US risks losing real dominance in retreat to isolation

In the wake of allied victory in the Second World War, America dominated the global economy. The Soviet Union may have been a military and geopolitical rival in 1945, but there was only one economic superpower. With much of Europe and Asia in physical and financial ruins, the US was industrial engine and credit provider to a devastated world.

In contrast to their predecessors after the First World War, US policy-makers firmly grasped this historic power and responsibility. Rejecting the myopic mistakes of Versailles, they crucially resisted and reversed the instinctive dash to the comfort of isolation. The determination to embrace and shape the postwar world became a shared goal across the domestic political divide.

Championing the United Nations, the Marshall Plan and then Nato, Democrat President Harry S Truman burnished the open vision of his iconic predecessor, Franklin D Roosevelt. On the other side of the aisle, military veteran Dwight Eisenhower abandoned retirement to serve as the first secretary-general of Nato, defeated isolationist rival Robert Taft for the Republican nomination, then won the White House in 1952.

Through all the challenges and changes of the next 64 years, the commitment of an outward-looking United States to the broader world proved a reliable and reassuring constant.

Unsurprisingly keen to exploit their power in shaping the postwar global monetary system — most crucially by insisting that the dollar emerge from Bretton Woods in 1944 as the global reserve currency — US policymakers also displayed a deft understanding of the shared benefits of better times for both friend and former foe alike.

The post-war decades up to the early 1970s were a golden era of unprecedented progress

The critical outcome of Bretton Woods was that the world needed dollars. Until the world could sell its goods and services to US buyers to receive dollars, or regain its credit-worthiness with US banks to borrow them, US policy was content to all but give them away in its own self-interest. Marshall aid, support for the nascent European coal and steel community, and the trade access afforded to Japan and others, were policies designed to supply much-needed dollars to a desperate world.

Against this backdrop, global trade expanded, helping to fuel a sustained recovery. The postwar decades up to the early 1970s were a golden era of unprecedented progress.

The hegemony of the dollar and its unrivalled role as the global reserve currency has survived all challenges. Remarkably, even the break with gold, and the effective collapse of Bretton Woods in 1971, served only to strengthen rather than weaken its position.

Although the US economy is now roughly the same size as the EU — accounting for just over one fifth of global GDP — the dollar still accounts for almost three-quarters of global foreign exchange reserves, and almost nine-tenths of foreign exchange transactions.

This dominance confers advantages. This aptly named exorbitant privilege enables the US to exchange costless paper for goods, services and assets, enabling US citizens to consume more than they produce.

This excess consumption — the balance of payments current account deficit — has averaged around 3% of GDP, and has been a feature of the US economy for decades. This privilege has delivered extraordinary benefits to the land of the free.

In his book Exorbitant Privilege: The Rise and Fall of the Dollar and the Future of the International Monetary System, economic historian Barry Eichengreen says the likelihood of continuing dollar dominance is still high with one, possibly prescient, caveat: “Economic and financial mismanagement by the United States is the one thing that could precipitate flight from the dollar. And serious mismanagement is not something that can be ruled out. We may yet suffer a dollar crash, but only if we bring it upon ourselves.”

In stark contrast to his predecessors, the current occupant of the White House has a different view of the power and responsibility of the US. The evidence is that the benign rationality of US engagement with the rest of the world is inverting.

The possibility that this may undermine the long-held position of the dollar at the heart of the global monetary system is real and growing. Its recent weakness — against the euro in particular — may prove an early harbinger of a longer-term malaise. Policymakers across the globe face losing a reassuring constant, while the US faces the loss of a valuable real privilege chasing a delusional fantasy to put America First.

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