The Age of Impunity
And How to Fight It
In the 1960s, French Finance Minister Valéry Giscard d’Estaing complained that the dominance of the U.S. dollar gave the United States an “exorbitant privilege” to borrow cheaply from the rest of the world and live beyond its means. U.S. allies and adversaries alike have often echoed the gripe since. But the exorbitant privilege also entails exorbitant burdens that weigh on U.S. trade competitiveness and employment and that are likely to grow heavier and more destabilizing as the United States’ share of the global economy shrinks. The benefits of dollar primacy accrue mainly to financial institutions and big businesses, but the costs are generally borne by workers. For this reason, continued dollar hegemony threatens to deepen inequality as well as political polarization in the United States.
Dollar hegemony isn’t foreordained. For years, analysts have warned that China and other powers might decide to abandon the dollar and diversify their currency reserves for economic or strategic reasons. To date, there is little reason to think that global demand for dollars is drying up. But there is another way the United States could lose its status as issuer of the world’s dominant reserve currency: it could voluntarily abandon dollar hegemony because the domestic economic and political costs have grown too high.
The United States has already abandoned multilateral and security commitments during the administration of President Donald Trump—prompting international relations scholars to debate whether the country is abandoning hegemony in a broader strategic sense. The United States could abandon its commitment to dollar hegemony in a similar way: even if much of the rest of the world wants the United States to maintain the dollar’s role as a reserve currency—just as much of the world wants the United States to continue to provide security—Washington could decide that it can no longer afford to do so. It is an idea that has received surprisingly little discussion in policy circles, but it could benefit the United States and ultimately, the rest of the world.
The dollar’s dominance stems from the demand for it around the world. Foreign capital flows into the United States because it is a safe place to put money and because there are few other alternatives. These capital inflows dwarf those needed to finance trade many times over, and they cause the United States to run a large current account deficit. In other words, the United States is not so much living beyond its means as accommodating the world’s excess capital.
Dollar hegemony also has domestic distributional consequences—that is, it creates winners and losers within the United States. The main winners are the banks that act as the intermediaries and recipients of the capital inflows and that exercise excessive influence over U.S economic policy. The losers are the manufacturers and the workers they employ. Demand for the dollar pushes up its value, which makes U.S. exports more expensive and curtails demand for them abroad, thus leading to earnings and job losses in manufacturing.
The costs have been borne disproportionately by swing states in regions such as the Rust Belt—a consequence that in turn has deepened socioeconomic divisions and fueled political polarization. Manufacturing jobs that were once central to the economies of these regions have been offshored, leaving poverty and resentment in their wake. It is little surprise that many of the hardest-hit states voted for Trump in 2016.
The domestic costs of accommodating large capital flows are likely to increase and become more destabilizing for the United States in the future. As China and other emerging economies continue to grow and the United States’ slice of the global economy continues to shrink, capital inflows to the United States will grow relative to the size of the U.S. economy. This will amplify the distributional consequences of dollar hegemony, further benefiting U.S. financial intermediaries at the expense of the country’s industrial base. It will likely also make U.S. politics even more fraught.
Given these mounting economic and political pressures, it will become increasingly difficult for the United States to create more balanced and equitable growth while remaining the destination of choice for the world’s excess capital, with the overvalued currency and deindustrialization this implies. At some point, the United States may have little alternative but to limit capital imports in the interests of the broader economy—even if doing so means voluntarily giving up the dollar’s role as the world’s dominant reserve currency.
The United States would not be the first country to abdicate monetary hegemony. From the mid-nineteenth century until World War I, the United Kingdom was the world’s dominant creditor, and the pound sterling was the dominant means of financing international trade. During this period, the value of money was based on its redeemability for gold under the so-called gold standard. The United Kingdom held the largest gold reserves in the world, and other countries held their reserves in gold or in pounds.
The United States would not be the first country to abdicate monetary hegemony.
In the first half of the twentieth century, the British economy declined, and its exports became less competitive. But because the United Kingdom adhered to the gold standard, running a trade deficit meant transferring gold abroad, which reduced the amount of money in circulation and forced down domestic prices. The United Kingdom suspended the gold standard during World War I, along with several other countries. But by the end of the war, it was a debtor nation and the United States, which had accumulated huge gold reserves, had replaced it as the world’s principal creditor.
