The Slow Demise of the Dollar Empire

The US dollar is strong these days. But this is just a snapshot. The gradual end of the dollar empire is in the making.

The IMF has just announced that it will review the composition of basket of special drawing rights (SDRs ) later this year. To maintain the external pressure for further liberalization of the Chinese economy, the People Bank of China (China´s central bank) has an interest to have the renminbi (or yuan) included in the SDR basket already in 2015. So far, only four global currencies share the honor to be part of that basket. All are part of the Western bloc (dollar, €uro,pound and yen). To qualify for inclusion in the SDR, the Chinese authorities need to initiate a series of liberalizing reforms : financial openness to promote currency convertibility and a wider intervention band for flexibility and market determinination of the renminbi.

SDRs are a kind of artificial money held at the IMF, money not traded on foreign exchange markets. That´s why SDRs are at times dubbed the Esperanto of global currencies as it does not perform all the functions of money. Although SDRs can act as part of official foreign exchange reserves, they can neither be used for intervention in currency markets nor as an anchor currency. Nonetheless, the inclusion of the Chinese currency in the SDR basket would be a very big step in the recalibration of the current world order, which was largely built after WWII. Why is that?

The BRICS have been calling for quite some time to replace the US dollar as the international reserve currency, possibly with the SDR basket. This request was reiterated several years ago by the UN Commission on the Reform of the International Monetary and Financial System, headed by Joseph Stiglitz. True, the US dollar so far is fulfilling an important  network role for the global economy. Like English as a world language, it has features of a natural monopoly. But as the SDR basket consists only of currencies in rich countries, any demand of poorer countries for a reserve currency´(to build up FX reserves, say, for precautionary motives) is akin to ´reverse aid´ to the four SDR countries.

Seigniorage is an 'exorbitant privilege' (Valéry Giscard d'Estaing in 1960) for the country whose currency is the international reserve currency. In addition, the one-sided dependence of the SDR basket (about 80% of which are currently based on dollar and euro) acts pro-cyclically on commodity prices as commodity-based currencies are missing in the SDR basket.

 

The inclusion of the renminbi in the SDR basket would have both  signal and real effects for China and the international monetary system. China's high-risk currency mismatches would be mitigated by the internationalization of the renminbi; the international monetary system would be more balanced. A further opening of the Chinese financial system might perhaps improve the efficiency of resource allocation, but it is almost certain to also increase China's financial risks. China´s promotion of financial reform and capital-account opening by joining the SDR basket might perhaps be compared in retrospect to the stimulatory effect of China's WTO accession on SOE Reform. Unless it served as a major step to a big financial crash...

If history is any guide, it will take thirty to seventy years until the dollar empire is replaced by a multiple currency system or even a renminbi empire. Already today, China is in the lead as the world's largest economy, exporter and net creditor. Great Britain´ pound sterling lost only during WWII the dominant reserve currency role to the US dollar although she had lost the lead as an economic power to the United States as early as 1872 and in 1914 had turned into a the net debtor country. It was only the growing convertibility of the US dollar after WWI that enabled the dollar´s steady climb to a pole position as international reserve currency . Now it is China's turn ...

Kindleberger´s Global Leadership Concept: A Scorecard for China, Germany & the US

It is often suggested (and disputed) that the Pax Americana is coming to an end. The term has connected with the international leadership power (also: hegemonic power) of the United States, at least since the end of World War II. The Bretton Woods institutions, the OECD and NATO can be understood as a steering instruments under American leadership. The beginning of the end of American leadership takes place in a world that is - unlike the 1990s after the collapse of the Soviet Union and its satellites -  no longer felt as unipolar, but as a multipolar or apolar.

The unstoppable economic rise of China since more than three decades and her more recent assertive foreign policy stance, especially in the context of the BRICS group and global financial diplomacy, have established China's international leadership ambition[1]. Even Germany has been catapulted (albeit reluctantly) by the Euro crisis in the role of European leadership[2] – an outcome very different than intended by Jacques Attali and François Mitterand when they pushed for the Euro.

The US, China and Germany: How far do these three countries (still or already) satisfy an international claim to be a benevolent, solidary hegemon in the constructivist sense foremost defined by Charles Kindleberger[3]? The idea of ​​a well-intentioned leading power requires willingness to bear a disproportionate share of the costs of the provision of global public services for the stabilization of the international financial and economic system. Specifically, Kindleberger has defined five global public goods:

• acceptance of open markets to absorb exports from crisis regions;

• the countercyclical provision of long-term financing;

• a stable exchange rate system;

• securing macroeconomic coordination;

• a willingness to act as ´lender of last resort´ in systemic crises.

How well do the US, China and Germany meet the provision of global public goods in financial and economic area - yesterday and today? The table attempts a schematic representation. X stands for ´positive´, (X) for mixed, O negative performance. To be sure, the calibration has to be subjective and somewhat arbitrary. But it has the merit to point the attention to the leaders, away from the ´periphery´, when it comes to assuming responsabilities for avoiding or solving crises such as the current Eurozone crisis.

