Earlier this month Donald Trump accused the man he had appointed to run the United States Federal Reserve, Jerome Powell, of being an “enemy”. His public dressing down of the central bank chair, who is supposed to be independent, was accompanied by further escalations of the US–China trade war. Mr Trump wants Mr Powell to lower rates to spur growth in the sputtering US economy and give him the upper hand with Beijing. This incompetence and bluster is hardly inspiring global confidence. It was a coincidence, however, that on the same day the Bank of England’s governor, Mark Carney, warned the annual gathering of the world’s central bankers that the global economy was becoming over-reliant on the dollar. That may have been fine when the US was viewed as a responsible leader of the world economy. Mr Carney plainly thinks that is not the case today.
There are reasons to worry. Almost every nation is tied to the monetary policy of the US. More than half of all trade invoices are in dollars, as are nine-tenths of all foreign exchange transactions. Since the 2008 global crash, corporate and government levels of dollar debt in the emerging world have rocketed, leading to financial instability. Despite the Trump administration’s volatility and belligerence, the dollar keeps rising in value. It matters not that the US Fed cut rates in July: investors want to put their money into greenbacks. This is no new phenomenon: the US’s “exorbitant privilege” was noted decades ago.
Yet with great power comes great responsibility, as the US found out when forced to stabilise financial markets during the worst financial crisis since the Great Crash of 1929. The US Fed engaged in loans, guarantees and outright purchases of financial assets that were not only unprecedented but cumulatively amounted to $29tn. This staggering amount is twice the size of the nation’s GDP.
Mr Carney’s solution was to call for the emergence of alternative international reserve currencies. He thought it would be a good idea to create a new “synthetic hegemony currency”, to make the global monetary and financial system more “diverse”. Yet the problem is that before any currency can replace the dollar, world markets have to develop a great deal of trust in a new international lender of last resort. Right now that is the US Fed – which is why Mr Trump’s attacks are so disconcerting. The president’s failure to grasp macroeconomics is terrifying. The US trade deficit, which drives the president crazy, means that the US is a net importer of capital.
That means that the US government provides safe US dollar assets so it is hard to see how the trade deficit can be eliminated without damaging the global financial system. John Maynard Keynes worried in 1944 that the Bretton Woods system could rely on the dollar only as long as America had a trade surplus, and the moment the US became a deficit country, the system would collapse. That is what happened in 1971. Mr Carney echoed this sentiment in his speech, noting “past instances of very low rates have tended to coincide with high-risk events such as wars, financial crises and breaks in the monetary regime”. Mr Trump’s concern that the dollar is too strong may be reasonable. But his unpredictable actions are making the problem much worse. Tariffs and interest rate cuts will not lower its value. In the short term, some kind of concerted international action by central banks could bring the value of the dollar down. But that would need a volte-face from the Trump administration and a commitment to abandoning trade and currency wars.