On January 16th, 2021, the European Union set out plans to strengthen the international role of the Euro. The EU seeks to erode U.S. dollar dominance and lessen the Bloc’s vulnerability to financial risks, including U.S. sanctions.
The plan includes measures to help protect against currency shocks, and allow greater scrutiny of foreign takeovers, according to a draft of the proposal obtained by Bloomberg. The plan to foster “openness, strength and resilience,” was reported on by the Financial Times:
“The extra-territorial application of unilateral sanctions by third countries has seriously affected the EU’s and its member states’ ability to advance foreign policy objectives, to honor international agreements and to manage bilateral relations with sanctioned countries,” the document says. “At times, unilateral actions by third countries have compromised legitimate trade and investment of EU businesses with other countries.”
According to Reuters, the initiative, which is an announcement of a long-term strategic direction rather than an action plan, follows Britain’s EU departure, which took Europe’s biggest financial hub — the City of London — outside the EU’s jurisdiction.
“With the withdrawal of the UK from the EU, there is a strong need and opportunity to develop domestic market infrastructures,” the Commission said in a paper addressed to EU governments, the EU parliament and the European Central Bank. (Source)
The reason behind this strategic move is the 2018 fallout from former U.S. President Donald Trump’s withdrawal from the Iran nuclear deal, and subsequent sanctions, the terms of which left Europe unable to continue trading with Iran.
EU-based securities depositories Clearstream and Euroclear were affected by the Iran decision. The EU-based SWIFT bank payment and messaging system had to disconnect Iranian banks. “The EU should develop measures to shield EU operators in the event a third country compels EU-based financial-market infrastructures to comply with its unilaterally adopted sanctions, or through other means that interfere with legitimate EU operations,” the Commission said.
Could this announcement indicate the beginning of the end for U.S. dollar dominance? The EU’s dependency on the U.S. dollar is not sustainable – American sanctions imposed on EU companies after Trump’s withdrawal from the nuclear agreement proved how this is a direct threat to wealth and prosperity in the Eurozone. Going forward, it is America’s endless monetary and fiscal expansion that truly puts European wealth at risk.
The American budget deficit and debt are similar to Greece’s in 2009.
By the end of 2020, The U.S. federal budget deficit is projected to reach a record of $3.3 trillion. This increase is largely a result of government spending in response to the coronavirus pandemic. U.S. federal outlays for 2020 totalled $6.6 trillion, $2.2 trillion more than in 2019. Revenue for 2020 is projected to be $3.3 trillion, too, which leaves the deficit at $3.3 trillion. The Congressional Budget Office (CBO) projects that this deficit for 2020 will be 16% of U.S. gross domestic product (GDP), which is the largest it’s been since 1945. (Source)
In 2009, Greece’s budget deficit exceeded 15% of its gross domestic product. Fear of default widened the 10-year bond spread and ultimately led to the collapse of Greece’s bond market. This would shut down Greece’s ability to finance further debt repayments. The 10-year government bond yield passed 35% until vast debt restructuring forced private bondholders to accept investment losses in exchange for less debt. The debt-to-GDP ratio allows investors in government bonds to compare debt levels between countries. The Greek debt to GDP ratio was 115% in 2009, far below the American 127% in 2020. (Source)
Greece wanted the EU to forgive some of the debt, but the EU didn’t want to let Greece off scot-free. The biggest lenders were Germany and its bankers. They championed austerity measures. They believed the measures would improve Greece’s comparative advantage in the global marketplace. The austerity measures required Greece to improve how it managed its public finances. It had to modernize its financial statistics and reporting. It lowered trade barriers, increasing exports.
Most importantly, the measures required Greece to reform its pension system. Pension payments had absorbed 17.5% of GDP, higher than in any other EU country. Public pensions were 9% underfunded, compared to 3% for other nations. Austerity measures required Greece to cut pensions by 1% of GDP. It also required a higher pension contribution by employees and limited early retirement. Half of Greek households relied on pension income since one out of five Greeks were 65 or older. Workers weren’t thrilled paying more contributions so seniors can receive same pensions.
The austerity measures forced the government to cut spending and increase taxes. They cost 72 billion euros or 40% of GDP. As a result, the Greek economy shrank 25%. That reduced the tax revenues needed to repay the debt. Unemployment rose to 25%, while youth unemployment hit 50%. Rioting broke out in the streets. The political system was in upheaval as voters turned to anyone who promised a painless way out.
The results are mixed. In 2017, Greece ran a budget surplus of 0.8%. Its economy grew 1.4%, but unemployment was still 22%. One-third of the population lived below the poverty line. Its 2017 debt-to-GDP ratio was 182%. (Source)
In comparison, President Joe Biden will ask Congress for $1.9 trillion to fund immediate relief for the pandemic-wracked U.S. economy, a package that risks swift Republican opposition over big-ticket spending on Democratic priorities including aid to state and local governments. “We have to act and we have to act now,” Biden said Thursday night in Wilmington, Delaware. He said he would lay out a second, broader economic recovery plan next month at a joint session of Congress next month.
