Putting the Dollar in Jeopardy

For 70 years, a key element of American power has been the dollar’s standing as the world’s premier currency. But Washington’s repeated use of economic sanctions as a foreign policy weapon has encouraged China and other powers to consider financial alternatives, write Flynt and Hillary Mann Leverett.

By Flynt Leverett and Hillary Mann Leverett

Since World War II, America’s geopolitical supremacy has rested not only on military might, but also on the dollar’s standing as the world’s leading transactional and reserve currency. Economically, dollar primacy extracts “seignorage” — the difference between the cost of printing money and its value — from other countries, and minimizes U.S. firms’ exchange rate risk.

Its real importance, though, is strategic: dollar primacy lets America cover its chronic current account and fiscal deficits by issuing more of its own currency — precisely how Washington has funded its hard power projection for over half a century.

U.S. Treasury Secretary Henry Morgenthau, Jr., addresses the delegates to the Bretton Woods Conference, July 8, 1944. (Photo credit: World Bank)

U.S. Treasury Secretary Henry Morgenthau, Jr., addresses the delegates to the Bretton Woods Conference, July 8, 1944. (Photo credit: World Bank)

Since the 1970s, a pillar of dollar primacy has been the greenback’s role as the dominant currency in which oil and gas are priced, and in which international hydrocarbon sales are invoiced and settled. This helps keep worldwide dollar demand high. It also feeds energy producers’ accumulation of dollar surpluses that reinforce the dollar’s standing as the world’s premier reserve asset, and that can be “recycled” into the U.S. economy to cover American deficits.

Many assume that the dollar’s prominence in energy markets derives from its wider status as the world’s foremost transactional and reserve currency. But the dollar’s role in these markets is neither natural nor a function of its broader dominance.  Rather, it was engineered by U.S. policymakers after the Bretton Woods monetary order collapsed in the early 1970s, ending the initial version of dollar primacy (“dollar hegemony 1.0”). Linking the dollar to international oil trading was key to creating a new version of dollar primacy (“dollar hegemony 2.0”) — and, by extension, in financing another forty years of American hegemony.

Gold and Dollar Hegemony 1.0 

Dollar primacy was first enshrined at the 1944 Bretton Woods conference, where America’s non-communist allies acceded to Washington’s blueprint for a postwar international monetary order.  Britain’s delegation — headed by Lord Keynes — and virtually every other participating country, save the United States, favored creating a new multilateral currency through the fledgling International Monetary Fund (IMF) as the chief source of global liquidity.

But this would have thwarted American ambitions for a dollar-centered monetary order. Even though almost all participants preferred the multilateral option, America’s overwhelming relative power ensured that, in the end, its preferences prevailed. So, under the Bretton Woods gold exchange standard, the dollar was pegged to gold and other currencies were pegged to the dollar, making it the main form of international liquidity.

There was, however, a fatal contradiction in Washington’s dollar-based vision. The only way America could diffuse enough dollars to meet worldwide liquidity needs was by running open-ended current account deficits. As Western Europe and Japan recovered and regained competitiveness, these deficits grew. Throw in America’s own burgeoning demand for dollars — to fund rising consumption, welfare state expansion, and global power projection — and the U.S. money supply soon exceeded U.S. gold reserves.

From the 1950s, Washington worked to persuade or coerce foreign dollar holders not to exchange greenbacks for gold. But insolvency could be staved off for only so long: in August 1971, President Richard Nixon suspended dollar-gold convertibility, ending the gold exchange standard; by 1973, fixed exchange rates were gone, too.

These events raised fundamental questions about the long-term soundness of a dollar-based monetary order. To preserve its role as chief provider of international liquidity, the U.S. would have to continue running current account deficits.

