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Once again, I am asking you to help me understand why foreign currency exchange matters

This post was inspired by a combination of my ignorance regarding the geopolitical implications of currency exchange, a desire to understand what BRICS is and how it works, and comments in this post making fun of Paul Krugman. (https://hexbear.net/post/1040996)

In the comments to the linked post, comrades @emizeko@hexbear.net and @quarrk@hexbear.net discuss an article with an embedded video where economist Michael Hudson rips into some of Krugman's work. (https://www.nakedcapitalism.com/2023/05/ny-times-is-wrong-on-dedollarization-economist-michael-hudson-debunks-paul-krugmans-dollar-defense.html)

It's funny, but what I'm really interested in is an idea that Hudson presented. If I understand him correctly he states the following:

If countries conduct trade using American dollars, they have to first acquire these dollars by providing the US treasury with their own currency. This also requires establishing an American bank account. The US then uses that foreign currency to finance military bases/activities in places that require that currency.

The implications, as I understand them, are that you now have an American bank account holding at least some of your assets, and it's vulnerable to being seized by the US government. It also means that a byproduct of using dollars is that the US acquires the means to pay leases, bribes, contractors, etc. to facilitate military dominance all over the globe. Thus, many nations desire to increase their security by moving away from the dollar.

Comrades, help me out. Is this correct? What other basic things are there to know? Is this really why dollar dominance is so important?

6 comments

CascadeOfLight

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The constant need for US dollars also maintains the dollar's value. The US doesn't just have access to other countries' money - it can infinitely print a commodity that everyone else needs to get their hands on.

It's like if you could pay for everything in your life just by writing IOUs to everyone, because everyone else trades between each other using those IOUs. The Treasury can print bills (or more realistically, conjure electronic money at the press of a button), distribute that money to US banks, those banks can distribute it to US business and those businesses can buy actual physical things from other countries in exchange for (intrinsically worthless) paper or electrons, because that paper is needed for arranging trades by that country with further countries. It means the US gets to continuously import huge amounts of resources from other countries, without having to export back goods of equal value. And so, using those resources, it can build the military apparatus that then surrounds the countries those resources came from. The downside of this for the US is that it means no industries for those imported goods can exist in the US, because they could never compete with the cheap prices from abroad, so the US workers become unemployed, plunge into poverty or have to take on debt to survive - the US solution to this is to simply ignore it.

This is a thorny problem for BRICS and particularly China - it wants to keep exporting goods so that its citizens can have jobs (they still haven't pressed the communism button yet, so large numbers of jobs still require a 'market justification' to exist), but continuously exporting goods means your currency keeps flowing back to you, as people use it to buy your goods, so it can't be used by third parties to arrange trades. China could become a net importer, the way the US is, in order to displace the dollar with the yuan, but then all its workers would become unemployed which the Chinese leadership actually doesn't want to happen (because unlike US leaders, they possess human souls). It's an extremely difficult knot to untangle.

::: spoiler Speculation ahead My personal belief, is that China is going to try to climb up the tech ladder and reach a kind of 'export equilibrium' by acting as the end stage of a world-wide value chain - it will export finished high tech goods, made from components imported from less industrially developed countries in the BRI. Now, this is more or less exactly what the US and Europe do, but unlike them China seems to be exporting technological and industrial advancement too. So in my estimation, while the US was content to remain at an essentially stagnant industrial level, exploiting deindustrialized vassal states for nothing more advanced than raw materials, China will try to continuously add higher and higher stages of technology to the end of the manufacturing 'chain' while passing the lower 'links' off to other BRI countries.

If this works, China will be able to simultaneously develop and industrialize other countries (freeing them from the West's grip as resource vassals) while maintaining its own lead in technology and advanced manufacturing - but this does also require Chinese scientists and engineers to be constantly pushing the boundary of industrial capability, lest the other countries 'catch up' to their level of manufacturing and 'put them out of their job', plus maintaining an exact balance of "high-tech end good" to "industrial component" trade with other countries to support both industrial jobs AND rising standards of living all the way along the 'chain' - a challenging proposition to say the least. In any case this is all purely my speculation, and I can't claim any special knowledge or insight on the situation beyond other posters, so it's quite probable nothing I've written here is correct anyway. :::

Rod_Blagojevic

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Okay, I'm gonna put this in my own words to see if I understand:

In dollar dominated trade, there is a constant need for US dollars. To acquire dollars, goods of value need to be exported to the US. The US only needs to print o otherwise create these dollars in order to receive these goods. They don't have to exchange goods or services of equal value.

This net inflow of goods to the US allows the US to fund its military at the expense of the countries like China that it trades with. An internal consequence of this arrangement is that dollars are invested in foreign industry instead of domestic industry, leading to an increasingly immiserated American working class. This isn't a problem in the US because the government has no obligation to maintain or improve workers' living standards.