That initiative will include money for longer-term development goals such as infrastructure and climate change, the transition team said. The pandemic aid bill — spanning $400 billion for Covid-19 management, more than $1 trillion in direct relief spending and $440 billion for communities and businesses — comes in at more than double the bipartisan bill approved last month, and only slightly below the March 2020 Cares Act.
“The Fed basically inflates the financial system until it collapses”
In his brilliant interview on the coming financial bubble and 2020 election, David Stockman, a former congressman and director of the Office of Management and Budget under Ronald Reagan, made this prediction on June 20th, 2020. “Our economy has already shouldered a heavy burden of nearly 78 trillion U.S. dollars of debt-of which household debt is 16.2 trillion U.S. dollars, corporate debt is 16.8 trillion U.S. dollars, and government debt is 23 trillion U.S. dollars. Therefore, the most undesirable thing is to further reduce Interest rates and to encourage everyone to borrow more. “
The Federal Reserve, on December 20th, 2020, made a key adjustment to its efforts to support the economy, while upgrading its outlook for growth. As expected, the Fed held benchmark interest rates near zero following the conclusion of its two-day meeting. The Fed delivered in that respect, saying it would continue to buy at least $120 billion of bonds each month “until substantial further progress has been made toward the Committee’s maximum employment and price stability goals,” the post-meeting statement said. “These asset purchases help foster smooth market functioning and accommodative financial conditions, thereby supporting the flow of credit to households and businesses,” the Federal Open Market Committee added in a statement that gained unanimous approval.
The Fed had already committed to not raising rates until inflation exceeds its 2% goal even if unemployment comes down to levels that normally had signaled price pressures. Changing the language around the asset purchases underlines the central bank’s commitment to seeing the recovery through from its coronavirus-era slump. “Together, these measures will ensure that monetary policy will continue to deliver powerful support to the economy until the recovery is complete,” Fed Chairman Jerome Powell said at his post-meeting news conference. (Source)
According to Mr. Stockman, the one thing that Donald Trump is going to accomplish in his misbegotten tenure is that his ferocious attack against the Federal Reserve will tear away the veil that it’s a beyond-politics cabal of geniuses who are safeguarding your livelihood. He’s going to tear it apart. He’s going to totally besmirch and destroy the credibility of the Fed, at least in the eyes of his base. It’s going to create an enormous political debate about central banking. “The Fed is the number one, the number two, and the number three enemy of prosperity, capitalism, free markets, individual liberty, and the wealth of people in the world today.”
“Recessions don’t happen because the Fed is tightening credit costs for Main Street. That’s the old days. That’s your grandfather’s economy and your grandfather’s Fed. But we’re now in the era of bubble finance. The Fed basically inflates the financial system until it collapses, and then it spills over into the mainstream economy through corporate C-suite panics.” Since the 2008 financial crisis, although the Federal Reserve has held a big stick and spared no effort to suppress interest rates, causing a big explosion of corporate debt, this explosion has not actually brought any growth in productive investment. In fact, the difference between corporate capital expenditure minus capital consumption is now almost negligible compared to the eve of the Internet bubble burst 20 years ago. (Source)
On the fiscal side, Stockman suggests the country cannot afford the price tag to bail out the country. A fierce critic of President Trump, he contends the administration’s plan to hand out $2,000 to every American is financially irresponsible and will only postpone an inevitable recession. (Source) “U.S. bond liquidity evaporated, and Treasurys failed to serve as an effective market hedge. Market panic ensued. The Fed entered the market in unprecedented scale and scope, purchasing about $1 trillion in government debt in about three weeks. This Covid-induced episode stands in contrast with the global financial crisis a decade ago: U.S. bonds then served as the ultimate safe haven.” (Source)
The Greek debt crisis as a potential scenario for the U.S. dollar endgame
The global economy is facing a bizarre challenge: America, making up only 4% of the world’s population, has the power to determine global economic fates. U.S. dollar dominance means the global economy is determined by domestic American economic and monetary policy needs. According to the Washington Post, Mr. Trump’s campaign spent U.S.$ 5 billion to win the presidential election in 2016. House and Senate candidates spent in total U.S.$ 4 billion on their 2016 campaigns. (Source)
This group of less than 1000 people spent a total of approximately U.S.$ 9 billion and has caused an increase in American national debt of almost $7.8 trillion during Trump’s time in office. This represents a leverage of over 866. (Source) “As of Dec. 31st, 2020, the national debt had jumped to $27.75 trillion, up 39 percent from $19.95 trillion when Trump was sworn in.” (Source) Trump alone, in his four year term, caused an increase of nearly 40% in the national debt it took his 44 predecessors 240 years to accumulate.
The EU’s announcement on Jan 16th, 2021 recognized that this unsustainable fiscal governance had devastating potential for the European continent. The catastrophic consequence have been showcased in countless Wall Streets cases, some playing out right now. According to Bloomberg “Governments have spent some $12 trillion in fiscal support alone, while the U.S. Federal Reserve is buying $120 billion of bonds monthly to keep borrowing costs low in the world’s top economy. In numbers:
The amount GameStop shares soared in just 12 months.
