Financial markets just sent a wakeup call to the U.S. Eleven nations in the Commonwealth of Independent States (CIS), including Ukraine, eliminated the dollar as a reserve currency. This is the most recent signal of fundamental changes in the dollar exchange system. Other countries, most notably the BRIC nations, are aggressively expanding the use of their own currencies, especially the Yuan, as reserve currencies and as a medium of exchange.
The U.S. can no longer prop up the dollar exchange system. Donald Trump is in much the same situation as Richard Nixon in the 1970s. In those years the U.S. was hemorrhaging gold. By abandoning the gold exchange system Nixon could continue to pursue fiscal and monetary policies that devalued the dollar.
Over the past two decades, under both Republican and Democratic administrations, the U.S. has pursued fiscal and monetary policies undermining the value of the dollar. The U.S. has failed to stabilize prices and continues to incur deficits and accumulate debt at an unsustainable rate. The protectionist policies pursued by the Trump administration have created chaos in international financial markets.
The dollar exchange rate system was created with the assumption that a stable dollar would serve as a reserve currency and medium of exchange and anchor the dollar exchange rate system. But we have entered a new era of competitive currencies, much as Milton Friedman envisioned. The dollar must now compete with other currencies, and with alternatives to government currencies such as digital currencies. Countries now use alternative currencies and digital currencies because they are superior to the dollar as an anchor for their financial systems.
Perhaps this is the shock needed for the U.S. to begin pursuing prudent fiscal and monetary policies. During the ‘Great Moderation’ of the 1990s the U.S. did stabilize prices and reduce debt to sustainable levels. But after two decades in which we have abandoned those fiscal and monetary policies, we can no longer rely on elected officials to right the ship of state. We should follow the lead of other countries, such as Switzerland, and enact constitutional fiscal and monetary rules as guardrails against failed policy.
If we follow along the current path the outcome may be like that of the U.K. after World War One. Despite the fact that the War left the U.K. with a weakened financial system, they continued to peg the pound to gold at an overvalued exchange rate. During the Great Depression the U.K. as well as the U.S. and other countries, were forced to abandon the gold peg. In those years the Smoot Hawley Tariff Act imposed the highest tariffs in U.S. history.
While the international financial system has not collapsed as it did during the Great Depression, we are witnessing a fundamental restructuring of the dollar exchange system. President Trump has used Executive Orders to increase tariffs to levels not seen since the 1930s. He has threatened to impose 100% tariffs on China in retaliation for their export controls on rare earth minerals. But the U.S. no longer dominates international trade and finance as we did after World War Two; the reality is that U.S. restrictions on trade and investment, including sanctions, have failed.
The decision of other countries to abandon the dollar as a reserve currency is like the canary in the coal mine signaling this failure, and we ignore those signals at our peril. As other countries, and especially China, expand their footprint in international trade and finance the U.S. must recognize them as competitors, not enemies. Normalizing trade and financial relations with China could help avoid needless conflict over other issues, most importantly national security. The collapse of the international financial system during the Great Depression set the stage for World War Two, and we seem to be following a similar path today.
We are experiencing a constitutional crisis. We are now dependent on President Trump to negotiate trade agreements with other countries through Executive Orders. That is not what the Founders intended. The Constitution places the power to levy tariffs clearly in the Congress, not in the Executive branch. Citizens should demand that Congress fulfill its constitutional duty, even if this means petitioning the Supreme Court to resolve the constitutional crisis.
