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John Looby: Putting America first may end dollar dominance

Section: Daily Dispatches

By John Looby
The Sunday Times, London
Sunday, June 9, 2019

For three-quarters of a century, the hegemony of the dollar and its role as the global reserve currency has been secure. Even the break with gold, and the effective collapse of Bretton Woods in 1971, served only to strengthen rather than weaken its position. Crucially, the dominance of the dollar was cemented by the big oil-exporting states -- led by Saudi Arabia -- asking for payment exclusively in US dollars.

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More recently, China has played a central role. Thirty years ago, Sino-US trade was essentially irrelevant. Since then, the trade relationship has exploded, with the US consuming vastly more than the value of its output, and China doing the mirror opposite. By choosing to direct the vast bulk of its dollars into US treasuries, China is now the biggest private creditor of the US federal government, and arguably the single biggest supporter of the dollar.

Although the US economy today is roughly the same size as the EU -- accounting for just over a fifth of global GDP -- the dollar still accounts for almost three-quarters of global foreign exchange reserves, and almost 90% of global foreign exchange transactions.

In his insightful 2010 book, "Exorbitant Privilege: The Rise and Fall of the Dollar and the Future of the International Monetary System," economic historian Barry Eichengreen concludes the likelihood of continuing dollar dominance remains high. Yet his reasoning has a caveat: "Serious economic and financial mismanagement by the United States is the one thing that could precipitate flight from the dollar. And serious mismanagement is not something that can be ruled out. We may yet suffer a dollar crash, but only if we bring it upon ourselves."

Grappling with the likelihood of such US self-harm, the post-war path of the UK and its troubled currency is instructive.

In 1945, the UK had an extensive empire, formidable armed forces and a globally significant currency. It was also a nuclear power, a permanent member of the UN security council and a serious presence across Asia, Africa and the Middle East. Notwithstanding its relative decline, disproportionate power and prosperity continued to beckon.

But the reckless risk of the Suez Crisis in 1956 -- where the threat to sterling from the Oval Office proved decisive -- effectively ended the UK's autonomy. Never again would it be free to act without the imprimatur of the White House. The overestimation of its power had proven calamitous.

By 1976 the UK economy was widely and accurately known as "the sick man of Europe". Mired in industrial strife and with sterling crashing again, the Callaghan government had little choice but to seek a humiliating IMF bailout in the form of a huge dollar loan. The telling image of the chancellor of the exchequer Denis Healy at Heathrow airport, forced to abandon a trip to Hong Kong and return to the treasury to apply for the loan, captured vividly the loss of power and prestige.

The more sanitised version of the Obama doctrine is: "Don't do stupid stuff." Generally seen as a pithy insight guiding his approach to foreign policy, it arguably summarises the broad approach of post-war US policy in many areas. For decades, as the architect and chief beneficiary of the post-1945 global order, America has adroitly defended and extended the reach and the power of the rules-based multilateral system.

The end of US dominance was never likely to be smooth. But compared with his post-war predecessors, the current occupant of the White House has a radically different view of the power and interests of the US. The evidence is accumulating that the benign rationality of US engagement with the rest of the world has inverted.

The possibility that this may undermine the dominance of the dollar is now real and growing. The salutary experience of the UK highlights the cost of myopic and reckless decisions. China, for example, can direct its dollars wherever it chooses. While buying treasuries has been its historic choice, future choices may well be different.

More generally, a new era may be dawning where policymakers and investors across the globe are losing a long-standing constant, while the US faces the loss of a valuable privilege chasing a delusional fantasy to put "America First". Like sterling before it, there is nothing inevitable or immortal about the dominance of the dollar.

It's time for investors to review their exposure to dollar-denominated assets. Complacent inertia could prove very costly.


John Looby is a senior portfolio manager at KBI Global Investors. The views expressed are his own.

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