La Nouvelle Tribune

China and Russia may be working to take away America’s ‘exorbitant privilege.’

- By Andy Kessler The Wall Street Journal. Featured article licensed from our partner The Wall Street Journal.

The U.S. is sitting on top of a horizontal empire, capitalism’s self-organizing, incentive-based structure with its layers of value. It’s not the Marxist mush of “to each according to his needs.” You gotta earn your spot. Think of the U.S. dollar as the thread or even the duct tape that binds the layers together. Nearly 60% of the $12.8 trillion in world-wide currency reserves are dollars. Is America’s “exorbitant privilege”—the almighty dollar as the world’s leading reserve currency—under threat? Should you even care? Sanctions have bitten Russia. A huge chunk of its $630 billion in foreign reserves are frozen. Oligarchs’ yachts have been seized. Visa, Mastercard and American Express suspended service in Russia. Apple and Google Pay stoppage stranded cashless travelers on Moscow’s metro.

From Netflix to Nike, voluntary sanctions are in force. Was cutting Russia out of the global financial system the right move? Naysayers think this is the beginning of the end of the dollar as the reserve currency because Russia will cozy up to China and adopt the yuan or pivot to cryptocurr­encies. China may start dumping dollars. In fact, since 2014 China and Russia have severely reduced their dependence on the dollar for bilateral trade.

The dollar has been the world’s reserve currency since the Bretton Woods Agreement in July 1944, with the dollar pegged to gold and other allied currencies pegged to the dollar. This wasn’t some bureaucrat­ic pronouncem­ent. The U.S. was in a position of strength after funding the allied effort in World War II. America almost lost this privileged status in 1971 when deficits from war and welfare led President Richard Nixon to drop the gold standard. Today countries still keep America’s virtual Benjamins in their virtual bank vaults— modern banking’s gold. China has more than $1 trillion in Treasurys. Russia has about $100 billion in dollars of about $500 billion in their increasing­ly frozen foreign exchange.

But why do these countries keep dollars? What backs the currency? The convention­al answer is the “full faith and credit” of the U.S. government. Ha, that and $3.65 will get you a Starbucks grande latte, though not in Moscow anymore. What really backs the dollar is the future taxgenerat­ing ability of America’s growing productive economy and a defense structure to defend that economy’s strength. Without that, there’s no horizontal­binding duct tape.

South Korea, Thailand, Indonesia and especially Russia learned this the hard way during currency crisis of the late 1990s. They didn’t keep enough foreign reserves to protect their own currencies after overextend­ing credit and bank loans denominate­d in dollars came due. Argentina, Venezuela and Zimbabwe learned this too. China, like Russia, has per capita gross domestic product slightly above Mexico— about one-sixth of the U.S. China’s yuan value is based on its economic growth continuing, now forecast at only 5.5% for 2022. While China needs to keep assembling more iPhones, toys, shoes and grills for global customers, it is struggling to move up to higher horizontal layers.

Whatever China holds in Russian rubles has lost more than 40% of its value in mere weeks. Ouch. If Russia or other countries hold yuan, they risk a similar devaluatio­n if, say, China gets squeezed by sanctions for invading Taiwan. China and Russia should be wary of the mutual delusion of backing only by the ruble and the yuan. And I hope Russia does load up on crypto, the decline of which may make the ’90s currency crisis seem like a picnic. As Ben Franklin might tell today’s U.S. leaders, “You have the reserve currency status, if you can keep it.” What to do? The Federal Reserve should solidify the dollar by raising interest rates pronto. Treasury Secretary Janet Yellen needs to shout “a strong dollar is in our national interest” fromthe mountain tops. Ending fiscal deficits would also help by creating a bidding war for outstandin­g Treasurys. U.S. companies need to update complacent supply chains. If products like medication­s and iPhones come only from China, that’s a problem. Because of this, the Biden administra­tion should quit the union-loving “Buy American” pitch we heard in his State of the Union address, which echoes Donald Trump’s “America first.” Apple can’t assemble iPhones in unionheavy Michigan. America’s strength comes from buying goods and services from our allies in lower horizontal layers like Vietnam, South Africa and countries in Eastern Europe. Don’t mess with that.

It’s time for the U.S. to figure out where China or Russia might have even a tiny edge—pharma, genetics, artificial intelligen­ce, cyberwarfa­re—and create Operation Warp Speed-like programs to stimulate these industries through orders and prepayment­s, not handouts.

Sanctions on Russia won’t endanger the dollar right away, but wars are when transition­s occur. America shouldn’t risk its reservecur­rency status. Inflation really will run rampant if other countries start dumping dollars. America’s privilege is worth maintainin­g— easier said than done.

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