World Power

Few countries can exert much power in the rest of the world. There are just five permanent members of the United Nations Security Council, the ones who can cast vetoes on important UN decisions. Or take the G7, a US-led political forum of rich countries that has, well, seven members. The concentration of global power is extreme, and it rests upon the different ways a country can have influence over how the world works.

Some of these ways are obvious, for example, using military power to force another country to submit. Many are not, especially those that are linked into the system that envelops the world economy. Five dimensions of international power can be used to gauge the status of countries.[1] These show not only how the US is far more prominent in the hierarchy than suggested by a simple measure of economic size, such as GDP. They also map the relative importance of other countries and throw new light on a major geopolitical issue today: the rise of China.

China rising

China was once seen mainly as an important supplier of cheap goods and a valuable dynamo for the world economy. Now the US looks upon China as the biggest threat to its global interests. Every year, many hundreds of pages on this topic are published for the US Congress, adding to a steady stream of material directed at US policymakers from think tanks and lobby groups.[2]

In 1990, China accounted for just 2% of the world's GDP. Since then, that share has doubled every decade and China will likely account for 18% in 2021.[3] This has worried the small group of countries that dominates the world’s key institutions, because quantitative changes can also bring about qualitative shifts. Will they be able to stay in charge as they had done, now that a country from outside the rich club has risen to the fore? That question is posed especially for the US. All those institutions – the United Nations, the IMF, the World Bank, the World Trade Organisation and others – have been shaped by it.[4] The first three also have headquarters in Washington DC or in New York.

Russia – formerly, the Soviet Union – is the traditional US political enemy. Yet, it is principally a military obstacle, notwithstanding the more recent US belief that it can influence Presidential elections through buying Facebook advertisements. China, by contrast, presents a much wider challenge to how the US sets the rules for the world, as seen when it ignores US-inspired sanctions against countries such as Iran. US political rhetoric and economic measures against China picked up with President Trump, and they have continued unabated with the new Biden administration. All the international meetings held by Biden and his officials since the start of the 2021 – at the G7, at NATO, in Europe and in Asia – have had a strong anti-China theme.

Measuring power

Power has many dimensions. Here are five aspects of economic and political power that are relevant for a country’s international influence.

Economic size is one measure of a country’s weight in the world, usually measured by its GDP. That GDP number is broadly related to the size of its domestic market, how many big corporations it has, and how important it is in international trade. The US is the world’s biggest economy, accounting for roughly 24% of world GDP. G7 countries – the US, Japan, Germany, the UK, France, Italy and Canada – together account for 45% of world GDP, despite having only 10% of the world’s population. GDP counts for more than people when it comes to power and influence.[5]

 

By 2020, China’s GDP was just under three-quarters of that for the US. Japan’s GDP was roughly a quarter the size of the US, Germany was at nearly a fifth, and the UK and France were each at roughly one-eighth. All countries have been affected by the Covid-19 pandemic, and it has had little effect on their relative positions. However, US sanctions will have curbed China’s growth to some extent in recent years.

A country’s foreign assets are another important measure of power. Such assets include the ownership of companies operating in other countries, together with holdings of financial securities, such as equities and bonds, and ownership of real estate.[6] These indicate how much control it has over resources in other countries, and the size of the assets is related to the potential revenues it can gain from them.[7]

At the end of 2020, the US had by far the highest stock of foreign assets, at roughly $22.7 trillion. Germany was next in line, but well below that with ‘only’ $6.3 trillion, and the Netherlands, the UK and France followed. China and Hong Kong’s foreign assets amounted to just under $5 trillion.

These asset ownership numbers, as much other published information, do not allow for the flows of finance between major countries and tax havens. Tax havens are registered as the owners of significant foreign assets in official data, yet most of their funds originally come from major country investors.[8] This should not have much effect on the top level calculations used here.[9]

International lending and borrowing by banks is a third measure. These data show how much a country is involved in channelling funds around the world, and are also linked to how far that country is a finance hub that can profit from international dealing. London is the largest centre for international banks. While it may be a surprise that London is bigger than Wall Street on this measure, that is because much US banking business is oriented towards the domestic US economy, not so much internationally.

Nevertheless, Brexit has had some impact on UK international banking. With the UK outside the single market for financial services in the EU, some banks have shifted their operations from the UK and into EU centres. France has gained most ground because of this, and jumped into second place just behind the UK by the end of 2020, moving ahead of the US, which was in third place (see the next chart).

How much a country’s currency is used in foreign exchange (FX) deals for trade and investment is another aspect of its economic status in the world. Directly or indirectly, this also adds to its global power. This is most evident for the US with the dollar, which is involved in 88% of all currency deals.

Most commodities and important industrial goods, including oil, metals, grains, technology, pharmaceutical and aerospace products, are priced for trade in terms of US dollars. The same is true for many investment and financial deals, helped by the US having the world’s largest stock and bond markets, with international private and official funds buying those securities. Even the China-led Asian Infrastructure Investment Bank conducts its business mainly in US dollars.