But those deficits were ballooning, for Washington’s abandonment of Bretton Woods intersected with two other watershed developments: America became a net oil importer in the early 1970s; and the assertion of market power by key members of the Organization of Petroleum Exporting Countries (OPEC) in 1973-1974 caused a 500 percent increase in oil prices, exacerbating the strain on the U.S. balance of payments. With the link between the dollar and gold severed and exchange rates no longer fixed, the prospect of ever-larger U.S. deficits aggravated concerns about the dollar’s long-term value.

These concerns had special resonance for major oil producers. Oil going to international markets has been priced in dollars, at least since the 1920s — but, for decades, sterling was used at least as frequently as dollars in order to settle transnational oil purchases, even after the dollar had replaced sterling as the world’s preeminent trade and reserve currency.

As long as sterling was pegged to the dollar and the dollar was “as good as gold,” this was economically viable. But, after Washington abandoned dollar-gold convertibility and the world transitioned from fixed to floating exchange rates, the currency regime for oil trading was up for grabs.

With the end of dollar-gold convertibility, America’s major allies in the Persian Gulf — the Shah’s Iran, Kuwait, and Saudi Arabia — came to favor shifting OPEC’s pricing system, from denominating prices in dollars to denominating them in a basket of currencies.

In this environment, several of America’s European allies revived the idea (first broached by Keynes at Bretton Woods) of providing international liquidity in the form of an IMF-issued, multilaterally-governed currency — so-called “Special Drawing Rights” (SDRs). After rising oil prices engorged their current accounts, Saudi Arabia and other Gulf Arab allies of the United States pushed for OPEC to begin invoicing in SDRs. They also endorsed European proposals to recycle petrodollar surpluses through the IMF, in order to encourage its emergence as the main post-Bretton Woods provider of international liquidity.

That would have meant Washington could not continue to print as many dollars, as it wanted to support rising consumption, mushrooming welfare expenditures, and sustained global power projection. To avert this, American policymakers had to find new ways to incentivize foreigners to continue holding ever-larger surpluses of what were now fiat dollars.

Oil and Dollar Hegemony 2.0

To this end, U.S. administrations from the mid-1970s devised two strategies. One was to maximize demand for dollars as a transactional currency. The other was to reverse Bretton Woods’ restrictions on transnational capital flows; with financial liberalization, America could leverage the breadth and depth of its capital markets, and it could cover its chronic current account and fiscal deficits by attracting foreign capital at relatively low cost. Forging strong links between hydrocarbon sales and the dollar proved critical on both fronts.

To forge such links, Washington effectively extorted its Gulf Arab allies, quietly conditioning U.S. guarantees of their security to their willingness to financially help the United States. Reneging on pledges to its European and Japanese partners, the Ford administration clandestinely pushed Saudi Arabia and other Gulf Arab producers to recycle substantial parts of their petrodollar surpluses into the U.S. economy through private (largely U.S.) intermediaries, rather than through the IMF.

The Ford administration also elicited Gulf Arab support for Washington’s strained finances, reaching secret deals with Saudi Arabia and the United Arab Emirates for their central banks to buy large volumes of U.S. Treasury securities outside normal auction processes.

These commitments helped Washington prevent the IMF from supplanting the United States as the main provider of international liquidity; they also gave a crucial early boost to Washington’s ambitions to finance U.S. deficits by recycling foreign dollar surpluses via private capital markets and purchases of U.S. government securities.

A few years later, the Carter administration struck another secret deal with the Saudis, whereby Riyadh committed to exert its influence to ensure that OPEC continued pricing oil in dollars. OPEC’s commitment to the dollar as the invoice currency for international oil sales was key to broader embrace of the dollar as the oil market’s reigning transactional currency.

As OPEC’s administered price system collapsed in the mid-1980s, the Reagan administration encouraged universalized dollar invoicing for cross-border oil sales on new oil exchanges in London and New York. Nearly universal pricing of oil — and, later on, gas — in dollars has bolstered the likelihood that hydrocarbon sales will not just be denominated in dollars, but settled in them as well, generating ongoing support for worldwide dollar demand.

