assets now came with serious risks and started to look for alternatives. Soon thereafter discussions started about the creation of a BRICS currency.
Talk of U.S. dollar decline is now so loud that it is impossible to ignore. U.S. Treasury Secretary Janet Yellen has recognized these developments, saying that we should expect a gradual decline in the dollar’s share of global reserves. The response from those who want to assume dollar dominance moving into the future has been a reversion to Fukuyama. They portray the dollar as historically unique and the dollar-based global system as being a sort of “end of financial history.”
Until the dollar arrived on the scene after the Second World War, they argue, the settling of world trade had been a messy process, often involving gold and other “barbarous relics.” The emergence of the dollar, with its deep liquid capital markets and its sophisticated legal system, changed all this forever. And thus, humanity reached the end of financial history.
The most sophisticated proponent of this view is the economist Michael Pettis. Pettis argues that the U.S. dollar is in fact the world’s first true reserve currency. “While sterling was indeed used more than other currencies in Europe to settle trade,” Pettis writes of Britain’s time as the ruler of the world economy, “and the credibility of its conversion into gold was hard-earned by the Bank of England after the Napoleonic wars, whenever sterling claims rose relative to the amount of gold held by the Bank of England, its credibility was undermined. In that case foreigners tended to reverse their use of sterling, forcing the Bank of England to raise interest rates and adjust demand to regain gold reserves.”
The dollar is different, Pettis and others argue, because since 1971 when President Nixon closed the gold window, it has been a purely fiat currency. This has meant that America can run potentially limitless trade imbalances with the rest of the world. The was a departure from the past, when, if a country had run a trade deficit with its trade partners, gold would have flowed from the deficit country to the surplus country. This would have provoked the deficit to devalue their currency relative to gold and the trade deficit would close.
Not so in the era of U.S. dollar hegemony. America’s trade deficits—and even those of American allies like Britain—can be financed by either giving paper money to foreigners or allowing them to recycle this paper money into American assets. While Pettis leaves open the question of whether this system might ever come to an end, more eager end of financial history proponents portray this enormously powerful system as so globally embedded as to be invincible.
This reaction is nothing short of bizarre. One need not be an economist to recognize that there is something amiss about this system. Just why should other countries send valuable goods and services to the United States and other Western countries in return for what ultimately amounts to worthless paper?
End of financial history proponents typically allude to American military power. This argument is lifted straight from the hard left, who have long portrayed the U.S. dollar system as an outgrowth of American imperialism. Yet this extremely simplistic view is no truer when defenders of America articulate it than it is when America’s detractors do.
There is no link, factual or logical, between American military power and U.S. dollar dominance. If a country decides to stop holding dollars, the U.S. Navy does not have orders to blockade their ports; nor should they, as such a move would be utterly mad. This hoary old narrative simply shows the extremely naïve view held by some about how military and geopolitical power is distributed and exercised.
The reality is that the U.S. dollar system remains in place so long as other countries play along. Why do they play along? Until recently they played along mostly because it was of benefit to them. In the 1990s and the 2000s developing countries, led by China, used the U.S. dollar system to build their economies. They recognized that by selling manufactured products to the United States and other Western countries, they could rapidly develop—and, in an act of classic mercantilism, they took advantage of this.
Yet this was never going to be a permanent arrangement. Once these countries had lifted their economies up from the dust, they were always going to turn away from this system whether gradually or suddenly. The fact that Western leaders did not realize the game that was being played is a testament to just what a strange period in history the 1990s and 2000s, with their staunch Fukuyaman optimism, was.
Since the 2008 financial crisis, the system of U.S. dollar hegemony has existed in a sort of limbo state. In the 2010s, the Chinese stopped relying on large trade surpluses to power their economy, instead turning to domestic investment. Since the lockdowns in 2020, likely in response to the protectionist rhetoric that proliferated in the Trump administration, China has turned its trade away from the United States and toward developing countries.
Even sophisticated thinkers like Pettis seem to have missed these momentous shifts. “The end of dollar dominance doesn’t mean a global trading system that simply and non-disruptively shifts from denominating trade in dollars to denominating it in some other currency,” he writes, “It means instead the end of the current global trading system.”
To a very large extent, the “current global trading system”—by which Pettis seems to mean the one that dominated in the 1990s and 2000s—is already over. Does this mean an impending collapse of the U.S. dollar? Probably not. The seizure of Russian foreign exchange reserves—a policy that will likely go down, together with Churchill’s return to the gold standard in the 1920s, as one of the worst economic decisions in history—has greatly accelerated the process, but this does not mean impending apocalypse.
U.S. dollar hegemony will likely wane gradually over the next ten or twenty years. Other countries will feel their way around, as if in a poorly lit room, for what works and what does not. Eventually a new equilibrium will be reached where the U.S. dollar is one among many global trading currencies.
This means that Western countries need to get their house in order immediately. They can no longer rely on running large trade deficits with developing countries. If they do, they may wake up one day to find that these products are no longer available at reasonable prices and that they have no capacity to produce them themselves.
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For this reason, a serious industrial policy is needed. It is not too much of an exaggeration to say that we only really have one shot at getting such a policy right. Yet the energy is currently not there. Still dizzy from their end of history soporifics, Western leaders are enacting policies that claim to be industrial policies, but that are in fact green energy policies.
The Biden administration’s Inflation Reduction Act spent six dollars on green energy and environmental subsidies for every dollar it spent on manufacturing subsides. And the aggressive protectionist moves made by both the Trump and Biden administrations primarily against China are self-destructive in their naivete. They rest on the assumption that Western countries are in control of trade flows. But they are not, and no one has ever banned their way to prosperity.
Our only option is to rebuild. We need to recognize that the world is changing and that the West no longer has control over the global economic situation. We only have true control over our domestic affairs. Yet instead of trying to rebuild our manufacturing bases, we chase green dreams and satiate ourselves with glories that have long since passed.