Something strange is happening when President Donald Trump can bemoan America’s trade deficits while cheering the effectiveness of U.S. sanctions.
Not satisfied with targeting only China, Trump is threatening to expand his trade-war campaign to other countries as global leaders gather for the G-20 meeting in Japan. Vietnam is “almost the single worst abuser of everybody,” he told Fox Business Network on Wednesday. European nations “were set up in order to take advantage of the United States.” On Twitter, India’s trade stance came in for criticism, too.
Meanwhile, the long arm of American sanctions has been choking the Iranian economy; sending the stocks of Chinese banks falling in Hong Kong; and keeping Huawei Technologies Co. Chief Financial Officer Meng Wanzhou entangled with Canada’s courts.
The links between deficits and sanctions are deeper than often appreciated.
The extraordinary power of U.S. sanctions depends on the dollar’s role in global trade. In previous spats with Tehran, Washington never managed to cut off the flow of Iranian oil to foreign countries. This time around, even key customers such as India and South Korea are standing down for fear of falling afoul of the U.S. government, thanks to the Swift payment network last November bowing to Treasury pressure to cut off Iranian banks.
Any transaction in dollars must ultimately be cleared via U.S.-based correspondent or intermediary banks. As a result, dollar-denominated economic activity anywhere in the world is potentially under the jurisdiction of Washington’s Office of Foreign Assets Control. Any institution that feels like trying to thumb its nose at this risk should look to the billions in fines paid by BNP Paribas SA, Standard Chartered Plc, HSBC Holdings Plc and others over the past decade.
It isn’t just trade with the U.S. itself that’s affected. Commodities, apparel and semiconductors are largely priced in greenbacks, putting a huge share of the global economy under the Treasury’s sway. About 88% of foreign-exchange transactions globally in 2016 involved the dollar, according to the Bank for International Settlements.
Why are dollars so fundamental to the world economy, even as the U.S. accounts for a smaller and smaller share of output?
A major reason is that there are simply so many of them. Some $11.5 trillion in dollar-denominated credit was being extended to borrowers outside the U.S. at the end of December, according to the BIS, far more than the 3.2 trillion euros ($3.7 trillion) in that currency and 49.2 trillion yen ($449 billion). Central banks hold about $6.6 trillion in greenbacks, accounting for more than 60% of global foreign-exchange reserves.
That all hangs on America’s current account deficits. Each month that the current account is in deficit, the capital account must be in surplus to balance things out. The result is a growing pile of overseas financial assets – in common parlance, “dollars” – spread around the world, providing the lifeblood of the global financial system.
It’s certainly possible (if extremely unlikely) for a sufficiently driven government to remake global supply chains to the point that the U.S. switches from a generation of current account deficits to a surplus. For things to balance out, though, that would necessitate another of the world’s big economic blocs – whether the euro zone, or China, or Japan – switching from its current surpluses towards deficits.
Where greenbacks once greased the world economy, yuan, or euros, or yen would instead flow out to finance the Chinese, euro zone or Japanese current accounts. The dollar would retain its status as the international unit of account for a while – but gradually, a dwindling supply would cause more and more transactions to switch to more readily available currencies.
Eventually, we’d end up in a situation like the one that prevailed in the interwar period of the 20th century, when no one currency could claim to be the principal channel of global finance. Perhaps one would even be able to replace the dollar as the key global reserve currency, as the dollar once replaced the pound.
That’s an improbable scenario – but it’s ultimately the one that could emerge if the U.S. stopped financing its spending by going into debt with the world. A president who’s determined to enhance U.S. power should tread carefully. In monetary terms, America’s apparent weakness has long been its strength.
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David Fickling is a Bloomberg Opinion columnist covering commodities, as well as industrial and consumer companies. He has been a reporter for Bloomberg News, Dow Jones, the Wall Street Journal, the Financial Times and the Guardian.
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