US power in this FX dimension relies on the fact that nearly all deals involving US dollars must be settled through the domestic US banking system. Images of drug dealers and criminals crossing borders with bags of cash may be good for the cinema, but they do not represent what really happens to international transfers of funds.

This means that if the US government doesn’t like you – whether you are an individual, a company or a country – then it can try to prevent you from doing currency deals, even if you are not based in the US. If a bank nevertheless does deal with you in dollars, or even in another currency, then the US can fine that bank and threaten to shut it out of the huge US market. The US government’s Treasury Department has a special agency for this purpose, appropriately named the Office of Foreign Assets Control.

Other countries with important currencies could try to exert power in the same way, but their currencies have far less international significance. For example, the euro’s share of world FX markets is just 32%,[10] with the Japanese yen half of that in third place and the UK’s pound sterling in fourth.[11] So far, China’s renminbi currency has remained very minor in terms of global trading, at around 4%.[12] This is based upon the relatively late inclusion of China in financial markets, together with many more government controls on the flow of capital than is the case for other major countries.

The amount of military spending is a simple gauge of how far a country can use force against another, or threaten to use it, and is the fifth measure of power used. The US is once again in the top rank here, and it also has military bases in over 50 countries. By contrast, China has bases in just three other countries (Djibouti, Myanmar and Tajikistan).

Even if much US military spending is, in reality, more of an indirect subsidy to the domestic US economy and corporations, or is on equipment with inflated prices, its total spending of a huge $778bn in 2020 still gave the US plenty of scope to project power. This sum was more than three times bigger than China’s and twelve times bigger than Russia’s. The US lead over other major countries in military spending has increased in the past two years.

Power outcomes

Each of the five factors has some limitations regarding its accuracy or coverage. But together they give a good summary of power and are available for a large number of countries. This measurement of global power is endorsed by how the results for the top 20 countries include the five permanent members of the UN Security Council, all of the G7, and most of the G20 countries.

A country may have a high score on one component and very little on another, but all except a few countries in the world have a negligible score on all of them. The US has an index score of 93.2, with China well below in second position at 37.7. Only six other countries have an index score above 10.0. More than 150 countries score less than 1.0. This picture of the extreme hierarchy of power is a challenge to anyone who uses the term ‘international community’!

 

Sources & notes: See the first chart for details.

This calculation of power depends upon individual country values and does not consider the effect of alliances between countries, or factors that are not as easy to quantify, such as cultural influence. If included, these would only add to the power of the US and generate a more towering image. Consider NATO, for example, which accepted that the ‘North Atlantic’ security region extended into Afghanistan, the first US target after September 2001. Or consider how US social media companies dominate the Internet, how the world’s youth wear baseball caps, like, backwards, and how even India’s massive film industry calls itself ‘Bollywood’.

What next?

The US is worried about the rise of China’s economy, although US power extends much further than a simple economic measure would suggest. A look at the power index for the major countries over the past two decades shows how China has also built some non-GDP dimensions of power, notably in military spending, international banking and the ownership of foreign investment assets.

 

Sources & notes: See the first chart for details.

In recent years, China dislodged the UK in number two spot on this ranking of world power. The UK is the world’s fifth largest economy, but has its status boosted by its role in international banking. That reflects its position in world finance, although the form that this takes is also changing with the rise of China and other Asian countries, and the relative decline of European economies.[13] The more that international business grows outside of the traditionally dominant group of countries, the less important are the rules that they impose for how the world economy must work.

The US sees the rise of China not just as unwelcome competition, especially in the technology sphere, but also as a serious future threat to its hegemonic status, one that must be dealt with today. Other countries closely linked to the US, and especially other Anglo members of the ‘5 Eyes’ spying network (UK, Australia, Canada, New Zealand) are in a similar position, because they have been an integral part of a system that has dominated the world since 1945. That is why the rise of China inevitably becomes a geopolitical issue.

Some countries in Europe, particularly Germany, have a different perspective. Politically they are pro-US, and they are also economically cautious about China. But they would also like to have an alternative to relying solely upon the US, or US permission, whether that is for technology, for energy, or for other vital supplies. They are right to be concerned that the US is inclined to unilateral policy moves that can go against European interests. That remains true under Biden, although his administration stepped back from its former hard stance against the completion of the Nord Stream 2 gas pipeline from Russia.

Not surprisingly, China has responded to the US policies over the past decade, and the risk that as a result of these policies it could be pushed to the edges of a world economy controlled by hostile countries.[14] A key part of its response has been to press ahead with the massive trade and investment programme begun in 2013: the ‘Belt and Road Initiative’. This involves more than 130 countries, mainly in Asia, Europe and Africa, but also extending into Latin America. Faced with US sanctions and political manoeuvres, China is building up a network over which the US and its allied powers have far less control.

