The Lament of the Dollar System

Source: Zh堡Mikko

Origin

The current global economy and monetary system are creations of American-style globalization. After breaking free from the constraints of gold, American-style globalization operates on three key mechanisms:

The US dollar serves as the sole dominant currency, with American demand being a source of growth for the global economy. In short, the US produces currency while non-US entities accumulate it; the US has export demand while non-US entities provide export supply. This creates a massive flow of bilateral trade.

Thanks to the freedom of finance (banking) and the expansion capacity of pure credit currency, the dollar system has penetrated globally under the premise of unrestricted capital flow. Dollar credit/deposits and dollar assets/liabilities link the US with non-US economies, forming a massive bilateral capital flow.

As the manager of the dollar zone, the United States is the dominant player (hegemon/daddy flavor) in the international order.

Nowadays, the dollar system is filled with various astronomical figures that have exceeded the scale of the U.S. domestic economy. This is due to the high growth (income) demand and asset allocation needs (forward/term dollar income) of non-U.S. economies, which require a continuous expansion of the dollar volume to be fulfilled.

With the fall of the Berlin Wall and China’s accession to the WTO, American-style globalization welcomed a massive influx of eligible labor. Within the region, dollar labor income shifted towards lower-cost workers, completing the income rebalancing within the dollar zone. Meanwhile, some economies in the region, due to the decline in the eligible labor population (aging), transferred their labor income abroad.

Figure: Transfer of Income

The lower average wages globally have flattened the Phillips curve, thereby suppressing inflation. At the same time, the traditional approach of using loose monetary and fiscal policies to boost local demand and stimulate output (gaps) and inflation has failed due to the complete liberalization of cross-border capital flows. In plain terms, global supply will quickly absorb the slight stimulus from local demand, leading to a very long period of low inflation before the pandemic, and central banks had no reason to tighten monetary policy in a low inflation environment, which also resulted in lower global interest rates.

One characteristic of American-style globalization before the pandemic was the coexistence of low growth, low inflation elasticity, and low interest rates in developed economies, corresponding to high growth, more sensitive inflation elasticity, and higher interest rates in some emerging economies. Investment demand from developed economies shifted to emerging economies, which exported deflationary pressure from their working-age population.

In this symmetrical imbalance process, the real beneficiaries are the (multinational) corporate sector. The corporate sector enjoys a very low interest rate environment, flexible tax identities, and global market revenues.

For example, take apples as an example:

• Its sales revenue occupies a very high share of the global mobile phone market.
• Can deploy its production base in economies with the lowest labor costs in the world.
• Based on the production and resource endowments of different countries, fragmenting its own supply chain and division of labor.
• Equity financing can be conducted in the world’s largest stock markets.
• Its bond financing rates are lower than those of some sovereign countries, and it can conduct multi-currency financing across borders.
• Tax-free, its effective tax rate is not determined by the U.S. government, but by its tax jurisdiction.
• Its massive dollar income can be allocated across major asset classes globally.

However, sovereign entities are limited by national borders, and resident entities are limited by citizenship, and neither has the ability to replicate cross-border identities like enterprises do.

Many insightful researchers have discovered the differences between today’s globalization and that of half a century ago. At that time, the regulation of international capital flows and the reserve behaviors of government departments meant that globalization was top-down. Therefore, the issues of globalization at that time could be addressed top-down through so-called global coordination or some form of supranational mechanism. However, in the current stage of globalization, the corporate sector is more adept. In other words, the meaning of the term “globalization” is more complex for businesses.

The U.S. government (not just the Trump administration) has long recognized this characteristic of the dollar zone/dollar system. During Biden/Yellen’s tenure, they also attempted to achieve the goal of “manufacturing reshore” through “supply-side economics,” and tried to bring back some of the tax base losses from U.S. companies moving overseas through a “global tax system”; immigration is also a way of labor income rebalancing (pressing down the average wage in the U.S.).