The amount of cash the world’s richest 500 people added to their combined net worth last year.
How much the S&P has surged since its low last March. (Source)
In “Lawless Madness on the Potomac, Part 1,” written on September 3rd, Stockman decried the overheated stock market, which had just had a blowout day, making the value of the U.S. stock market $36.6 trillion, or 187.8% of GDP, and putting it in “virgin territory where it has never gone before.” (Source)
How might this party end in tears, and for whom? Despite the successful implementation of the One Belt One Road strategy, and effective management of the Corona pandemic, this is the question my friends in Beijing have raised with me.
If we follow Mr. Stockman’s fundamentalist market logic, then America can only eliminate its monetary and fiscal bubble via austerity measures similar to what the EU & Germany forced Greece to implement. This restrictive approach is a no-go for the new Biden administration, as it would put further strain on an already discontented population (as seen by the storming of the Capitol on January 6th, 2021.) The only way forward for the U.S. right now, with the excuse of an out-of-control pandemic, is to continue increasing the supply of U.S. dollars.
The end of U.S. dollar dominance, with three new major currency regions
To solve the U.S.’ excessive liquidity problem, caused by financial and fiscal expansion, the best strategic option is to apply China and the East Asian Four Tigers’ development model to South American countries. As the backyard of the United States, using a new “Marshall Plan” could effectively prevent the spread of poverty across the Mexican border – as Trump’s wall was intended to do. The U.S. has failed, so far, to take advantage of its unique U.S. dollar privileges to achieve industrialisation and sustainable economic prosperity in neighbouring Latin America, for instance in Mexico.
In the macro environment of global liquidity excess (especially of U.S. dollars), demand will not be the bottleneck of economic growth. It is the skills and education of the poor that are the real issue. Effective industrial poverty alleviation in Latin America would help prevent long-term hyper-inflation in U.S. dollar regions, which would otherwise lead to the complete retreat of the U.S. dollar as a global trade currency.
In the past four years, Trump’s administration successfully initiated the destruction of U.S. dollar dominance. This can only be delayed, not stopped, especially if Biden’s administration continues down the explosive path of monetary and fiscal expansion. This would be an achievement indeed for Putin, as “Russia cultivated Trump as an asset for 40 years”. (Source)
The world market has already been divided into three different major currency regions. First, North America with U.S. dollar dominance backed by Middle Eastern oil supplies. Second, western Europe with Euro dominance backed by risky nuclear power, cheap Russian Gas supplies and still expanding renewable energy sources. Third, China, South East Asia, and One Belt One Road regions enjoying RMB dominance, backed mainly by Russian energy supplies, in competition with American and other sources.
The end of U.S. dollar dominance will be a gradual process. The speed and sustainability of this process will depend on many factors. There are three key elements: First, whether the U.S.’ own monetary and fiscal policies will be tied up in vested interests, such as continuing domestic income polarisation. Second, China’s abilities to respond to U.S. political and military intervention in e.g., the South China Sea and Taiwan Strait, specifically China’s ability to maintain its own established interests, thanks to U.S. dollars, and to simultaneously promote the internationalisation of the Renminbi. The third is whether the EU, especially Eurozone countries, can establish a cost-effective energy supply independent of the US$, as well as the necessary sovereign financial system. It is also essential that they enjoy the economic growth brought about by emerging markets such as China, while preventing the return of poverty in southern, central and eastern Europe.
Russia and China’s military power (particularly nuclear) guarantees that the Eurozone will not face American military threats as it becomes independent of the U.S. dollar. After the United States took control of the Ukraine, Germany relied on the North Stream II project as a cost-competitive gas supplier from Russia, despite frantic American sanctions. This project is as essential for the Eurozone as Saudi oil is for U.S. dollar dominance. In addition, it would significantly reduce energy costs for the German export industry. The last 100 km of the pipeline can only be stopped by NATOs military intervention, justified countering Russian threats.
The painful lessons and successful resolution of the Eurozone’s 2009 debt crisis equipped its core decision makers with the necessary vigilance required to undertake all precautionary measures. Therefore, neither Brexit (a huge loss in the EU’s financial competency and infrastructure), nor the Nordic countries (as hardcore allies of the United States within the EU), can prevent the Euro from becoming increasingly dominant throughout the European continent.
The United States’ dependence on European technology and Chinese low-cost manufacturing is what makes U.S. dollar dominance a real benefit, but it is also the driving force behind the end of this dominance.
Increasing the supply of U.S. dollars, supposedly to sustain dollar hegemony, actually helps Americans fulfil both their industrial and personal consumption needs by buying products made in e.g., Germany or China. Thus, a prerequisite for continued U.S. dollar dominance is the economic prosperity of both the Euro and Renminbi areas, which will inevitably lead to both currencies replacing the U.S. dollar as dominant currencies. This is a paradox which cannot be resolved by the U.S. nor their allies in the European parliament. Such is the inherently capitalist, free market logic behind the shared future of humankind.