Global economy faces threats from dollar nationalism

The U.S. dollar isn’t just America’s currency, unfortunately. It’s the world’s. While the U.S. contributes about 15.5% to the global GDP based on purchasing power, a staggering 88% of international currency transactions involve the dollar. Additionally, around 58% of global reserves are held in U.S. currency.

Economic Impact and Global Dependence

The economics behind the dollar’s overwhelming global presence are complex. Its role as a reserve currency supports a U.S. current account deficit, benefiting U.S. importers and creating markets globally, yet it also shifts the U.S. economy away from traded goods.

The spread of the dollar essentially turns the Federal Reserve into the global central bank by default. This extensive use gives the American state immense power, with U.S. financial sanctions often serving as a commercial death sentence.

In a world growing increasingly multipolar and antagonistic, questions arise about the sustainability of this blend of punitive measures and commercial cooperation. Some in Washington worry that overusing the sanctions tool could weaken confidence in the dollar, diminishing America’s power. Yet, a greater threat looms from the workings of the currency system itself.

Fluctuating Systems and Political Ramifications

The global dollar system functions optimally when the dollar is plentiful, U.S. interest rates are low, and other currencies are strong, fostering global economic activity. However, the current scenario is the opposite. The U.S.’s robust economic recovery has prompted the Fed to hike interest rates, sending the currency soaring and stressing dollar-based transactions worldwide.

While this situation is uncomfortable, it’s not yet a systemic concern. Financial elites globally are adept at managing the pressures of a strong dollar. Both the European Central Bank and the Bank of Japan are adjusting their rates accordingly, and major emerging market central banks have the resources to manage their currency depreciation.

However, if exchange rate fluctuations become too severe and U.S. rates remain high for an extended period, this facade of stability could crumble, pushing the dollar issue into the political arena. President Luiz Inácio Lula da Silva of Brazil has even discussed with other BRICS nations the possibility of establishing a dollar alternative.

The impact of recent interest rate hikes has been particularly damaging on the world’s economic fringes, reversing lending to the poorest countries, a situation neither the IMF nor the World Bank has managed to mitigate.

In the U.S., the strong dollar politics are most significant. The Biden administration views the dollar’s surge as a symptom of America’s strong economic recovery and has not politicized it. In contrast, Donald Trump and his advisors view a strong dollar as detrimental to America, benefiting competitors like China.

Trump’s circle, including advisor Robert Lighthizer, supports using tariffs to push for a coordinated dollar devaluation and has even considered making the Federal Reserve subordinate to presidential control to enforce lower interest rates.

Under both Trump and Biden, U.S. policies have integrated industrial policy, trade policy, green initiatives, and geopolitics into a nationalistic mix. Incorporating the currency system could significantly politicize the global currency framework, far beyond the targeted impacts of financial sanctions.

Whether Trump is serious about his economic policies remains to be seen, as his first term was marked by restraint due to the influence of more conventional advisors.

Dollar Dynamics and Future Uncertainties

The U.S. established its dollar system in 1944 at Bretton Woods, with President Richard Nixon first disrupting it in the early 1970s. Following the 2008 financial crisis, the U.S. led a new era of quantitative easing. Now, the question for 2024 is whether the ongoing crisis in American democracy might spill over into the global economy.

Recent U.S. inflation trends may offer a glimmer of hope, with core inflation possibly easing for the first time in six months. However, the core consumer price index is still rising too quickly for Federal Reserve policymakers, who are closely monitoring the timing for interest rate cuts.

This week, various economic reports will shed more light on producer prices, housing starts, and industrial production, with Fed Chair Jerome Powell and other regional Fed presidents set to speak on these issues.

The resilience of the American consumer continues to challenge the Fed’s inflation targets. Despite solid retail sales in early 2024, projections suggest a potential slowdown. As the global economy watches, the interplay between U.S. politics, economic policies, and the dollar’s strength will continue to shape not just national but global economies.