The dollar is currently the international measure of value. It has been so since it became the international reserve currency, as a result of the Bretton Woods agreement in 1944, following WWII. This agreement enabled the US to redesign the architecture of the global monetary system on its own terms. As an outcome of the Bretton Woods Conference, the value of currencies was fixed against the USD and the USD in turn was pegged to gold at 35 USD/ounce. At the time, the largest bullion deposits were in the possession of victorious America, that also held a large part of the European gold reserves due to the Second World War. This agreement came to a sudden halt, when president Nixon unilaterally decided to effectively end the Bretton Woods system by unpegging the dollar from gold, and rendering the USD a fiat currency. This step has come to be known as the “Nixon Shock”; it had severe and widespread ramifications on the world economy and shook the global economic power balance. Volatility and uncertainty ruled the markets, the 70s US recession took hold and inflation was felt globally.
Today, the role of the USD in global and national economies is pivotal and decisive. Most traded commodities, including oil, gold, and silver, are priced in USD. For the most part, negotiations regarding international trade take place in the American currency and contracts are most commonly valued in US dollars as well. All in all, around 70% of international trade is conducted in US dollars, and if we exclude intra-trade between European countries which take place on a Euro basis, the percentage goes up to 90%. Central banks worldwide hold a considerable portion of their reserves in USD, as the primary reserve currency. All of this explains how the American currency came to be in such high global demand.
The Federal Reserve supplies this currency with a current national debt estimated at $22.5 trillion in 2015, or 125% of GDP according to OECD. In fact, the Fed, was one amongst many central banks who injected 4.7 trillion dollars into their economies in rounds of Quantitative Easing. Liquidity was increased by lowering interest rates, and by issuing bonds and having the Fed buy them, amongst other massive purchases of securities and assets. Since we are currently living in the dollar standard, the whole world is affected by America’s monetary policy and the decisions of the Federal Reserve. Thus, the global results of this policy were as dismal, as they were predictable: As the Fed prints more dollars and thus increases the quantity of money circulating, it affects the value of every dollar held by anyone all around the world, disseminating inflation everywhere.
Countries on the receiving end of this policy, have the options of either letting their currency appreciate or printing more money themselves, to offset the effect. Experience shows that both options have their ramifications. Allowing one’s currency to appreciate would weaken the country’s competitiveness in global markets as the prices of its exports would increase. On the other hand, printing more money results in inflation of the local currency and risks increasing the value of imports, which can be detrimental, if the country imports most of its basic necessities.
Push factors aiding and abetting inflation exportation
There are several “push” factors which help drive the dollar out of the US and thus lead to exportation of inflation. One such factor is the aforementioned Quantitative Easing policy of the Fed, which involved buying bonds from the market and creating artificial demand, while causing the Fed’s rate to remain low and prices to go up worldwide.
Additionally, as financial expert Mike Maloney points out, the dollar is simply a paper note printed by the Fed. Its ability to store value is questionable and it is subject to fluctuations based on the Fed’s decisions, unlike stable stores of value, which withstood the test of time such as gold. As long as we are living in the dollar standard era, we will be prone to bouts of inflation, deflation, and economic and social turmoil.
The advantage that America has is that it can print its dollars and not risk having inflation, like other nations, since the demand for the dollar is still considerably high. The US, being the issuer of the international reserve currency, can print dollars or issue bonds anytime, and use them to buy assets. The cost of printing the dollar is trivial in comparison with the value of the products that can be bought with those dollars. The US can import at virtually no cost, and thus export its inflation to other countries.
However, the flip side of this advantage, is that the Fed’s debt burden just keeps getting bigger and bigger as other countries keep on buying. As we know, the US debt had reached a tipping point in 2008, kickstarting the global financial crisis, but the ratio of debt to US GDP has been growing since 1980s. It began to shrink following the 2008 crisis, however, recently, the head of Duquesne Capital, Stanley Druckenmiller, warned that the size of the American debt is reaching dangerous levels. As he pointed out, net cash flow is negative, while debt rates are still going up. S&P had already warned in 2011 that it would downgrade American bonds as a result of the country’s debt burden. If anything, this reveals that America’s GDP and the real production levels in the economy are not keeping up with, nor do they suffice to cover the Fed’s dollar printing policy.
Consequences, direct and indirect
In the past, international investors would gladly hold USD as a store of value or as a means to trade in American markets, but as the dollar began flooding the world economy, its charm and value shrunk, and it fell out of favor, as preferences shifted to other currencies. The unwanted, surplus dollars were thusly left for many countries’ central banks to “clean up” from their markets, to preserve the balance in their local economies. When central banks are forced to intervene and to print more of their own currencies in order to buy the excess dollars, domestic interest rates go down, inflation is generated and primary commodity prices are quick to increase. The consequences of this can be seen in a global scale today, as these pressures can be amplified by and even threaten the most vital of resources: Food.
The factors leading up to the food crisis are, of course, intricate and complex. One of the main factors is increasing populations, which is particularly prevalent in nations which lack self-sufficiency in food production and supplies and in countries with little food security. Those countries need to import basic food supplies such as grain, which have high nutritional value from countries like the US. They have therefore little bargaining power and in order to access those essential supplies, they have to sell off the dollars of their reserves, causing depreciation of their own currency and thus generating inflation.
The first symptom of this course of “necessary evil”, is that the wages of domestic workers in those countries drop. This effect is particularly intensified when the country is heavily dependent on imports and has a weak industrial base, as is the case with most developing nations. Decreasing purchasing power ensues and the economy stagnates. Workers produce more for less, while those who hold USD receive more value for less money, and thus inflation is imported through higher prices, or in other words, lower real wages.
The US’s monetary policy has significant implications for the global economy and at the core of this issue we find a fundamental, structural weak point: As long as the dollar standard stands, US monetary policies, low interest rates and successive rounds of QE, will continue to affect and to infect local economies worldwide. Although this system is not bound to change anytime soon, at some point, a good and fair alternative will have to emerge for the global financial system to get on a stable track to growth.