These developments will foment divisions in the world that every country will have to deal with. In the next few years, we will live in interesting times as the established powers led by the US fight to maintain their domination.

 

Tony Norfield, 14 September 2021

  

APPENDIX

 

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[1] This article updates my analysis of September 2019, where I showed that the Index of Power had put China in #2 position. See here.  The Index calculation here adds a country’s foreign portfolio assets to its direct investment assets, to get a better measure of its total foreign assets. (Previously, I only counted FDI, but I have since found good data on portfolio assets.) It also makes some adjustments to eliminate possible double counting of intra-China relations between China and Hong Kong, which are treated as separate countries in all official data. See the Appendix to the article for more details.

[2] For example, the US-China Economic and Security Review Commission has issued annual reports since 2000. Its December 2020 report was nearly 600 pages: https://www.uscc.gov/annual-report/2020-annual-report-congress

[3] Sources for GDP and other data used are given in the Appendix to this article. The US share of the world economy has fallen from 30% in 1990 to 24% in 2021.

[4] The former institutions, or its predecessor, the GATT for the WTO, emerged from the post-1945 political realignment led by the US. The President of the World Bank is almost always a US citizen, while the Managing Director of the IMF is always a European. The WTO has had a more diverse list of Directors General. Decisions by each institution are rarely passed if the US disagrees, a result helped in the case of the IMF by a voting allocation that always enables the US to block any IMF action.

[5] GDP numbers can be calculated in various ways. Here, the nominal value of GDP in a single currency is used to compare countries.

[6] In standard official statistics, ownership of 10% or more of a company in another country is considered foreign direct investment. Ownership of less than 10% of the company’s equity is considered a foreign portfolio investment, as are holdings of foreign debt securities. These are all added together here to give the measure of a country’s total foreign assets.

[7] Large corporations, usually from rich countries, can also profit from their commercial domination of producers in other countries via so-called supply chains, for example, Apple’s relationship with its suppliers, or western fashion companies getting their products made in Asian countries. However, these relationships are difficult, if not impossible, to measure.

[8] One study shows, for example, how a nationality-based measure could greatly increase the registered US and other major country holdings of bonds and equities in particular countries. These holdings are under-estimated by the usual residency-based measures in official data, as the residency can also be a tax haven. See pages 44 and 48, especially, of: https://bfi.uchicago.edu/wp-content/uploads/BFI_WP_2019118_Revised.pdf

[9] This is because the data I use measure total outflows from a country, which should include the funds first sent to tax havens before being resent elsewhere. However, the ‘round tripping’ of funds to escape tax would not be counted properly. For example, if US investors sent funds to a company registered in the Cayman Islands for the purpose of investing back in US assets, that first flow would appear as a foreign asset of the US when it is not.

[10] The euro’s share of global FX markets is divided up among the 19 euro country members according to their relative GDPs. Germany has the biggest share of that, followed by France, Italy and Spain.

[11] Note that the total shares of all currencies add to 200% because there are two currencies in each foreign exchange deal.

[12] Less surprisingly, the separate Chinese currency of Hong Kong also has only a small role in world FX trading. Its currency value is tied very tightly to the US dollar’s.

[13] See Tony Norfield, The City: London and the Global Power of Finance, Chapter 9 and the Afterword to the paperback edition, Verso, 2017.

[14] For a discussion of these topics, see my articles ‘Racism & Imperial Anxiety: US vs Huawei’, 16 April 2019, here, and ‘China and US Power’, 14 July 2020, here, each one on EconomicsofImperialism.blogspot.com.

Imperial Hypocrisy and Greek Debt Data

The recent Greek referendum 'No' to its creditors' plans was welcome, even unique in recent history, as a sign of some serious resistance to being crushed by the exigencies of capitalism. Yet, the referendum has changed nothing because the Greek economy remains at the mercy of the creditors, especially its euro-based creditors. It is worth looking back at some points on the history on this, which will shift attention from the intransigence of German politicians like Merkel and Schauble to the double dealing of the French.

The question of writing off some of the obviously unsustainable debts was first raised back in 2010, when Greece's problems first exploded into view as the debt was over 130% of its GDP. Then, a certain Dominique Strauss-Kahn, the hereditary European who was chosen as the head of the IMF, and also a key French politico, was against a debt 'restructuring' (ie write off). No doubt citing fundamental IMF principles and the laws of God, or Mammon, Monsieur DSK was no doubt also mindful of the fact that a large proportion of Greek debt was held by French banks. In March 2010, French banks were holding the biggest pile of dung. Out of €134 billion worth of European bank claims on Greece, French banks had €52 billion, one and a half times as much as Germany.

