The U.S. Dollar: A Victim Of Its Own Success

1
2067

America’s most powerful weapon of war does not shoot, fly or explode. It’s not a submarine, plane, tank or laser. America’s most powerful strategic weapon today is the dollar.

The U.S. uses the dollar strategically to reward friends and punish enemies. The use of the dollar as a weapon is not limited to trade wars and currency wars, although the dollar is used tactically in those disputes. The dollar is much more powerful than that.

The dollar can be used for regime change by creating hyperinflation, bank runs and domestic dissent in countries targeted by the U.S. The U.S. can depose the governments of its adversaries, or at least blunt their policies without firing a shot.

Before turning to specific tactics, consider the following. The dollar constitutes about 60% of global reserves, 80% of global payments and almost 100% of global oil transactions. European banks that make dollar-denominated loans to customers have to borrow dollars to fund those liabilities.

Those banks do their borrowing in the eurodollar deposit market, or with dollar-denominated commercial paper or notes. Being based in Switzerland or Germany does not allow you to escape from the dollar’s dominance.

The U.S. not only controls the dollar itself. It controls the dollar payments system. This consists of the Treasury’s digital ledger of holders of U.S. debt, the Fedwire payments system among U.S. Fed member banks and the Clearing House Association (successor to the New York Clearing House and proprietor of CHIPS, the Clearing House Interbank Payments System) composed of the largest U.S. banks.

A dollar payment going from a bank in Shanghai to another bank in Sydney runs through one of these U.S.-controlled payments systems.

In short, the dollar is the oxygen supply for world commerce and the U.S. can cut off your oxygen whenever it wants.

The list of ways in which the dollar can be weaponized is extensive.

The International Emergency Economic Powers Act of 1977, IEEPA, gives the president of the United States dictatorial power to freeze and seize assets and block payments.

The Treasury’s Office of Foreign Assets Control, OFAC, maintains a blacklist of individuals and companies with whom financial intermediaries, such as banks and credit card companies, are forbidden to transact. Individuals on the OFAC list are like dead men walking when it comes to travel and business.

The Committee on Foreign Investment in the United States, CFIUS, can block any foreign acquisition of a U.S. company on national security grounds.

This list of financial weapons goes on, but you get the idea. The U.S. uses the dollar to force its enemies into fronts, crude barter or the black market if they want to do business.

Examples of the U.S. employing these financial weapons are ubiquitous. The U.S. slapped sanctions on Russia after the 2014 annexation of Crimea and invasion of Eastern Ukraine. The U.S. waged a full-scale financial war with Iran from 2011–13 that resulted in bank runs, hyperinflation, local currency devaluation and social unrest.

The U.S. was pushing Iran to the brink of regime change in 2013 when President Obama declared a truce to pursue what became the Joint Comprehensive Plan of Action, JCPOA, or the Iran nuclear deal. President Trump has now ended that deal and the financial war with Iran has resumed where it left off in 2013, but tougher than ever.

The U.S. is slapping stiff Section 301 penalties on China for theft of intellectual property. Other obvious victims of U.S. financial weapons are North Korea, Syria, Cuba and Venezuela.

The actions described above did not arise in the normal course of trade and finance. The Russian, Iranian and other sanctions noted are explicitly geopolitical, while the Chinese sanctions are geostrategic to the extent the U.S. and China are vying for technological supremacy in the 21st century.

None of these sanctions would be effective or even possible without the use of the dollar and the dollar payments system.

Yet for every action there is a reaction. America’s adversaries realize how vulnerable they are to dollar-based sanctions. In the short run, they have to grin and bear it. They’re fully invested in the dollar both in their reserves and in the desire of their largest companies like Gazprom (Russia) and Huawei (China) to become major global players.

Transacting on the world stage means transacting in dollars.

And dollar-based sanctions are a powerful financial weapon for the U.S. But our adversaries and so-called allies are not standing still. They are already envisioning a world where the dollar is not the major reserve and trade currency.

In the longer run, Russia, China, Iran, Turkey and others are working flat-out to invent and implement nondollar transactional currencies and independent payments systems.