Image: Big pharmaceutical companies do not pay taxes locally

Trump’s approach is different from theirs, but his goal is the same: to bring manufacturing and businesses back, improve domestic employment, and address America’s twin deficit problem, which has led to the emergence of tariffs.

Tariff

Why are tariffs imposed indiscriminately on all economies? Essentially, tariffs are another expression of Yellen’s “global tax system.”

If you are too lenient towards certain economies, then soon the commercial entities of those economies with trade surpluses and dollar accumulations will package their national trade goods as products from low-tax jurisdictions through transshipment trade or direct foreign direct investment (FDI), just like those giant tech/pharmaceutical companies hoard their revenues in tax havens. After 2018-2019, some Southeast Asian countries and Mexico took on the role of “export transshipment.”

Image: Everything is compared with Japan

Trump’s new policy did not cover service trade, which indicates that he has not identified the core of the trade issue. He overlooks the Netherlands, Luxembourg, and Switzerland, which are major sources of income for the U.S. service trade. In other words, since he has decided to target non-U.S. surplus economies, why not also target domestic corporate sectors that are accomplices? It is these domestic giants that are creating these surpluses.

Since the tariff mechanism is not unilateral and also involves dynamic bilateral tariffs among non-American countries, Trump can further intervene through secondary tariffs. However, other non-American countries are not NPCs; non-American economies can respond by taking proactive countermeasures and by internal rebalancing among non-American countries.

But rebalancing does not solve the incremental problem. The exit of American demand means that to maintain the original trade pattern, there must be an economy to provide the total demand that the exit of the dollar zone is missing, replacing the United States to bear the twin deficits.

Therefore, in the near future, the international monetary system will face several mirrored, vulgar issues:

• The United States does not provide total demand, who will provide total demand? How will it be provided? Which economic sector provides it?
• Who ultimately bears the tariff revenue that the United States wants to capture? Is it the American residents and businesses or the non-American residents and businesses?
• Which country will take on the dilemma of the Triffin dilemma? Expand and export its own currency to provide “global growth”?
• Which country’s capital market can accommodate the reserve and investment demand brought about by the expansion of its currency?
• If no one is willing to take on the responsibility of international currency/international security as a public good, what will the landscape of multilateral international monetary settlement look like?

From the trends in Europe and China, both typical surplus countries are starting to consider the issue of domestic demand—Europe is doing so by increasing defense spending, while we are showing signs of a shift towards consumption-driven growth. However, it is clear that, just as Trump envisions the return of manufacturing, changing the existing economic growth model will be a systematic project that takes a decade-level time cycle.

If tariffs are borne by consumers in the United States, it comes at the cost of economic growth and consumption drag. If major domestic corporations in the U.S. bear the burden, it comes at the cost of a decrease in corporate profits (growth), capital allocation (R&D/CAPEX/repurchase), and a loss in stock value, which impacts the wealth effect. If it is at the expense of other countries, it sacrifices the income of foreign manufacturers/workers and even affects exchange rates.

Unfortunately, the initial effect that the Trump administration expected (the depreciation of non-US currencies) has been replaced by the depreciation of the dollar due to recession expectations. Clearly, investors are more concerned that tariffs will ultimately come at the expense of domestic economic growth in the United States.

River and Garden Landscape Plan

In my opinion, Trump misidentified the problem of globalization, and his use of tariffs as a form of “leverage” has made his goals too vague. If it were me, I would submit a draft for Jianghe Garden to replace the so-called Mar-a-Lago agreement akin to synthetic meat, in order to put the brakes on the dollar system; after all, it’s still self-destructive.

• Restructure national fiscal revenue and expenditure, curb medical insurance, social security, and pension, and cut social welfare safety nets.
• Following the example of FHLB, establish a federal central infrastructure fund/bank and introduce equity investors, rather than issuing century bonds.
• At the same time as withdrawing troops, we will negotiate a “reverse Marshall Plan” with our allies to strengthen FDI investment in the United States from Europe and Japan
• Deepen the antitrust actions against tech giants and offshore tax evasion, strictly control stock buybacks and dividends.
• Optimize banking regulation to allow banks to return to deposit/loan activities
• Repeal TCJA, reintroduce Tobin tax through the Foreign Tax Bureau, and tighten cross-border financial capital flows.
• One-time devaluation, increase domestic energy and other commodity exports through negotiations.