In 2010, Greece was given further IMF and other loans, amounting to €110 billion. This was not because Greece did not have enough debt already, but because this was a way of paying off liabilities to the European banks, among other things, and making the new debt a liability of the Greek state to official creditors, who would have more power in forcing eventual repayments. One study estimates that:

"Whereas in March 2010 about 40% of total European lending to Greece was via French banks, today only 0.6% is. Governments have filled the breach, but not in proportion to their banks’ exposure in 2010. Rather, it is in proportion to their paid-up capital at the ECB – which in France’s case is only 20%.

"In consequence, France has actually managed to reduce its total Greek exposure – sovereign and bank – by €8 billion, as seen in the main figure above.  In contrast, Italy, which had virtually no exposure to Greece in 2010 now has a massive one: €39 billion.  Total German exposure is up by a similar amount – €35 billion.  Spain has also seen its exposure rocket from nearly nothing in 2009 to €25 billion today.

"In short, France has managed to use the Greek bailout to offload €8 billion in junk debt onto its neighbors and burden them with tens of billions more in debt they could have avoided had Greece simply been allowed to default in 2010.  The upshot is that Italy and Spain are much closer to financial crisis today than they should be."


This was not a full escape for private creditors, since they (including non-Europeans) were also pressured to write off roughly half of their 'assets' - around €100 billion - in a 2012 restructuring of Greek sovereign debts. But in 2012 this had become more manageable, since there had been some economic recovery and also much more intervention by central banks to prop up the financial system.

The sticking point for Greece's creditors remains writing off official debt. Now the IMF, led by Christine Lagarde, another French politico - who once smiled sweetly at Yanis Varoufakis, perhaps expecting the compliance that her position demands - is able to negotiate with a lower exposure of the French banks and the French state. Her aim now is essentially to put the burden of the creditors' setbacks onto eurozone members in general, especially Germany. Previously, the (French) banks, as the main original creditors, would have been in the front line for write offs.

In this context, there is another neat, hypocritical manoeuvre by French president François Hollande, who now wants to act as the supporter of a deal for Greece. France has long positioned itself as the saviour of southern Europe, hoping politically to build up a counterweight to Germany's supporters in any euro-based vote. As long as France can manage to put the economic burden of its political decisions onto some other country, then it will continue to do so.

Tony Norfield, 7 July 2015

PS: The authors of the debt analysis cited above also note that Greece has an unusually large amount of defence spending compared to other NATO countries of more than 2% of GDP. Why Greece needs this, apart from idiotic nationalism believing that Turkey will invade at any moment, is a mystery, but is another dysfunctional feature of the economically unviable Greek state.

Greek Lessons

Here are some points to consider when sorting through the news stories about Greece.

The media coverage is naturally focused on day-to-day events. However, the key point to understand is that, long before the crisis broke in 2010-11, the Greek economy was unviable. It had for many years been dependent on grants from the EU, extensive credits and low interest rates. Before the 2008 worldwide financial implosion, these boosted Greek living standards. Post-2008, there was the reckoning, starting with much higher borrowing costs.

What had characterised Greece both before and after 2008 was a low level of tax revenues compared to state spending, but this was only another way in which its fundamental economic weakness was expressed. Greece had little to offer apart from shipping and tourism. But tourism had become more uncompetitive, while shipping was 'offshore', paying little tax. Along with other weak, usually southern European states, such as Portugal and Spain, but also Italy, Greece had found its competitive position undermined with the rise of cheap labour countries in Asia.

In 2010-11, the EU 'solution' was to lumber the Greek state with more debt so that it could pay off private bank creditors, mainly German and French banks. This was to avoid a reckoning in terms of writing off debts that could not be paid by adding to the debt pile which was now held to be held mainly by the Greek government. The political logic at that point was that the European banking system could not withstand taking more write offs when it was so weak, and the legions of policy-making geniuses had not yet managed to work out anything else.

A debt write off -  effectively 100bn euros or so - was then organised in 2012. Private creditors took a hit in a 'debt swap', being forced to restructure their 'assets' into loans at greatly subsidised interest rates. However, by that time, the Greek economy had collapsed under austerity measures imposed by creditors, so nothing improved and the ratio of debt to GDP continued to soar.

There followed a never-ending story of Greek-EU negotiations and subterfuge. By 2013, Syriza managed to convince itself, or at least had the political platform, that a much better deal was possible, both staying in the euro system and getting an end to austerity policies. After forming a government in January 2015, it did next to nothing to challenge the Greek oligarchs or deliver a reality check to the Greek middle class, its social base, and instead postured against Germany, the main creditor country, and annoyed all of its creditors. But, with their Ukraine policy falling apart, and with their policies in the Middle East and North Africa in a shambles, leading to many thousands of refugees trying to escape to Europe, the creditors had other things on their minds apart from endless meetings with recalcitrant Greek debtors.

So far, the Greek government has not yet defaulted on other official (government/IMF) creditors. But the European Central Bank (ECB) has extended many tens of billions of loans to the Greek government and given Greek banks another almost 100bn in emergency liquidity via the Greek central bank. On Tuesday there is also a Greek government payment due to the IMF, a default on which does not happen for a country that is meant to be one of the insider's club, yet there appear to be no funds to pay it.

