Why the Dollar-Based International System Is Breaking Up

The Federal Reserve’s higher interest rates after 12 years of zero interest rates are devaluing the asset side of banks’ balance sheets.  This frightens depositors and they withdraw their deposits.  Depositors also are withdrawing their money because they can get much higher interest rates on safe US Treasuries. According to some reports, $1 trillion has already been withdrawn from US banks.  Bloomberg is reporting rumors that Schwab’s $7 Trillion empire based on low rates is cracking from bond losses.  In the face of this vulnerability of the financial system, the Federal Reserve raised interest rates further.

There is also the problem of the currency and interest rate derivatives.  No one knows the risk in these instruments.  The US dollar itself is declining in use as world reserve currency.  Alarmed by Washington’s weaponization of the dollar with sanctions and confiscations, much of the world is arranging to abandon the dollar’s use to settle international trade accounts, but the supply of dollars is not declining.  This implies a fall in the dollar’s exchange value. The offshoring of manufacturing and food production has made the US heavily dependent on imports.  A loss in the dollar’s exchange value resulting from countries settling their trade balances in other currencies means a sharp rise in US inflation.

The Federal Reserve hasn’t the intelligence to think through the consequences of its higher interest rate policy.  The federal government cannot comprehend the consequences of offshoring for the US trade deficit or the consequences of continuing massive US budget deficits for the Treasury market.

Washington is too arrogant to comprehend the new way in which the US is perceived abroad.  The world sees the dollar-based reserve currency system as Washington’s punishment device, and the world sees dollar-based debt expanding while demand for dollars declines.  The result will be a drop in the foreign exchange value of dollar denominated financial instruments such as stocks and bonds.

The collapse of the Soviet Union gave Washington the opportunity to lead the world on a path of peace and economic development.  But the neoconservatives could not resist their attempt for world hegemony and launched twenty-five years of war.  Wall Street and corporate executives with eyes on bonuses could not resist deindustrializing the US by locating US manufacturing offshore, thus boosting Chinese economic growth instead of American economic growth.  These major failures indicate the total failure of US policymakers.

The repeal of the Glass-Steagall Act in the closing days of the 20th century launched the US into the 21st century on a path of financial instability.  Nothing has been done to correct this, and nothing has been done to correct the offshoring mistake or the failure to control the supply of government debt.  As countries move away from using the dollar to settle international transactions, a dollar glut will result in US inflation and declining American living standards.

Discussing the seriousness of our country’s situation with Michael Hudson, it is difficult to find hope. To admit that mistakes are being made implies acknowledging that we are on the wrong path and that China, Russia, and those governments aligning with them are on a better course, using their banks for financing industrial wealth instead of acting as brokerage casinos and dealing in financial arbitrage and debt leveraging.  No American policymaker will risk being asked “why do you support the policies of Xi and Putin?”  That they, and not us, have the right policy is not a permitted thought.

Article cross-posted from Paul’s blog.