Nowadays, Besant is in a very bad situation. On one hand, he has no say in tariffs, and on the other hand, he needs to justify the President’s absurd TCJA in an environment of high debt, which has fundamentally not changed the U.S. government’s fiscal problems in the post-pandemic era. The idea of reducing government employees (clerks) to support manufacturing jobs is also fanciful; it would be better to directly establish state-owned enterprises for internal digestion.

The Lament of the Dollar System

Trump still has enough space to stop the deep damage to the dollar system, but time waits for no one. If he continues to resolutely implement the plan outlined in the Miran text, then we may indeed be at a significant turning point in the international monetary system.

The decoupling at the trade end is merely the decoupling between goods, trade financing, and settlement/valuation currencies. If the United States continues to pursue a double surplus, then the inevitable decoupling afterward will be assets/liabilities, or a reversal of total bilateral capital flows. The scale of dollar credit and dollar debt/equity financing will shrink globally.

At this time, the status of the US dollar as a reserve currency will also be impacted due to the “isolation” of various countries and the new multilateral pattern of international settlement. The asset allocation of countries’ reserve assets, sovereign funds, asset management companies, and banks’ cross-border financing will further shift towards multiple currencies or (with a low probability) to some super-sovereign asset as a substitute/temporary anchor (old gold, new BTC, or some new currency in the AI era?). The US capital market will inevitably undergo a process of reduction from oversupply to standard supply.

The United States’ deficit issue and fiscal gap may not be narrowed by DOGE’s efforts. If Trump further exploits the hidden default on U.S. debt (such as the mandatory collection of U.S. debt fees mentioned in Miran’s article, or by indulging in inflation), then the allocation ratio of U.S. debt will also further decline.

Image: What DOGE?

The withdrawal of this portion of funds will bring about a new question—where to go? Is it a return flow? Or is it to find a new large capital market that can accommodate the investment (long-term return) needs of this portion of funds?

Finally, in extreme cases, is it possible for the dollar exchange rate to be weaponized?

The End of the Three Rates Declining

In my graduate career, I have witnessed the three rates in the dollar system gradually bottoming out:

• Zero interest rate and negative interest rate policies induced by low inflation
• Tax competition drives down rates, companies pursue effective low tax rates.
• Depreciation of the exchange rate to capture a larger share of US dollar trade.

We are currently out of low interest rates and low inflation due to the pandemic, while Trump’s policies target tax rates (albeit skewed), and it is probably a natural consequence to face changes in the exchange rate situation later.

I am neither Kindleberger nor Triffin, but I think that if either were still alive, they would both notice the “anchor” problem of the current dollar system—an inflation targeting system where a global currency is anchored only to domestic prices of goods and services. Is this reasonable?

At this point, we have roughly outlined the entire framework elements of the dollar system:

• Triffin’s Dilemma, the N-1 Problem, and the classic Mundell Problem (the Trilemma), which are the imbalance issues in the current American-style globalization system.
• The main contradiction of the United States, as the United States (id) relates to the United States in the dollar zone (ego) and the governance of America (superego)
• The contradictions between the US and non-US economies encompass symmetrical issues such as supply and demand, imports and exports, income and expenditure, assets and liabilities.
• The misalignment issue in the economic sector, the globalization dimensions of sovereignty, enterprises, and individuals are misaligned.
• The anchor of currency/finance (inflation targeting) issue

Perhaps within Zoltan’s framework, a certain trinity of balance may be established between capital, labor, and physical goods through the concept of duration. However, it is unfortunate that he did not complete his framework, and the author also lacks the ability to reconcile the value network between contemporary economics, the balance of payments (BoP), national income accounts (NIPA), and funds flow (FoF).

Or perhaps Trump’s self-destruct program will leave us with a ruin full of hope?