The ECB may have today (Sunday) issued the coup de grace that the euro system is not otherwise able to deliver by refusing to increase its liquidity provision to Greek banks. So there will be a banking system closure in Greece on Monday, with no sign of when banks will be able to open again.

There is no legal mechanism for being kicked out of the euro, nor for a member leaving it, as far as I am aware. If anything, a euro member leaving might well threaten its membership of the wider EU. Yet, the ECB can stop doing business with one of its constituent parts, namely the Greek central bank. By stopping further funding of Greek's imploding banking system, the ECB, if it continues, will preside over the collapse of Greece's economy, forcing an exit from the euro system.

There are many economic details in dispute regarding the EU/IMF/ECB conditions to be agreed with Greece, but the creditor position at present is that the debtors have walked away from negotiations, so there is no more to discuss. One interesting angle is the question of taxes. Syriza's offer was to push the burden of adjustment onto corporate taxes rather than spending cuts, given that the latter would be focused on pensions, etc. Apart from any normal, reactionary bias in creditor demands, the inability of the Greek government to collect taxes must have been a factor in rejecting this alternative programme.

What happens in the next few days will signal again how far the 'independent' ECB is independent of the need to abide by its formerly sacrosanct rules in order to keep the euro political-economic system intact. A Greek exit from the euro is believed by many politicians to be less of a problem than it would have been in 2010-11. That is probably true, but it will nevertheless be a serious blow. One aim of Europe's bumbling ruling classes may have been to crush Syriza in order to undermine oppositional movements, such as Podemos in Spain. However, by showing that there is an exit door for euro members, even if it leads a lift shaft, this also shows that other countries may be pushed into it.

More broadly, the destruction of the Greek economy is a sign of what awaits other, previously privileged, countries that cannot make the grade in today's rapacious and imperialist world economy. If there is a lesson in the Syriza episode it is that a middle class-led movement that tries to restore the status quo ante inevitably fails.

Tony Norfield, 28 June 2015

Note: One of the first articles on this blog, 'Origins of the Greek Crisis', 24 June 2011, covered the background to recent events.

Dimensions of Dollar Imperialism

The US has long been thought to enjoy an ‘exorbitant privilege’ based on the dollar’s role as the major global currency.[1] This article looks at the different elements of the dollar privilege and how these work, not only in ‘normal’ times but, especially, in the current crisis.

1. Global role of the dollar

All paper currencies are so-called ‘fiat’ currencies, with a value set by the governments that issue them, not by their intrinsic value. Currency notes cost a few cents each to produce, so their much higher nominal value and buying power of $1, $5, $20, $100, etc, is based upon an established system of commercial law that means they can be exchanged for goods up to the same price. As long as the power of the state is unquestioned, at least in this regard, then there is no need to waste resources producing currency that has an intrinsic value in line with its nominal value. In other words, there is no need to have a $20 bill that actually costs $20 to make. This works well within the national boundaries of the state, which are usually the limits for the national fiat currency being legal tender.

But why then should a European, Asian, Latin American or African country accept dollar payments for their products when they are outside the national territory of the US? The dollar payments will not even necessarily be in the form of paper bills, and may only be a credit registered in a bank account. The reason for the dollar’s acceptability is US economic and political power. The US established a system of global finance after 1945 that was dollar-based, and the US was, and still is, the largest economy in the world. [2]

US pre-eminence is diminishing, but the institutions of US power remain in place and have so far faced little challenge. In foreign exchange trading, for example, the US dollar was on one side of 85% of all global currency deals in 2010, despite the alternative of the euro.[3] Important commodity prices are quoted, and contracts are set, in terms of US dollars, from oil to agricultural products and metals, and this phenomenon also applies to major industrial goods such as aircraft, components for electronics products, military equipment and the products of other many other industries traded internationally.[4] In financial securities markets, the US also stands out as the biggest in the world. The New York Stock Exchange is the largest equity market, by market capitalisation, and the US is also home to the world’s largest bond market.[5]

So the US currency has a global role based on US power. The sections below spell out what advantages the US gains from this.

2. Dollar seigniorage

The simplest form of advantage for the US, and also the least important, is that of ‘seigniorage’. The term describes the profit that a government can make by printing money with an exchange value higher than its cost of production, as in the printing of denominations of dollar bills mentioned above. All governments printing money that will be accepted within their national boundaries have this advantage, but the US has a particular advantage because the dollar is also accepted in many foreign countries. Especially when the local currency is seen as being unstable, for example when there is a risk of very high inflation rates, then companies and ordinary people may hold US dollars as their ‘store of value’. They are holding bits of paper that cost a few cents each to produce but which may have a legal tender value of many thousands of dollars. If the dollars have entered circulation in the country through the cash payment for that country’s exports, then the US has exchanged its green bits of paper for that country’s resources.

