In today’s Money Morning…why the ‘exorbitant privilege’ of the US dollar comes with an obligation…a fundamental misunderstanding of the global economy…and more…
I have three words for Donald Trump: Quid. Pro. Quo.
Which is Latin for ‘this for that’. You’ll see what I mean in a moment.
Forget the little spat between Trump and Malcolm Turnbull. That’s nothing. I was actually thankful for the news that Trump gave Turnbull an earful on a recent phone call.
It reminded me that we have a Prime Minister…where has he been since the election?
The much more worrying comment from Trump came overnight. From today’s Financial Review:
‘Overnight Trump told a group of religious and political leaders that it’s time for the US to get tough. “The world is in trouble — but we’re going to straighten it out, OK? That’s what I do,” he said at the National Prayer Breakfast. “We’re gonna straighten it out.”
‘Trump also added: “We’re taken advantage of by every nation in the world, virtually. It’s not gonna happen anymore.”’
This is a really big statement from Trump. If it’s a genuine representation of his beliefs, the post-Second World War economic order is about to undergo a profound shift.
Longer term, that’s not such a bad thing for the world as a whole. But, unwittingly for Trump, it will probably have the biggest impact on the US. And it won’t be a good one.
End of the US Dollar as the World’s Reserve Currency?
Remember yesterday I wrote about how Harry Dexter White secured for the US the advantage of having their dollar as the world’s reserve currency?
It was a massive win for the US. It effectively gave them the golden goose. They could take as many golden eggs as they pleased.
As this win become apparent, French President Charles De Gaulle expressed his displeasure with the monetary arrangement by calling it an ‘exorbitant privilege’.
Indeed it was. And the US is still taking advantage of it. In 2016, the US current account deficit is expected to come in around US$470 billion. This represents excess US consumption over production.
It is able to borrow so much largely because of the status of the US dollar. As I explained yesterday, other countries are happy to receive dollars in return for goods and services, or interest on loans, because those dollars (debt) are an asset in their hands.
It’s a system that massive favours the US. They’re getting something for nothing.
In return for this sweet deal, the US has had a sort of a pact with the rest of the world that it will act as global cop, and manage the system. This of course costs a lot of money, but it’s money the US gets easily via demand for dollars from foreign central banks.
Quid pro quo
This is the quid pro quo that the global system operates under.
The US gets goods and services, in exchange for a paper promise to repay at some distant future date. And the rest of the world gets to employ their workers to keep them from rioting, while the elites enjoy the perks of the ‘system’. If they’re lucky, they get an invite to Davos each year.
But this system evolved in ways that no one could have predicted. It turned out that foreign central banks were happy to buy unlimited amounts of US dollars, because it increased their reserves and kept their own currencies weak. They wanted their export dependent economies to have a trade advantage.
As this trend continued, US manufacturers couldn’t compete. So they took their manufacturing operations to the countries with cheap labour and cheap currencies to set up shop.
This keeps prices low and consumption high. Win win!
But Trump, like a deal making megalomaniac, doesn’t see the current situation as an outgrowth of a flawed international monetary system. He only sees one side of the bargain, and he thinks he’s not getting a good enough deal.
While his rhetoric sounds tough and will certainly keep his supporter base happy, it lacks a deep understanding of how the global economy works, and the US’ place in it.
Trump to ‘straighten it out’?
Ironically, Trump’s comment about the ‘world being in trouble’ is also an outgrowth of the financial system. Presumably he’s referring to the rise of terrorism around the world.
How is he going to ‘straighten it out’, though?
Taking the US out of others’ affairs might help, but it will also create a vacuum for other powers to get involved. Which could lead to even more destabilisation.
If we ignore the fact that the Rashidun Caliphate took Jerusalem from the Byzantines in 637, and thus sparked an ongoing tussle for the city and region that continues to this day, you could argue that the rise of the US as ‘global cop’ gave rise to modern day terrorism.
Don’t get me wrong. I’m not blaming US imperialism like some left wing ignoramus. I’m pointing out that the US (and British) involvement in the Middle East to secure oil supplies created major tensions in Middle Eastern societies.
It’s no surprise that Osama Bin Laden was a Saudi national. The autocratic Saudi royal family became massively rich by allying with the US, and this put a lot of noses out of joint in Saudi Arabia. Including Bin Laden’s.
And the war in Syria, the latest Middle Eastern debacle, is a direct result of the West trying to interfere in the region. It’s very messy, but Saudi Arabia, the US and Britain supported ‘rebels’ trying to overthrow the ruling Syrian regime.
It turns out these ‘rebels’ consisted of people we now collectively refer to as ISIS.
So if Trump wants to ‘straighten out the mess’ he better have a decent plan. No one has been able to do it for about 2000 years!
Trump is trying to run the country like he runs his businesses. That is, bombastically and with a can do attitude. To be honest, I find it refreshing. It’s about time we had a non-politician in politics.
But his ego will get the better of him. All leaders have an ego. But really great leaders have the humility to know that they can’t know or do everything. Trump is nowhere near this point.
I humbly suggest that he needs an adviser on international economics. I nominate my colleague Jim Rickards. There is no one who knows more about the subject — and its interaction with financial markets — than Jim.