3 Pillars of Exorbitant Privilege

by | Apr 4, 2023

France and China have agreed to pay for LNG in yuan.

Brazil and China have agreed to settle trade in yuan and reals.

Russia and India will settle trade in rupees.

And even the original gangster of petro-dollar trade, Saudi Arabia, has abandoned dollar-only payments for oil.

The world is aligning away from U.S. dollar dominance and towards something much different.

And because of the realignment, the lifestyle Americans enjoyed at the expense of the rest of the world is no longer possible.

A French Guy Said So

That lifestyle began with the Bretton Woods agreement established in 1944.

This system pegged the U.S. dollar to gold at a fixed exchange rate and pegged other currencies to the dollar. The privileged position that emerged helped the U.S. dominate the international monetary system.

Soon, the U.S. dollar became the preferred currency for international transactions. Countries held large amounts of U.S. dollars in their central bank reserves, extending that privilege further by making the U.S. dollar the de facto reserve currency of the world.

In the 60s, French Minister of Finance Valéry Giscard made note of that advantage by stating:

“The United States has an exorbitant privilege to turn its dollar into a worldwide currency with no restriction. That’s something that no other country can do. But it’s something that is in the process of ending.”

Giscard was wrong on that last part.

The subsequent petro-dollar agreements extended that American privilege a few more decades.

In the early 1970s, the U.S. government negotiated with Saudi Arabia and other major oil-producing countries to price oil in U.S. dollars. This forced countries around the world to hold U.S. dollars to purchase oil. And greater demand for the dollar gave the U.S. significant leverage in global financial markets.

But Giscard was right to label that privilege “exorbitant.”

And a 1, and a 2, and a 3…

Privilege #1:

The U.S. could borrow in its own currency and run persistent trade deficits.

Other countries, meanwhile, had to accumulate U.S. dollar reserves to ensure they could pay for imports and service foreign debt.

When they didn’t, their currencies and economies tended to implode.

Privilege #2:

The U.S. could also export inflation.

As the U.S. Federal Reserve increased the money supply, the resulting inflation forced countries to buy more U.S. dollars to maintain their currency pegs and purchase oil. So many dollars floating outside American borders helped spread inflation outside those borders as well

This spared the American consumer from the full consequences of U.S. inflationary policy.

Privilege #3:

The U.S. could engage in economic warfare at low cost.

Since all trade was conducted in dollars, the U.S. could easily cut off access to the U.S. financial system and freeze assets held in dollars.

So, when anyone challenged that privilege, the U.S. could use that privilege to defend it with economic sanctions.

These sanctions came at almost little to no cost to Americans.

Combined, these Pillars of Privilege defined the American lifestyle for 7 decades.

But Americans can no longer spread the cost of deficit spending, currency debasement, and force outside of U.S. borders.

Because these pillars, like everything else, have given way to entropy.

I’ll tell you more about that tomorrow.

Take What the Markets Give You.

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