It is obviously difficult to measure with any precision the value to the US of international seigniorage, and estimates vary widely, but it is thought that a stock of perhaps $300-600bn of US currency is circulating overseas, an amount that rises every year.[6] A proportion of this will be money used in drug deals and other illegal activities, but the effect is to deliver the US economy a sizeable benefit. In some manner, foreigners have delivered the US the goods that it wants, whatever these may be, and many of the providers have held onto the cash.

3. Cheaper dollar finance

Seigniorage is nevertheless only a very narrow conception of the advantages that the US gains from the role of the dollar. Most users of the dollar in international trade and finance do not hold the cash in their hands, but in a bank account or in the form of US dollar financial securities (titles of ownership to US assets, such as equities or bonds). With these, the holders receive interest or dividend payments, so the US does not receive the funds for free. But a key benefit of the global role of the US dollar is to get cheap, low risk finance. This comes about in two ways.

Firstly, through the fact that the US can draw upon the financial resources of the world economy, so it has much easier access to funds than do other countries. One important aspect of this has been the dollar’s high share – around two-thirds - of official foreign exchange reserves. After the Asian financial crisis of 1997-98, many countries in the region – and elsewhere – built up their currency reserves as a means of economic insurance against renewed trouble.[7] The US dollar was the currency of choice for these reserves, as the major means of payment for international goods and global finance. So it was that through the 2000s, a growing US current account deficit was funded by huge inflows of finance, especially from Asian central banks that bought US Treasury securities and other US dollar-denominated assets. One study suggested that the impact of these purchases of dollar securities was to reduce the borrowing costs of the US government by as much as 150 basis points (or 1.5%) for 10-year debt, compared to what the cost might otherwise have been.[8]

Secondly, by issuing debt in terms of dollars, the US can avoid taking on foreign currency risk. In a US-centred crisis, the value of the dollar might fall against other major currencies, but that does not matter if the US has little or no debt denominated in euros, yen or sterling. Countries that do not have such a privileged position in global finance – those that are not imperialist powers - are usually forced to borrow in the major foreign currencies and suffer the full consequences when a crisis hits.

This cheap, low risk finance cuts the cost of funding the large US trade deficit. It also enables the US to generate more earnings on its foreign investments than foreigners do on their investments in the US. This is despite the fact that the value of US overseas assets is far less than the value of assets that foreign investors own in the US. In 2010, US net foreign investment income amounted to a massive $171bn.[9]

4. US benefits in a crisis

The US government controls the world’s major currency with by far the biggest impact on international trading and financial transactions, even if these deals do not involve the US economy or US companies. Deals that are made in US dollars need to be settled in US dollars. This is not necessarily done by getting hold of the cash bills. Much more frequently it is done by getting access to dollar finance through a banking relationship. It is here that US financial power is supreme.

A crisis disrupts business, making companies and people more vulnerable to changes in financial relationships. Perhaps a buyer cannot get access to the loan required, or a producer may not be able to finance the output that was planned. Market prices may also be pushed too low or too high by dramatic currency or commodity price moves. As doubts grow regarding who can survive the crisis, having access to credit is indispensable. The Federal Reserve, the US central bank, is in charge of this for much of the world economy given the role of the dollar, and access to financial support from the Fed counts.

In recent years, many central bank authorities have had to bail out their domestic banking systems, but the Fed has played a much bigger role. It has provided extra funds, for a fee, to foreign banks in the US – especially the European ones. It has also provided extra dollar liquidity, also for a premium fee, to the European Central Bank to distribute to euro-based banks, the latest in mid-September. The New York Times reported on why this move was in US interests:

“In recent days some European banks have faced difficulties in borrowing dollars, whether from other banks or from money market funds in the United States. There was fear that if they could not borrow dollars, they would be forced to cut off loans to American companies or sell dollar-denominated assets, perhaps forcing prices down in already unsteady markets.”[10]

This vulnerability of European banks – despite the protection they get from the ECB – is based on the fact that much of their business is conducted in dollars, a currency that only the US can print, and of which the US controls the supply. So far, the fear of economic collapse and the contagion from it has led to cooperation between the major powers. But the role of the dollar in pricing aerospace products and other international commodities means that it is critical for non-US banks to be able to access dollar funds, and the cooperation seen so far from the US need not be as easily available in future. Le Monde has already complained that the US Fed was making non-US banks in America file non-US assets as security, even if they were not actually borrowing any dollar funds from the Fed. [11] The complaint was rather confused, but reflects the fact that, even in a crisis, the US is in a privileged position to set the rules when it comes to finance.

5. Imperial power and the dollar

Declining US economic power is offset to an important extent by the continued prominence of the US in global finance. As has been shown, the US is able to borrow in its own currency at low interest rates, and it can readily attract funds based on the huge size and liquidity of dollar financial markets, given the global role of the US dollar. Even the US credit rating downgrade in August did not dent this. It is the dollar’s global role based on the continuing power of US imperialism that makes the US a ‘safe haven’ for financial markets, even when the American economy is in crisis.

