Since roughly the last year of World War II, the U.S. dollar has enjoyed what one-time French finance minister Valéry Giscard d’Estaing once called the “exorbitant privilege” of being the world’s reserve currency. It’s had that position since roughly 1944, when it seized the role of the world’s currency hegemon from the British pound sterling.
How We Got Here
By July 1944, it had become clear that Allied advances over the Nazis in Europe all but ensured that the Allies, and particularly the United States, would dominate the postwar world. It was then that 730 delegates from 44 countries convened at Bretton Woods, New Hampshire, to reestablish the postwar global monetary order.Together, they agreed to a multinational system whereby global currencies would be convertible to the U.S. dollar at fixed exchange rates that could be modified, if necessary, within a very narrow band. The dollar, in turn, would be convertible to gold at $35 an ounce. It was left to the United States to ensure that the dollar/gold exchange rate remained stable.
But by 1971, social welfare spending on Lyndon Johnson’s “Great Society,’’ the Vietnam War, and dollar investment in overseas businesses, factories, and other assets, as well as balance of payments deficits resulting from imports from more fully recovered Japan and Europe, had greatly expanded the amount of dollars in global circulation. U.S. officials recognized the nation’s gold reserves were insufficient to honor its commitment to convert dollars into gold at $35 an ounce. That year, Europeans started converting small amounts of their dollar for gold. Then, the British asked for a “guarantee” of the dollars they held in reserve.
A currency crisis was brewing. And the United States needed to circumvent it before it happened.
So in August 1971, President Richard Nixon, at the urging of his advisers, convened a secret meeting at Camp David over three days, concluding on Aug. 15, a Sunday. That evening, the president announced to the world in a nationally telecast statement a purported “temporary” closing of the gold window—prohibiting conversion of dollar to gold—to stop any run on U.S. gold reserves. That “temporary” closing lasted until 1975, when a meeting of the International Monetary Fund (IMF), another legacy of Bretton Woods, approved a “managed” or “dirty float” of currencies at a conference in Jamaica. The IMF was to operate to maintain stability via some ambiguous “guardrails,” at least nominally, but central banks—including the U.S. Federal Reserve, the Bank of England, Bank of Japan, et al.—were able to intervene to support their respective currencies.
The dollar was—finally and officially—off the gold standard and was now a “fiat currency”—meaning the dollar had value in the United States simply because the government said it did.
But in other countries, after President Nixon closed the gold window, the U.S. dollar became, with other currencies, essentially a commodity. If you wanted to buy U.S. property or securities, or acquire U.S. products, you needed to obtain dollars to pay for them. Since the dollar had been overvalued by its link to gold, closing the gold window caused the dollar’s value to decline and inflation to increase.
To ameliorate some of the decline, President Nixon’s Treasury secretary, William Simon, made a secret deal with Saudi Arabia in 1974 in which the United States agreed to sell arms and give protection to the House of Saud in exchange for the Saudis investing their U.S. dollar reserves from oil sales in U.S. Treasurys instead of some other “hard” asset.
Where We Are Today
In 1974, when Mr. Simon arranged his deal with the Saudis to avoid a “dollar crisis,” our national debt was roughly 32 percent of gross domestic product (GDP). We were winding down our decades-long involvement in Vietnam and Southeast Asia and had secured a détente with Cold War adversaries China and the Soviet Union.Today, the United States is more than $34 trillion in debt, about 120 percent of our GDP—more than it was even during World War II. A little more than $7 trillion of that—the value of the entire U.S. annual budget—is held by foreigners. We are on our way to $1 trillion a year in debt service, more than our defense budget. And the $10 your grandmother stuck in your birthday card that was lost in the commotion of your birthday party in 1971 would, if found today, be worth $1.20.
In the world, the United States is engaged in escalating conflicts with two powerful, nuclear-armed adversaries, China and Russia, and in the war that Iran’s terrorist proxy, Hamas, is waging on our ally, Israel.