The United Kingdom returned to the gold standard in 1925, but it did so at the prewar exchange rate, which meant that the pound sterling was highly overvalued, and with much-depleted gold reserves. British exports continued to suffer, and the country’s remaining gold holdings dwindled, forcing it to cut wages and prices. The country’s industrial competitiveness declined, and unemployment soared, causing social unrest. In 1931, the United Kingdom abandoned the gold standard for good—which in effect meant abandoning sterling hegemony.
In 1902, Joseph Chamberlain, then secretary of state for the colonies, famously described the United Kingdom as a “weary titan.” Today, the term aptly fits a United States that sees its economic might waning relative to that of other powers, particularly China. International relations theorists and foreign policy analysts debate the grade and extent of the U.S. decline and even the outlook for a “post-American” world.
Some argue that under Trump, the United States has deliberately abandoned the project of “liberal hegemony”—for example, by creating uncertainty about U.S. security commitments. Others describe the U.S. retreat from hegemony as part of a longer-term structural retrenchment. Either scenario makes wholly conceivable that the United States will follow the British precedent and voluntarily relinquish monetary hegemony. Whether and how this might happen has surprisingly been little discussed.
At the moment, the dollar looks more dominant than ever. Even as the U.S. economy has plunged into recession and shed millions of jobs, the demand for dollars has increased—just as it did after the 2008 financial crisis. Foreigners sold large numbers of U.S. Treasury bonds in March, but they exchanged them for U.S. dollars. The Federal Reserve injected trillions of dollars into the global economy in order to prevent international financial markets from seizing up, expanding the system of swap lines with other central banks that it used in 2008. Even as the Trump administration’s mishandling of the pandemic reinforced the view that the United States is a declining power, the actions of the Federal Reserve and investors around the world have underscored the centrality of the dollar in the global economy.
Yet this should not reassure the United States. The influx of capital will continue to harm U.S. manufacturers, and the pandemic-induced downturn will only compound the pain felt by workers. In order to alleviate the mounting economic and political pressures in regions such as the Rust Belt, the United States should consider taking steps to limit capital imports. One option would be to supply fewer dollars to the global economy, pushing up the value of the currency to a point where foreigners would balk at buying it. Doing so would make U.S. trade less competitive, however, and weigh down already excessively low inflation.
The influx of capital will continue to harm U.S. manufacturers
Alternatively, the United States could call the bluff of those powers, including China and the European Union, that have called for a diminished global role for the dollar. There is no obvious successor to the United States as the purveyor of the world’s dominant reserve currency. To allow capital to flow freely in and out of China, for instance, would require a fundamental—and politically difficult—restructuring of that country’s economy. Nor can the eurozone take over so long as it depends on export-led growth and the corresponding export of capital. But the absence of a clear successor shouldn’t necessarily stop the United States from abandoning dollar hegemony.
The United States could impose a levy or tax that penalizes short-term, speculative foreign investments but exempts longer-term ones. Such a policy would get at the origin of trade imbalances by reducing capital inflows (trade barriers hit at the symptoms rather than the cause). It would also mitigate the current backlash against free trade and reduce the economically unproductive profits of financial institutions.
In an optimistic scenario, the world’s three economic hubs—China, the United States, and the European Union—would agree to construct a currency basket along the lines of the International Monetary Fund’s special drawing rights and either empower the IMF to regulate it or create a new international monetary institution to do so. The pessimistic but probably more likely outcome is that tensions—especially between China and the United States—would make cooperation impossible and increase the likelihood of conflict between them around economic issues.
Even if it is impossible to find a cooperative solution, it may make sense for the United States to unilaterally abandon dollar hegemony. Doing so would force China and the eurozone to deploy their excess savings at home, which would require them to make major adjustments to their economic models so that they produce more balanced and equitable growth. It would also limit the excessive profits of U.S. financial intermediaries and benefit American workers by bringing down the value of the dollar and making U.S. exports more competitive. In short, abandoning dollar hegemony could open the way for a more stable and equitable U.S. economy and global economy.
U.S. Financial Power Depends on Washington, Not Beijing