Of course, US financial institutions have also been hit by the economic crisis. The US government has organised shotgun marriages of several major banks and many smaller banks have gone bust in recent years. But the US financial system remains in a privileged position in the world economy, as a purveyor of the major currency, backed by the world’s principal central banking authority - the one that controls the tap of global credit and liquidity.[12]

Despite the attacks currently taking place on the living standards of the broad population in the US, it is suffering far less than the countries that were overwhelmed by major financial and economic crises in the past couple of decades, from Mexico, Brazil and Argentina to South Korea, Indonesia and Thailand. The record levels of US debt and borrowing have seen no imposition of austerity policies by the IMF, and the US has faced no sudden halt in its access to foreign capital as many other countries have, not least Ireland and Greece.[13] Such are the benefits of being the major imperialist power in the global economy. This is why the US will struggle to ensure that its dominant position, and that of the dollar, remains unchallenged.

Tony Norfield, 5 October 2011

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[1] The term dates back to the 1960s and was coined by Valéry Giscard d'Estaing, when he was a France’s minister of finance. A useful recent book on this question is Barry Eichengreen’s Exorbitant Privilege: The Rise and Fall of the Dollar, Oxford University Press, 2011.

[2] China is likely within the next few years to become the world’s largest economy, overtaking the US. Note that this article only looks at some of the economic and financial aspects of US power, not the military dimension.

[3] Figures taken from BIS, Triennial Central Bank Survey, Report on global foreign exchange market activity in 2010, December 2010. The dollar share was 84.9% and the euro’s 39.1%. Note that here the total is 200%, since there are two sides to all currency trades, but the US dollar’s share was still more than twice that of the euro.

[4] The dollar is the most used currency for all kinds of international transaction, and the currency with the broadest global spread of use. Although the euro has gained acceptability since its inception in 1999, a large part of its use is in Europe and surrounding countries. The euro has been a serious challenger to the US dollar as an alternative currency in which to denominate bond issues, etc, but its market share has always remained a significant margin below that of the dollar. See The International Role of the Euro, European Central Bank, July 2011, for details.

[5] The US is second to the UK as a national base for the global foreign exchange market, but the currency trading in the UK is mainly of non-sterling currencies, and especially dollars.

[6] At the time of the opening up of Central and Eastern Europe and the former Soviet Union to capitalism after 1989, their trade with the US was minuscule, but the dollar played a major role in their economies on the black market. The Deutsche mark had, by contrast, very little penetration, despite Germany’s stronger position in trade with these countries.

[7] The 1997-98 crisis was traumatic for many countries in the Asian region. They suffered collapsing currencies, a slump in living standards and found their national economic policies dominated by the IMF, whose program for ‘reform’ included the sale of domestic assets at low prices to foreign capital. Thailand, South Korea and Indonesia were among the worst affected in this regard, and China, the major accumulator of foreign exchange reserves in the 2000s, took note.

[8] For example, the 10-year US Treasury yield was as low as 4.5%, rather than 6.0%. See Francis E Warnock and Veronica C Warnock, ‘International Capital Flows and US Interest Rates’, Board of Governors of the Federal Reserve System, International Finance Discussion Papers, Number 840, September 2005. Notably, the US restricts the foreign purchase of US corporations if this might seem to be against the national interest, but it has no qualms about taking money from whichever country wants to buy US debt (at low yields). Thus China was prevented from buying US oil major Unocal, but it has been allowed to own a mountain of US Treasuries.

[9] The US shares this advantage with the UK. See ‘The Real US Debt Problem’, 26 July 2011, and ‘The Economics of British Imperialism’, 22 May 2011, on this blog for more details.

[10] New York Times, 15 September 2011.

[11] ‘Comment la Fed assèche les banques européennes’ (‘How the Fed squeezes European banks’), Le Monde, 23 September 2011.

[12] US banks are still among the biggest in the world in terms of global coverage and influence, and US power also extends beyond purely US banks. For example, American nationals working for non-US banks outside the US are still subject to US law, so they cannot deal with any country that the US declares out of bounds. This is a factor that has strengthened the impact of US sanctions on Iran, for example.

[13] The IMF is technically an international body, but runs largely according to US dictates. The US does not need to own it all. It accounts for a significant minority of the votes (17%), well ahead of the second largest country, Japan, with just 6%, and has enough influence over other members to ensure that IMF policies suit its interests.

It Can Always Get Worse …

The IMF recently issued its World Economic Outlook, a document that has the advantage of comparing trends across the global economy. Although the text is written in international policy bureaucrat newspeak, luckily the charts and tables more or less speak for themselves. Below I have copied some of the more salient figures to illustrate how the crisis has recently intensified in the major capitalist economies. In addition, I note some points from recent press reports that illustrate how trouble is also brewing below the surface.