In short, these bargains were instrumental in creating “dollar hegemony 2.0.” And they have largely held up, despite periodic Gulf Arab dissatisfaction with America’s Middle East policy, more fundamental U.S. estrangement from other major Gulf producers (Saddam Hussein’s Iraq and the Islamic Republic of Iran), and a flurry of interest in the “petro–Euro” in the early 2000s.

The Saudis, especially, have vigorously defended exclusive pricing of oil in dollars. While Saudi Arabia and other major energy producers now accept payment for their oil exports in other major currencies, the larger share of the world’s hydrocarbon sales continue to be settled in dollars, perpetuating the greenback’s status as the world’s top transactional currency.

Saudi Arabia and other Gulf Arab producers have supplemented their support for the oil-dollar nexus with ample purchases of advanced U.S. weapons; most have also pegged their currencies to the dollar — a commitment which senior Saudi officials describe as “strategic.” While the dollar’s share of global reserves has dropped, Gulf Arab petrodollar recycling helps keep it the world’s leading reserve currency.

The China Challenge

Still, history and logic caution that current practices are not set in stone. With the rise of the “petroyuan,” movement towards a less dollar-centric currency regime in international energy markets — with potentially serious implications for the dollar’s broader standing — is already underway.

As China has emerged as a major player on the global energy scene, it has also embarked on an extended campaign to internationalize its currency. A rising share of China’s external trade is being denominated and settled in renminbi; issuance of renminbi-denominated financial instruments is growing.

China is pursuing a protracted process of capital account liberalization essential to full renminbi internationalization, and is allowing more exchange rate flexibility for the yuan. The People’s Bank of China (PBOC) now has swap arrangements with over 30 other central banks — meaning that renminbi already effectively functions as a reserve currency.

Chinese policymakers appreciate the “advantages of incumbency” the dollar enjoys; their aim is not for renminbi to replace dollars, but to position the yuan alongside the greenback as a transactional and reserve currency. Besides economic benefits (e.g., lowering Chinese businesses’ foreign exchange costs), Beijing wants — for strategic reasons — to slow further growth of its enormous dollar reserves.

China has watched America’s increasing propensity to cut off countries from the U.S. financial system as a foreign policy tool, and worries about Washington trying to leverage it this way; renminbi internationalization can mitigate such vulnerability. More broadly, Beijing understands the importance of dollar dominance to American power; by chipping away at it, China can contain excessive U.S. unilateralism.

China has long incorporated financial instruments into its efforts to access foreign hydrocarbons. Now Beijing wants major energy producers to accept renminbi as a transactional currency — including to settle Chinese hydrocarbon purchases — and incorporate renminbi in their central bank reserves.

Producers have reason to be receptive. China is, for the vastly foreseeable future, the main incremental market for hydrocarbon producers in the Persian Gulf and former Soviet Union. Widespread expectations of long-term yuan appreciation make accumulating renminbi reserves a “no brainer” in terms of portfolio diversification.

And, as America is increasingly viewed as a hegemon in relative decline, China is seen as the preeminent rising power. Even for Gulf Arab states long reliant on Washington as their ultimate security guarantor, this makes closer ties to Beijing an imperative strategic hedge. For Russia, deteriorating relations with the United States impel deeper cooperation with China, against what both Moscow and Beijing consider a declining, yet still dangerously flailing and over-reactive, America.

For several years, China has paid for some of its oil imports from Iran with renminbi; in 2012, the PBOC and the UAE Central Bank set up a $5.5 billion currency swap, setting the stage for settling Chinese oil imports from Abu Dhabi in renminbi — an important expansion of petroyuan use in the Persian Gulf.

The $400 billion Sino-Russian gas deal that was concluded this year apparently provides for settling Chinese purchases of Russian gas inrenminbi; if fully realized, this would mean an appreciable role for renminbi in transnational gas transactions.

