Dollar collapse leads to US-China war

The Spoils of Hegemony As the issuer of the international reserve currency, the United States has garnered two unique economic benefits from dollar hegemony. First, for other countries to be able to continually accumulate dollar reserves by purchasing dollar-denominated assets, capital has to flow out of the United States and goods have to flow in. Effectively, the international economy must allow the United States to purchase a growing quantity of goods in order to facilitate the flow of capital into the coffers of other nations. As a result, the value of the dollar has to be kept higher than the value of other currencies in order to cheapen the price of imported goods. While this arrangement has come at the cost of an ever-growing current account deficit, it has also subsidized US consumption and fueled the growth of the US economy. Effectively, when a US citizen buys a cheap imported good priced in dollars, the exporter of that good must use those dollars to purchase dollar-denominated assets or invest that dollar in the United States, compounding the exchange effects of the system and aiding US economic growth. The second benefit of this system is its effect on the market for US government debt. The largest market in the world for a single financial asset is the multi-trillion dollar market for American bonds. This market, considered by many to be the most liquid in the world, allows any nation or large investor to park massive amounts of cash into a stable asset with a relatively desirable rate of return. While the depth and stability of US financial markets as a whole were part of the original reason nations gravitated toward the dollar as a reserve currency, the explosive growth of US government debt has made US Treasury bonds the center of the foreign exchange market and the most widely held form of dollar reserves. The use of the US Treasury securities in currency reserves has created an almost unlimited demand for US debt; if the federal government wishes to issue debt, someone will buy it if only as a way to acquire dollar holdings. This artificially high demand means that the United States can issue debt at extremely low interest rates, especially relative to its national debt and overall economic profile. And while the United States has had to pay off its existing debt by issuing new securities, no nation wants to call in its debt for fear that it would devalue the rest of its dollar holdings. While precarious and arguably dangerous in the long term, the reality is that as long as the dollar is the international reserve currency, the United States will have a blank check that no one wants to cash. Whether or not you agree with US fiscal policy, it is indisputable that the ability to finance its debt has allowed the United States to provide its citizens with a high standard of living and fund its enormous military programs. Essentially, dollar hegemony has served as the backbone of US primacy. Domestically, the ability to run effectively unlimited budget deficits has allowed the United States to fund its massive entitlement programs and, more recently, afford sweeping bailouts at the height of the recession. The United States has used its unlimited allowance, afforded by dollar hegemony, to finance its high standard of living and maintain the prosperity required of a hegemon. More importantly, the United States has used the demand for American debt to fund its military apparatus. Each year, the United States spends over US $600 billion on its military, excluding spending on the wars in Iraq and Afghanistan, constituting over forty percent of global military spending. Since the establishment of the post-World War II international order, the United States and its allies have relied on US military might to enforce their wishes upon the world and maintain the Western-dominated order. The ability to intervene militarily in any conflict that threatens US interests and maintain US geopolitical influence and hegemony is a direct result of dollar hegemony. For the past sixty-five years, the United States has relied on its excessive spending to fund its position of privilege and relied on the dollar’s position as the international reserve currency to fund this spending. The United States’ Undoing? Despite the dollar’s long history as the international reserve currency, the past few years have seen a growing number of calls for the end of dollar hegemony. Countries as diverse as France, Russia, and China have decried the dollar’s monopoly in foreign exchange markets, while in 2009 reports of a shift away from dollar-based oil trading surfaced in the Middle East. Reported plans to move away from the dollar reflected international frustration at a system fueling the United States’ “exorbitant privilege,” as the French have called it, one that rests its stability on the financial conditions of a country mired in debt and facing a financial meltdown. The implications of a true end to dollar hegemony, a shift away from the dollar as a reserve currency and pricing standard for oil transactions, could be catastrophic for the United States. In the worst case scenario, a drastic drop in demand for dollar-denominated assets would cause the interest rates on Treasury Securities to skyrocket, sending ripples through the US economy as the value of the dollar plummets. What is certain, however, is that whatever decrease in demand for US debt occurs will constrain the federal government’s ability to spend and the ability of the United States to defend itself. The United States has built its foreign policy around its vast military capability; a sudden budgetary shock and drop in military spending would leave the United States vulnerable as it scrambles to regroup in a new security environment. The ability of the United States to respond to threats across the globe would be diminished, and enemies would be incentivized to take aggressive action to take advantage of this new weakness. In particular, a rapidly militarizing China might be emboldened by its partial decoupling from US economic fortunes to adopt a bolder stance in the South China Sea, threatening US allies and heightening tensions with the United States. While war with China is all but off the table in the status quo, an international system devoid of both US military might and Chinese dependence on US debt as a place to park excess liquidity might lead to the conflict feared on both sides of the Pacific.