Russia has begun a major research and development effort in the area of distributed ledger technology (also known as “blockchain”) so that financial transactions can be processed and verified without reliance on Western-controlled banks.

This will not involve dead-end cryptocurrencies like bitcoin but entirely new utility tokens and cryptos. Imagine something like a putincoin and you’ll be on the right track.

China is pushing its trade counterparties to accept Chinese yuan as payment for goods and services. The yuan is a small part of global payments today (about 2%) but the yuan may get a boost as the U.S. sanctions on Iran kick in.

China is Iran’s biggest customer for oil, and if U.S. sanctions prohibit dollar payments for Iranian oil, then Iran and China may have no choice but to transact in yuan.

The International Monetary Fund, IMF, has already announced efforts to put its world money, the special drawing right, SDR, on a distributed ledger. This would make the SDR a global cryptocurrency for settling balance of payments transactions among China, Russia and other IMF members, also without reliance on the dollar payments system.

Alongside the new money in cryptocurrencies, there is the oldest form of money, which is gold. The use of gold is the ideal way to avoid U.S. financial warfare.

Gold is physical so it cannot be hacked. It is completely fungible (an element, atomic number 79) so it cannot be traced. Gold can be transported in sealed containers on airplanes so movements cannot be identified through wire transfer message traffic or satellite surveillance.

There is good evidence that Iran currently pays for North Korean weapons technology with gold, and good reason to expect that future Chinese payments for Iranian oil will be made at least partly in gold.

Imagine a three-way trade in which North Korea sells weapons to Iran, Iran sells oil to China and China sells food to North Korea. All of these transactions can be recorded on a blockchain and netted out on a quarterly basis with the net settlement payment made in gold shipped to the party with the net balance due. That’s a glimpse of what a future nondollar payments system looks like.

Finally, look at the evidence presented in Chart 1 below. This shows Russia’s reserve position from 2013–18. The reserve position collapsed from $540 billion to $350 billion as a result of the oil price crash beginning in late 2014. (And query whether the oil price collapse itself was engineered by the U.S. in retaliation for Russia’s annexation of Crimea).

Chart 1

Since early 2015, Russia has rebuilt its reserve position under the patient stewardship of Russian Central Bank head Elvira Nabiullina. Russian reserves are now back up to $460 billion and rising steadily.

Yet there’s one huge difference between Russian reserves in 2014 and those reserves today. That difference is gold. During the reserve collapse in 2014, Russia sold U.S. dollar assets as needed to maintain liquidity, but it never stopped buying gold.

Russian gold reserves rose from 1,275 tons in mid-2015 (near the reserve low) to 1,909 tons at the end of April 2018. That’s a 50% increase in gold reserves in less than three years. Using current market prices, the Russia gold hoard is worth about $90 billion, or 20% of Russia’s global reserve position.

Why would a country put 20% of its reserves into gold unless it expected gold to be a major part of the international monetary system in the future? It wouldn’t. Russia not only expects gold to be part of the system, it is in strong position to make that happen by working with China, Turkey and Iran in what I call the new “Axis of Gold.”

The bottom line is that the weaponized dollar will soon be a victim of its own success. While the U.S. was bullying the world with dollars, the world was quietly preparing a new nondollar system. The U.S. wanted diplomatic and military clout and it got it with the dollar.

But as the saying goes, “Be careful what you wish for.”

Wise investors will prepare now for a new nondollar payments system. You may not be able to buy crypto SDRs (yet), but you can certainly own gold, and you should.