Looking ahead, use of renminbi to settle international hydrocarbon sales will surely increase, accelerating the decline of American influence in key energy-producing regions. It will also make it marginally harder for Washington to finance what China and other rising powers consider overly interventionist foreign policies — a prospect America’s political class has hardly begun to ponder.

Flynt Leverett served as a Middle East expert on George W. Bush’s National Security Council staff until the Iraq War and worked previously at the State Department and at the Central Intelligence Agency. Hillary Mann Leverett was the NSC expert on Iran and – from 2001 to 2003 – was one of only a few U.S. diplomats authorized to negotiate with the Iranians over Afghanistan, al-Qaeda and Iraq. They are authors of  Going to Tehran.

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24 comments on “Putting the Dollar in Jeopardy

  1. This policy (official, or unofficial) of internationalisation of the RMB carries with it a few torrid dangers for CHina such as 1) persistent economic blackmail/subversion & other forms of american exceptionalism shenanigans by State Dept-supported Wall Street looters and speculators 2) threat of attack or outright war or even WW3 by the U.S. military in support of blatant and increasingly bold japanese provocations against China and 3) the spectre of U.S. intelligence agencies churning out mountains of dubious CHinese banknotes. ALL three threats are equally danger and CHina is unlikely to escape unscathed. The best solution ? Turn to GOLD ! ! ! ! ! ! ! ! KEEP LOTS of it.

    • jer:

      Why would gold be of any particular value?

      I can see why it has speculative value, but speculative things can change quickly.

      China would be better served by finding a way of avoiding being the dumping ground for the wastes of industrial production.

      Potable water, rice, wheat, all kind of important.

      • Bill Jones on said:

        Gold is money unlike the Fiat currency’s .

        Money has two attributes:
        It is a means of exchange.
        It is a store of value.

        Gold has demonstrated these attributes for 5,000 years.

        Governments always and everywhere fear it and try to restrict/destroy for two reasons:

        It restricts the ability of the State to loot the populace through the endless debasement of the currency.
        It exposes the degree to which debasement takes place.

        Not brain surgery.

        • Bill Jones:

          Gold has not had stable value for 5000 years, big mistake to claim that.

          Also statements like “gold is money” really don’t say anything about why.

  2. For me one point is missing in this analysis and in my opinion, the major point.
    The corruption going with the US dollar is the worst weapon of mass destruction.
    With the US’s ability to print ‘ad infinitum’ the dollar, the US has corrupted all the political leaders in Europe and the oligarchs in the rest of the world. It is the dollar that has allowed Washington and the Zionists to establish the ‘New World Order Empire’ which is destroying all the people’s roots [ 1) faith, 2) family, ehtnic and country structures, laws and justice]. In doing so, they are killing the spirit of the Republic and with the Emprire, they are putting back the people into slavery.

    • Jean:

      A lot of awful things are done and have been done in the name of faith, and family too. And I’m sure you can think of crimes committed for ethnic reasons.

      So you’ve provided examples of excuses used to abuse others.

      • jean de peyrelongue on said:

        The fact that in the past some people have been committing crimes using faith, family or ethnic reasons to enlist the support of others to achieve their ambition, cannot justify the present crimes. The fact that you have been beaten by your father does not justify beating your children.

  3. Hillary on said:

    How lucky we are to have the FED to be able to print all the necessary US dollars.
    I see that the US National Debt is ONLY $55K per US citizen.
    http://www.usdebtclock.org/
    Some of the oil producers like Saddam Hussein and Muammar Gaddafi wanted to be paid NOT in US dollars & look what happened to them.
    Russia , China , Brazil are next on the list to try their luck at disentanglement from using the US dollar as the “world currency”.

    • Jean de Peyrelongue on said:

      How can you be happy to behave like thieves, liars and murderer. The US has become a rogue state.

  4. As the authors realize the dollar has had problems as the reserve currency for all of the post world war two era–and things radically changed in the 1960s.

    But none of this is news.

    Yet like so many others, Ron Paul, springs to mind, these authors inaccurately think gold has some inherent value.

