You could go to the grocery store and buy food and never worry about not having enough (or even any) money in your bank account.
How could this happen? Well, so long as everyone felt that your cheques were good, the store would be able to use them as though they were money to pay staff and buy goods from suppliers. Over time, as more and more businesses accepted your cheques, you might even feel pressure to buy more groceries to get more of them into circulation for people to use.
While this could go on for a while, at some point someone would question your credit worthiness and take one of your cheques to the bank. If, upon presenting your cheque they were told by the teller that there were insufficient funds in your account, every one of your cheques would be seen as worthless. The people who held them would suffer a loss, your reputation would be ruined and, assuming you were not run out of town on a rail, any purchases you made in the future would be on strictly cash terms.
However, while this would be the inevitable outcome for an individual, the endless writing of cheques that can never be cashed is the very basis of our international financial system.
At the Bretton Woods conference towards the end of the Second World War, it was decided that the U.S. dollar would be the world’s reserve currency. Global commodities would be priced in dollars and trade imbalances would be settled in dollars. To give the dollar credibility, the U.S. promised foreign governments that they would be able to exchange dollars for gold at a fixed price of $35 per ounce.
However, as the U.S. became involved in Vietnam it needed to print dollars to finance the war. These dollars were often spent in Indochina and accumulated in the vaults of French banks operating in the region. As the French saw their dollar reserves ballooning, they brought them to the U.S. to be exchanged for gold.
By the late 1960s, there were far more dollars in global circulation than could be covered by the 8,000 tons of gold held by the U.S. Treasury. Essentially, the U.S. had written cheques (U.S. dollars) that could never be cashed (exchanged for gold).
To solve this problem, U.S. President Richard Nixon ‘temporarily suspended’ the convertibility of U.S. dollars for gold in August, 1971. From this point forward, the U.S. dollar was only valuable as a means with which to buy American goods and services. It was no longer “as good as gold.”
Predictably, throughout the 1970s the dollar lost value relative to gold and gold-backed currencies such as the Swiss franc. By 1978 confidence in the dollar had fallen so low that the U.S. government even had to borrow money using bonds denominated in Swiss francs and German Deutsche marks.
After issuing these so-called ‘Carter Bonds’ U.S. President Jimmy Carter, determined to restore international confidence in the dollar, appointed Paul Volcker head of the U.S. Federal Reserve System in 1979. When Volcker took office, inflation was running at over 13 per cent while interest rates were at 10 per cent.
To subdue inflation Volcker hiked interest rates to 20 per cent for much of 1980 and 1981. These ruinously high rates led to a wave of bankruptcies, a sharp recession and high unemployment. However, on the plus side, by 1982 inflation was under four per cent and foreign demand for the dollars required to purchase high-yielding U.S. Treasury bonds had boosted the dollar’s value from 1.5 Swiss francs in 1979 to almost 3 francs by 1985. Inflation had been beaten and confidence in the dollar as a global reserve currency had been restored.
However, the fundamental problem of America writing cheques it couldn’t cash had not been resolved. High interest rates had simply convinced foreigners to exchange their claims on American goods and services (dollars) for claims on U.S. government tax revenues (Treasury bonds). One promise, or cheque, had simply been exchanged for another.
Since the 1980s, this swapping of claims has only grown in importance. A Chinese thinker, Maj.-Gen. Qiao Liang has proposed that the U.S. uses the dollar to manage external trade and finance for its domestic benefit and that it is now using geopolitical instability to prop up the dollar as well. In a recent article entitled “America’s financial war strategy” the writer Alasdair MacLeod favorably examines Qiao’s analysis.
Qiao asserts that after the severing of the U.S. dollar’s link with gold, the U.S. has followed a predictable monetary policy cycle. Initially, it prints dollars and directs them overseas. This allows the U.S. to consume more than it produces while simultaneously stimulating financial asset booms abroad, as seen in Latin America in the 1970s and South-East Asia in the 1990s.
Then, when these policies threaten to erode confidence in the dollar as a global reserve currency, America switches tack and raises interest rates. Dollars previously sent abroad return to the U.S. to be invested in Treasury bonds. The outflow of dollars from developing economies, meanwhile, leads to financial and currency crises of the kind which shook Latin America in the 1980s and S.E. Asia in 1997. Subsequent International Monetary Fund ‘structural adjustment programs’ implemented to stabilize such economies in crisis serve to lock them into the global dollar system.
However, as U.S. government debt has grown it has become impossible for the U.S. to attract dollars from abroad by raising interest rates. If interest rates were raised to even five per cent, servicing the 20 trillion dollars of U.S. government debt would account for almost 1/3 of tax revenues. Rates approaching those last seen in the early 1980s would take every cent collected in taxes and more.
Unable to use higher interest rates to induce support for the dollar, Qiao asserts that the U.S. has, since the late 1990s, increasingly come to rely on force to both eliminate potential rivals and create a climate of instability and fear that would cause investors to seek out U.S. dollar assets as a “safe haven.”
According to his analysis, the break-up of Yugoslavia, while avoidable, was allowed to proceed in order to undermine confidence in the euro as an alternative reserve currency. Similarly, Saddam Hussein and Muammar Gaddafi were removed from power due to their plans to trade oil and other commodities in currencies (euros in Saddam’s case and gold-backed dinars in Gaddafi’s case) other than the dollar.
Looking at current events, MacLeod writes that “The latest war-mongering against North Korea, Syria and possibly Iran has much to do with persuading Congress to raise the debt ceiling, and to encourage capital flight back into a new wave of U.S. Treasuries without interest rates being raised. This neatly explains Trump’s change of heart over foreign adventures.”
Terrifyingly, we appear to have a global financial system dependent upon a self-perpetuating cycle of war funded by debt. Starting with the objective, for the U.S. dollar to continue in its role as the global reserve currency, foreigners need to continue buying U.S. Treasury bonds. However, in an environment of low interest rates, Treasury bonds are only attractive to investors seeking a safe haven from instability and chaos. To create these conditions, the U.S. military needs to bomb the Middle East and rattle sabres in East Asia. Closing the circle, to get the money to fund such military adventurism the U.S. government needs to continue selling U.S. Treasury bonds.
Tragically, this continued writing of cheques that can never be cashed results in American military personnel and civilians in the Middle East cashing in their chips. While the U.S. has been able to write such cheques for a lot longer than any individual, it is clear that using death and debt to secure the dollar’s primacy is unsustainable and cannot endure.