Scorecard for Global Kindleberger Goods

Public Goods	China	Germany	USA
Open markets	(X)	X	X
Long term finance	X	(X)	0
Exchange rates	(X)	(X)	0
Macro coordination	0	0	X
Last resort lending	(X)	0	X

Open markets: Germany and the US were so far, despite their agricultural protectionism, classic free trade nations; China as a developing country, instead, still prioritizes  the establishment and protection of new industries. However, TPP and TTIP are darkening the US free trade status; they undermine global trade through multilateral WTO rules, while they focus on enforcing primarily US standards not least to ´contain´ China[4]. Should Germany sign TTIP, it would retrograde from a multilateral free trade status adhered to for long.

Long-term financing: China is assuming nowadays a role model in the countercyclical provision of long-term loans. With generous development and export credits by Chinese national financial institutions in developing countries since the late nineties, China started to lead; in recent years, through establishing parallel multilateral development banks, China has started to challenge the US-led World Bank and the Asian Development Bank[5]. Germany has a well-equipped development bank and participates prominently in the EIB; but Germany in the euro zone has failed to provide constructive and solidary leadership – notably by hindering fiscal union and a common market for government bonds - despite its large contribution to the various Eurozone bailout funds. The United States is anything but a a provider of anticyclical long-term finance: with the focus on private portfolio investment and the ubiquitous pressure to dismantle capital controls, the US have a tradition of rather sponsoring pro-cyclical and crisis-prone finance.

Exchange rate stability: Since the collapse of the Bretton Woods system of fixed exchange rates, monetary policy of the US Federal Reserve has avowedly been based on US national objectives alone. China is still effectively pegging the renminbi to the US dollar and currently thereby preventing a global currency war at a time when the Bank of Japan and the ECB deliberately weaken the external value of their monies. China shows here global responsibility (but for how long?). Germany plays a rather destructive role in the euro zone that it helped create. Sure, together with France, Germany has infringed debt and deficit criteria set by the Maastricht Treaty and prevented sanction proceedings launched by the European Commission against her. But what matters more is that Germany has actively torpedoed   the creation of the institutional prerequisites for an efficient monetary union - fiscal and banking union as well as common government bonds.

Macroeconomic coordination: Here, the US remain the undisputed leading power, for example in the context of the G20 group, where they exert pressure on macroeconomic coordination and reduce external imbalances such as (beggar-thy-neighbor policies in the form of large surpluses in the current account). A neo-mercantilist mindset and widely ignored (or refuted) Keynesian economics prevent the understanding of the need for global macroeconomic coordination in both China and Germany - according to the St. Florian principle: "O heiliger Sankt Florian, verschon' mein Haus, zünd' and're an", equivalent to "St Florian, please spare my barn, set fire to another one".

Lender of last resort: The US Federal Reserve remains the unique international lender of last resort in the event of a global systemic financial crises. Due to underdeveloped financial markets and existing controls on capital movements, the People's Bank of China cannot play this role. But China's high foreign exchange reserves and public finances have been used vigorously in the global financial crisis 2007/8 to effectively prevent a decline in economic performance. Increasingly, China - parallel to its activities in global financial diplomacy – enters the scene as White Knight in allied countries in the context of the Second Cold War. Germany, by contrast, has undermined via Bundesbank, conservative media (such as the FAZ) and its constitutional court ´lender-of-last-resort´ actions by the ECB such as the ´Outright Monetary Transaction´ (OMT).

The listing of global public goods show to what extent China, Germany and the United States contribute to secure the financial and economic stability in each respective case. Germany has clearly failed to play the role of benevolent hegemon with the Eurozone. Do you still wonder why the world is familiar with the Washington Consensus and the Beijing Consensus but has never heard about a Berlin Consensus?

---

[1] Do read the excellent analysis by Hongying Wang (2014), „From “Taoguang Yanghui” to “Yousuo Zuowei”: China’s Engagement in Financial Minilateralism“, CIGI Papers No. 52, Waterloo, On:  Centre for International Governance Innovation (CIGI).

[2]  Robert Kappel (2011): “On the Economics of Regional Powers. Theory and Empirical Results“, in: Nadine Godehardt and Dirk Nabers (eds.): Regional Powers and Regional Orders, London: Routledge: pp. 68-92; Siegfried Schieder (2014), „Zwischen Führungsanspruch und Wirklichkeit: Deutschlands Rolle in der Eurozone“, LEVIATHAN: Berliner Zeitschrift für Sozialwissenschaft, 42. Jahrgang, Heft 3, S. 363-397.

[3] Charles Kindleberger (1973), The World in Depression, 1929-1939. Berkeley: University of California Press; and, idem (1986), „Hierarchy versus Inertial Cooperation“, International Organization, Vol. 40.4, pp. 841 – 847. There is some debate whether Kindleberger distinguished clearly enough between the terms ´hegemon´ and ´international leader´. While the hegemon “presumably wants to do it on his own behalf, a leader, one who is responsible or responds to need, who is answerable or answers the damand of others, is forced to ´do it´ by ethical training and by the circumstance of position” (Kindleberger, 1986, p. 845).

[4] L. Alan Winters (2014), „The Problem with TTIP“, Voxeu.org, 22. March.

[5] Sebastian Heilmann et al. (2014): “China’s Shadow Foreign Policy: Parallel Structures Challenge the Established International Order”, MERICS China Monitor, Nr. 19, Berlin: Mercator Institute for China Studies (MERICS).