    • Joe Tedesky on said:

      Yak, you are right, why peg the dollar to gold. Actually, you could peg the dollar to anything, but the point to be made is what you do with it afterwards. The problem, I see, is the U.S. has used the dollar as more of a weapon than a bartering tool.

      Although, I see your point, why gold? Why not wheat, or actual stuffs we consume? In fact scrap iron, and old plastic would have value as well. Whatever it would be it also includes being fair and responsible in any case.

      Enjoy your posts yaj hang in there. J.T.

      • Jean de Peyrelongue on said:

        Because gold it is available in limited quantity ( below 180 000 metric ton above ground),because it is unalterable and density is high19. Futhermore, it can easily splitted in small parts to make small coins.

        • Jean de Peyrelongue:

          Sorry the amount of gold in the world is not known. Nor is the amount of refined bullion clear.

          Gold is not unalterable anymore or less than any other non-radio active element.

          right it can be split easily, but that’s not relevant in 2014 and hasn’t been relevant for hundreds of years.

          That people retreat to buying gold in times of crisis yes, but that just suggests that gold bugs want to inspire fear and crisis.

  5. Joe Tedesky on said:

    I am not the brightest bulb on the tree, but I have been saying, how the U.S. would sanction itself into loneliness. Now, it appears that is what is happening. The list of sanctioned nations has grown so large one can only wonder who’s left to sanction.

    These sanctions are meant to bring opposition to the table. What is often overlooked is how business is a two way street. The Russian government is said to have 70% Microsoft/IBM technology. Since putting sanctions on American business doing business with Russia is put in place, one can only wonder who loses. These two computer techno giants (Microsoft/IBM) are certainly going to miss their mark with sales without Russia’s 70%.

    What is going to happen in Europe come winter. Will Europeans have enough fuel for heating? German business is already complaining about the lack of commerce due to these sanctions placed on them and Russia. Imagine Germany as a pivot nation. If Germany sways towards a Russian relationship then ask yourself, what does that mean?

    • Jean de Peyrelongue on said:

      Only the idea of one Nation imposing sanctions on another one is outrageous. It implies that one nation is feeling superior to the other and has the right to teach him a lesson. It cannot have any legitimacy, it is actually a war’s act and as such, a crime.
      Even the US’s sanctions on business and banking is looking to me as a racket, a way to steal competitors. Most of the motives for the sanctions are things daily practiced by the FED.
      The animosity towards the US created by these sanctions will backlash and cost dearly to the US.

  6. F. G. Sanford on said:

    @ Joe T., as to the question of who they will sanction next…Take a look at the deteriorating infrastructure, cuts to education, union busting, offshoring jobs, attempts to get their shit-hooks into Social Security, shuffling peoples’ pensions into unsecured speculative financial instruments, creation of international cartels to avoid fair tax contributions, international trade agreements which subordinate protective legislation to corporate authority (denationalization), creating a military manned (and womaned) by a poverty draft, failure to prosecute financial crimes, and the list goes on ad infinitum. Meanwhile, politicians have succeeded in substituting race-baiting, hate-mongering, gay bashing and religious mumbo-jumbo for real issues. All the blame is laid on lazy minorities, illegal immigrants, non-existent “terrorists”, religious apostates, deluded liberals and sex “perverts”.

    We could solve all these problems. We could ship the illegals back, jail all the lazy minorities, send the religious apostates to re-education camps, castrate all the gays and sterilize the lesbians (so they don’t reproduce?), and then we’d have the perfect society that all the right wing-nuts want. The terrorists? Well, they provide the answer to the “Economic Miracle” just like the last “perfect society” which implemented ‘Tea Party’ values. That would be Nazi Germany, where the “terrorists” were invaded, and the first thing that happened after invasion was confiscation of their gold reserves. Poland, Czechoslovakia, France and even the dead bodies in concentration camps were stripped of their dental gold. That financed the “economic miracle”. They’re hoping Ukraine and Russia will finance the next “economic miracle”.