Economic stagnation after the failure of stimulus policies

The first chart shows the economic cycle based on data from purchasing manager surveys. These surveys track the broad economy closely, and the reports are released more promptly than official GDP statistics. The 50 level for the index in the chart means no change in output; above 50 means growth, below means contraction. After collapsing in 2008, global output growth resumed from mid-2009, but now economies have dropped back towards stagnation. In general, the ‘advanced’ economies are doing worse than the ‘emerging’ economies, partly because the latter did not take on as much crippling debt.[1]

The basic message from this chart is that all the extreme policy measures enacted since 2008 to boost the global economy – huge budget deficits, the public sector taking on private sector liabilities, zero interest rates, etc - have failed to restore conditions for profitable capital accumulation and growth.

The latest policy innovation from the US Federal Reserve has not changed anything, and global equity prices dropped by 3-5% today.[2] The IMF itself is left asking governments that have low borrowing rates to borrow more and spend more to boost demand in the global economy. But these same countries are afraid that more borrowing may find them also on the road to financial ruin.

The view from the end of the road

That road does not look attractive. This is shown in another chart from the IMF report, depicting the extra amount of interest over Germany’s that governments in the euro area pay to borrow for two years. As can be seen from the left hand section of the chart, the curve for Greece moved towards 8000. This means the market was demanding it paid an astonishing 80% per annum more than Germany! (Today it was much lower, a mere 65% premium!) Less extreme are Portugal and Ireland, but an extra 10-15% is still catastrophic, even if it is not as surreal. On the right hand section of the chart, the scale of premium borrowing rates is far less for the stronger countries (an extra 0-5%), but Italy, Spain and Belgium stand out as under pressure from credit markets.

Germany clearly remains in the best position: the German government can borrow for 10 years at a rate of just 1.7%. However, it will be wary of spending to try and boost the global economy when it is widely seen as liable for bailing out indebted euro members.

Behind the scenes

All this looks bad, but behind the startling pictures things are actually worse. Take for example, Siemens. Last year the German industrial group set up its own bank, partly because it would then have more financial flexibility and partly because it was worried about the other (mainly European) banks with which it dealt. A few weeks ago it withdrew €500m from a French bank and added to the €4-6bn deposits that it holds directly with the European Central Bank.[3] This company’s concern is not exceptional, in fact European banks face serious problems getting cash from their counterparts in the money markets.

This is shown by the wider ‘spreads’ that European banks are paying for funds. The credit risk of lending to them has risen, so that if they can get any cash at all, they have to pay more to borrow. French banks are seen as the most at risk among the major European countries, given their exposure to Greece and other indebted countries, although they are far from being the only ones. Senior executives from BNP Paribas are currently on their way to tour the Middle East to try and drum up friendly investments from local potentates.

Safe havens?

In the latest phase of the crisis, the US dollar has strengthened against most other major currencies. This is not because the US is a ‘safe haven’ in troubled times, even though it has more weapons than anybody else, but because, for now, it may look in better shape than crisis-stricken Europe. The definition of safety in capitalist economic terms is a movable feast, depending on where next the focus of panic falls. This is difficult to forecast, especially because the cracks in the system are manifold.

Another recent IMF publication, its Global Financial Stability Report, has a useful colour-coded review of the crumbling structure of the major capitalist economies. This is shown in the next chart (you may have to increase the viewing size to see the numbers clearly) . Red means bad; amber means not good, green means OK, and possibly good, or at least better (white means no data available).

The data are percentages of 2011 GDP, except for bank leverage that is the ratio of bank assets to bank equity.[4] Most of the red boxes are on the European side, showing high levels of debt and bank leverage, principally in the suspected countries. However, disturbingly for those who think Germany is completely safe, its banks have the highest leverage in the world at 32! The US gets off relatively lightly on this assessment, with a few green boxes. But it is not clear how far the IMF ignores the huge loss potential to the government of the US Fed owning nearly a trillion dollars of mortgage assets, and its other implicit financial guarantees. Overall Germany and Canada seem to do best (though there are some gaps in the Canada assessment). Interestingly, the euro area as a whole is not so dreadful, but this is an average of a range from very bad to not bad. The UK has a mixed picture that makes it reluctant to boost spending and raise its risk level.

So, there are plenty of pressure points ready to explode as the crisis enters another phase. As the movie Airplane! might have noted, this is a bad year for capitalist policy makers to quit smoking.

Tony Norfield, 22 September 2011

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[1] See the chart of the debt levels in different countries in my article ‘Debt and Austerity’, 8 August 2011, on this blog.

[2] See my article ‘Operation Twist’, 21 September 2011.

[3] See ‘Siemens shelters up to €6bn at ECB’, Financial Times, 19 September 2011.

[4] See my article ‘Bank Profits & Leverage’, 25 August 2011, for more on detail this.