As the dispute continues as to whether or not there is actually a shortage of US currency available In Guyana, the Economist ran a very interesting article one week ago that reminds us of the critical role the American currency plays in anchoring the economy of the world, including ours. As the title, “Donald Trump and the dollar standard” suggests, the volatile United States (US) President may also affect the volatility of that standard and consequently the world’s economy.
Directly after World War II, when the World Bank and IMF were founded to coordinate the world economy, the US dollar, which was pegged to the price of gold, became the reserve currency, even as the US had to keep the requisite quantity of gold to “back” its currency. But in 1970, when the US, under pressure, unhitched the dollar from gold, countries increasingly began to keep their reserves in dollars – which are never kept in the banks of the individual countries, but in the US Federal and “correspondent” US banks. This is done as a hedge against volatility swings on the premise that with the US being the dominant economy in the world, it would be least affected by uncertainties.
Presently, almost US$10 trillion of debt is also denominated in dollars – rising exponentially from the US$1 trillion in 1980. The use of the dollar as a reserve currency and to denominate debt gives the US not only great power over the world’s economy, in that its fiscal and monetary policies ripple through almost every other economy, but also it can finance almost any amount of fiscal deficits since the paper it prints and calls “dollars” are automatically accepted for goods and services by the rest of the world. The latter, from this perspective, is financing America’s debts.
The Economist’s article offers a perspective on another topic that has surfaced recently in the ‘foreign currency shortage row’: exchange rate controls. At the time of the establishment of the Breton Woods financial institutions, about 40 per cent of countries had capital controls, but this grew to over 50 per cent by the 1980’s, which is remarkable when one considers that the number of countries had doubled through decolonisation in the same period. But from the 1980’s when the Washington Consensus insisted on liberalisation of financial markets, countries with capital controls plummeted down to about 12 per cent. This was accompanied by the comparable exponential increase of foreign reserves – especially denominated in United States Dollars – held by the “liberalised” economies. But in the last two years, there has been a mirror image increase in countries with exchange controls and decrease in the volume of foreign reserves. Guyana should take notice of this move to stabilise exchange rates via controls, rather than reserves.
The Economist highlighted that in light of Donald Trump’s declaration, his administration intends to “put America first”, especially in returning “production” to US shores. While on one hand some may feel that the US is getting a free ride to import foreign goods with the pieces of paper it prints, this – as we have seen – is not viewed kindly by domestic manufacturers and their work force. They point out that it is not “the US” that is gaining, but the one per cent.
It is feared that if Trump goes ahead with his promise to cut taxes and increase domestic spending massively, this may lead to inflation that would make the US reserves and dollar-denominated foreign debt less attractive and lead to an exodus that can threaten the entire global economy. Alternately, or in tandem, countries may decide to abandon the dollar as their hedge against volatility and impose tariffs and capital controls to perform that function as in the past. In either scenario, small countries like Guyana, which depend of global free trade, could be crushed.
Another more benign scenario could be the role of a reserve currency becoming shared by other currencies such as the Chinese Yuan. China had already declared it is willing to step in.