    Don’t ever let anybody fool you. Gold has intrinsic value industrially, chemically, electrically, medicinally, aesthetically, fiscally and is essential to research and development as an electrochemical catalyst. Why do you think the New York Reserve Bank won’t give Germany their gold back? That should be a tip-off. And, it’s a pretty good predictor of where Germany will stand if the loons running our country decide to start a nuclear war with Russia. Germany-Russia looks a lot more viable than US-EU, but that’s just my guess. If the “American Taliban” have their way, we’ll find out.

    • Joe Tedesky on said:

      F.G. Good to hear your opinion.

      In so far as gold, I didn’t agree with Nixon back when he took us off the gold standard. Let’s face it “the powers to be” call the shots. With all the debt the banks have created one can only imagine what the interest will yield them.

      I couldn’t say it better than you did here in so far as the crimes that are being imposed on the worlds society. The bigger question is what can be done to right all the wrongs. You must agree the police state is really here.

      You point out well how many, many peoples rights are at stake. The “American Taliban” is truly hard at work. What is even worst is many citizens fall for their ‘crap’. I maybe like you get very tired trying to set people right on many issues of our time, but it often seems like a losing battle. As an example; ask people if they ever heard about World Trade building #7, or mention the name Victoria Nuland. It amazes me how many people never heard of either. Don’t even mention how LBJ demanded that Kennedy’s office be cleaned out within a half an hour…normally it is a 2 hour job done during inauguration.

      In any case it is always good to read your comments. Thanks for your posting here. Take care…. J.T.

      • F.G:

        Gold has industrial value, but it’s limited.

        The NY Fed has in fact said the gold is going back to Germany, but in some years.

        And it’s that waiting time that increases the speculative price of gold. In other words, if the old all went back in a month it would be proven nearly valueless. The Germans understand this and certainly don’t want that valuation to crash.

        • F. G. Sanford on said:

          That’s the most delusional explanation I’ve ever heard. A given amount of gold will accrue or devalue at the same rate regardless of where it is stored. You should go immediately to Globalresearch.ca and read the John Goss article, which reveals how truly misinformed you are. The US has also confiscated Ukraine’s gold under the aegis of the “Yats” puppet regime.

          • You missed the point.

            Gold in limbo, or oil, increases the price.

            As do claims that the US stole Ukraine’s gold.

  7. Mark Thomason on said:

    Right.

    There is a cost to forming and using an alternative to the dollar. The cost is why nobody did it so far. It wasn’t worth it.

    Each time we use sanctions, we motivate one more nation to look for alternatives. Eventually, the nations looking for alternatives will between them have the resources to pay the costs of forming and using an alternative.

    Then, the dollar is done as we know it.

    Use of sanctions is an important power the US gets from the status of the dollar. Overuse of sanctions, too much of the time against too many nations, will defeat that power to use sanctions, just as surely as overuse of military power will lead to defeat.

  8. Richard on said:

    Big Russian companies are now transferring their funds to SGD as well, so says http://www.rbc.ru (a Russian version of Bloomberg). Sanctions most likely will speed up the process.

  9. Rough McHewn on said:

    The world is finally awakening to the fact that the American debt is owed in American Dollars, and as such, the US will never have to default: Here is the umpteen Trillions that we owe you. There! Paid in full! Be Happy.

    The catch being, that mountain of US dollars won’t buy bushel of turkey feathers.

    This would likely be the main reason that China, India, et al are quietly unloading their US Dollars for anything tangible. Can you blame them.

  10. Joe Tedesky on said:

    I haven’t finished reading all of it, but here is a link to an article about “The Pilgrim Society” …….

    http://www.silverdoctors.com/pilgrims-society-are-the-gold-silver-manipulators-not-bilderbergs-silver-supressors-part-3/

    Another John Goss………

    http://www.globalresearch.ca/ukraine-and-crimeas-vanishing-gold/5394306