• Citing three current and former U.S. officials, NBC News reported that China’s leader Xi Jinping boldly told the U.S. president that he intends to acquire Taiwan, a vital interest of the United States. Not only do we (and the rest of the world) get most of our microchips from Taiwan, but also 50 percent of the world’s maritime container traffic passes through the Taiwan Strait.
• The Ukraine–Russia war continues and has escalated in the past few days with no end in sight. This is a conflict in which U.S. Secretary of Defense Lloyd Austin has pledged American prestige by asserting in October that we will “deliver what it takes, for as long as it takes, so that Ukraine can live in freedom.” But just last month, President Joe Biden seemingly walked back his commitment by saying the United States will back Ukraine “as long as we can.”
• U.S. Navy forces deployed to the Red Sea to protect shipping and deter Iranian belligerence against Israel were attacked by Iranian-backed Houthi militants in Yemen. Scores of U.S. military personnel have been injured in Iraq and Syria in similar attacks.
Within our own borders, violent protests that went unchecked after the death of George Floyd, the breach of the U.S. Capitol on Jan. 6, 2021, and the Marxist-inspired pro-Hamas protests have rattled the sense of U.S. stability among foreigners more than at any time since the Vietnam War.
Given all that, it shouldn’t be a surprise that other countries are moving to de-dollarize their holdings. The world has growing concerns about the stability of the United States and our ability to meet our debt obligations. The Saudis, whom we have relied upon for 50 years to help maintain demand for the U.S. dollar as the world’s global reserve currency, announced that they are joining BRICS, the international coalition of Brazil, Russia, India, China, and South Africa. Egypt, Ethiopia, Iran, Saudi Arabia, and the United Arab Emirates joined the same day.
As if that weren’t enough, now the Biden administration is contemplating a policy that can’t help but exacerbate de-dollarization. According to the Financial Times, the United States and the G7 “are actively exploring ways to seize Russian central bank assets” in their countries to fund Ukraine because political opposition to continuing Ukraine support in the United States and Europe threatens the flow of money that has kept Ukraine afloat.
The paper reported it had seen a document written by the United States that said, under international law, “G7 members and other specially affected states could seize Russian sovereign assets as a countermeasure to induce Russia to end its aggression.”
Robert Schiller, the Nobel Prize-winning Yale economist, reportedly told Italian news outlet La Repubblica in an interview published last month that he warned against the tactic.
“This will be confirmation for the Russian leader that what is happening in Ukraine is a proxy war [and] it could paradoxically turn against America and the entire West,” Mr. Schiller said. He warned it could create “a cataclysm for the current dollar-dominated economic system” because it would sow doubt among other countries that their investments in U.S. Treasurys, markets, and financial institutions could be seized by the United States in a political dispute.
The United States’ “exorbitant privilege” has allowed us to roll up extraordinary levels of debt in exchange for, basically, IOUs we’ve given to our creditors. And given our level of debt, and particularly our debt-to-GDP ratio, our trading partners are now questioning our ability to repay it, the same as any other creditor.
Summary
The U.S. dollar is under assault by the global market. Although we continue to enjoy the largest, most transparent, and best-regulated capital markets in the free world, and the largest per capita consumer market, the other elements of dollar supremacy are eroding. Its status as the world’s reserve currency—its “exorbitant privilege”—is unlikely to last into the next decade. That will have enormous negative consequences for American citizens for the latter decades of this century. Interest rates needed to fund our debt will soar, closing out other alternative, productive investments in businesses and innovation.Congress absolutely must get a handle on our spending to make vigorous, real reductions and have the courage to raise taxes principally on its own donor class so that we get to a balanced budget no later than 2030. To grow our way out of debt as we did our World War II debt, we must make our nation more productive and more resilient. That means graduating more chemical engineers and computer scientists and fewer social workers and grievance studies graduates.
It means fiercely protecting our technology and re-shoring high-value-added manufacturing. It means making smart policy choices, across the board, to keep our people healthier and our children far better educated and much more physically fit to reduce health care costs. And we need to ensure that our family structures and institutions are more resilient so that charities and families—not governments—support our most challenged citizens.
If we don’t, we will come to the day the dollar dies—and with it, the republic.