1 COMMENT

  1. It is a bit long, and uses ‘Theo Lander’ in place of Leo Wanda, but basically it is accurate.

    In 1978 an American CIA agent named Theo Lander was retired or fired from the CIA, he was the most senior expert on the USSR and especially Russian trade and finances. He tried to tell the CIA top management that USSR was failing and that they did not need to fight them or to be afraid of them. That the Warsaw Pact armies were poor and the weapons undeliverable. This was not the message that the American weapon manufacturers wanted to hear and so he was pushed out of the CIA. He went to the US Treasury as part of the Secret Service and because of his expertise in international trade, became involved with the control of SWIFT, the interbank and intercontinental system to transfer money and settle financial transactions. He got to understand the DEC computers and the programs that ran on them. When Reagan was elected in 1980 Theo had a plan to destroy the USSR. Treasury would not allow him to present it, they did not believe in him and his wild ideas, maybe they did not realise the power that the US Treasury had in world affairs. Just before Reagan was inaugurated, Theo used his SS pass to get next to the President elect and before anyone could stop him, he said to Reagan, ‘Mr President I can destroy the USSR without using a single bullet or bomb, but they won’t let me tell you about it. You can use their money to destroy them.’ They hurried Theo away, but Reagan told his chief of staff to give the lunatic 15 minutes to present his idea in the week to come.
    Theo wrote out his plan and when his moment came, he asked Reagan to clear the room. Only two people should know about it Reagan and Theo.
    “Mr President,” Theo said, “the Bretton Woods agreement means that every country in the world must use US dollars for international trade. They must sell their goods for dollars and spend dollars to buy goods from other countries. But the price of dollars for each country changes depending on the demand at the particular time. Like all commodities, if there are lots of dollars for sale, the price goes down, if there are few dollars for purchase the price goes up. US Treasury, by issuing Treasury bills reduces the number of dollars available and by redeeming the treasury bills, more dollars become available. The Treasury can control the exchange rate for countries that need dollars or have excess of dollars.
    If Treasury time it right, then we make all the purchases of the USSR expensive, and make all the sales of goods by the USSR cheap. It is only a small percentage maybe one or one point five percent, but on all sales and purchases it can cripple their balance of payments and reduce them to poverty in a matter of years. Not only does it not cost the US anything, but in fact we can profit from destroying them.”
    Reagan said, “You mean if we sell Treasury Bills then we create dollars and make more of them and if we redeem the bills then we reduce the dollars”.
    “No Mr President, buyers have to give up the Dollars in exchange for the bills, and we put the dollars in our bottom drawer and give them the Treasury Bill, an IOU, redeemable in 30 or 60 or 90 days. For that period of time the dollars are out of circulation, we are holding them, thereby creating a shortage. When we redeem the bills, we give them the dollars in exchange for our IOU, and then they can spend them, creating a surplus of dollars. We can always sell the bills by offering a good discount and redeem them by offering a good price. Treasury can control the market.”
    “How will we know when the USSR needs dollars, before they come onto the market to purchase them?” asked Reagan.
    “Since 1973, more and more transactions are made via the SWIFT network as it steadily replaces the international Telex machines. Currently, between 80% and 90% of all international transfers are done via SWIFT. These transactions are often entered five or ten or more days in advance. If we have access to the records, then we know exactly how much money Russia will need in three or four days time, sometimes as far ahead as three weeks. We can move quickly and buy ahead of them, and also issue or redeem Bills to make the price even more punitive, no matter which way they have to trade.”

    Leo ended up with $22 trillion. Russia ended up destroyed along with many countries caught up in the sting.

    Tina took a drink and continued, “Theo explained [one of] his strategy. When a person wanted to buy shares in IBM, which were trading that day at 250, they would issue a buy order instructing the broker to buy a million shares at a maximum price of perhaps 260. The broker could then, if he was dishonest and a cheat, buy a million shares at 252 and then sell them to his client at 259, making an immediate profit with a guaranteed sale. If they were caught doing it, they could go to jail, but with a little sleight of hand and a large family or lots of friends, they could and did, get away with it for years. His plan was to do this in International Currency dealings. Theo would send me each day a fax with a table of 28 numbers. It would be either plus or minus depending on whether USSR needed to buy dollars or sell dollars in the four weeks ahead. The number would represent the millions of dollars that were scheduled to be traded each day. Of course it would change as the days progressed and better information became available, I had to be flexible, but I was to buy or sell ahead of them, and then enter the market to profit from their sales and purchases.”

    Saddam said ‘I want Euros not dollars’ Gaddafi said “I will set up a Gold backed Dinar for N Africa – Arabia”, Iran said we will set up a gold backed alternative Oil futures exchange.

    Silly boys.

Comments are closed.