China and many other countries prefer to remain as exporters because it allows them to employ their workers. Unlike the US, these governments have obligations to do this, but as a consequence they receive US currency for their exports while their own currency only circulates internally.

Okay. I think I got it, but I have some questions. How did dollar dominated trade arise and how is it maintained? Also, it seems to me that at a certain point receiving enough US dollars would give you a lot of power and the ability to effectively incentivize other US trading partners to work with you instead. How is this counteracted by the US? Maybe I'm just describing becoming a net importer (like the US) with all of the associated drawbacks?

Thanks for the answer to the original questions. This is very interesting. I've actually studied a lot of classical economics in a previous life, but I have never until this very moment been able to get in the right mindset to think about how currency works. I always hated it.

redtea

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I'll offer some thoughts but you might already know some of this if you studied classical economics; I'm unsure how much of this is 'currency' and how much is something else. Feel free to tell me I've missed the point!

I'm no expert but one other factor to consider is that every time the US prints dollars, it devalues the dollars that others already hold.

As for how it maintains power. It's a network that upholds the petrodollar. Enough countries agree only to trade oil in dollars and that's that. (Really, it could be all fossil fuels/energy, but let's keep it simple for my sake of nothing else.) No oil, no industry. No industry no trade – not even the lobsided trade where one country gives it's precious resources to the west for peanuts.

The other way for under developed countries to join in the world economy is to borrow dollars. They get squeezed by interest on those loans and by the deflation that hits the dollars they get in exchange for currency and other resources or commodities.

This is why Russia's success after being sanctioned is so monumental. Until then, it played ball and upheld the petrodollar for access to Western markets. Now? It has opened the way for the rest of the world to buy oil in other currencies. If the dollar loses its place as the reserve currency, it can't be used to bankroll so many military bases.

The US also protects the dollar with it's military. A relatively small portion of US domestic tax funds that military. Maybe 11%. The rest of the money comes from 'taxing' other states via the methods in question (currency manipulation, etc).

So the more that countries turn from the dollar, the less money the US has for it's military, and the less incentive to borrow or exchange in dollars, so the less the US has for it's military… Which means the way the US maintains it's power is starting to crack.

Rod_Blagojevic

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Fascinating. All my economics classes were a very long time ago, so I've forgotten the details of almost everything, and like I said, I never got much of a handle on how currency works. Thank you so much. I never really thought of how currency manipulation can work to create a material military advantage, which leads into a positive feedback cycle that makes it easier to further manipulate currency, and so on and so on... I wouldn't say I understand it, but I'm getting somewhere.

CascadeOfLight

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Yup, that's the situation as I understand it. As for how it originated, I'm summoning up Michael Hudson in (I think) Super-Imperialism - as far as I can remember, it essentially began with US war spending from Korea and Vietnam. Though firstly, after WW2 the US was by far the largest manufacturing economy in the world and also had enormous loans to half the world, so US treasury bonds were by far the safest place to store savings as there was absolutely no chance the US could default. The US was a net exporter through the 50s and early 60s, with the need to fill manufacturing jobs resulting in increased power for labor and the development of the middle class (helped along by leftover policies from the New Deal and the threat posed by rapidly improving Soviet living standards). The national debt was small because although US treasury bonds, denominated in dollars, were sought after for savings, lots of places also had to buy goods from the US using those dollar savings.

This changed as soon as the US started getting involved in land wars in Asia. Suddenly it needed to buy huge amounts of materials and goods to supply its armies, the formation of which also took a lot of working-age men out of its economy and didn't directly produce anything tradeable. The balance of dollar flow started to shift from inward to outward as other nations started selling goods to the US - however, having just got those dollars from the US, the safest place to store them was back in US treasury bonds! So the national debt started to climb, but with its huge tax base there was still no risk of the US defaulting so treasury bonds remained rock-steady. Even as the Vietnam war kept escalating, and the US had to buy in more and more goods and materials to keep up the war machine, printing more and more dollars to do so, those dollars just flowed straight back into US treasury bonds - other countries' dollar earnings were saved in the form of loans to the US! The US debt ballooned, but it didn't matter because of their (then-)unassailable economic lead ensuring that their bonds were still much safer than any other alternative. Once US economic advisors realised this, all barriers to the US printing more money started being lifted, culminating in Nixon making the dollar a fully fiat currency in 1971.

However, importing all these goods ended up allowing other countries' industries to develop, as well as putting pressure on US workers' wages through competition with foreign workers. Previously, US workers had high standards of living because although prices for goods in the US were high, their wages were also high. Economic rent-seeking was much lower, as it would have impeded industrial efficiency so it was stamped out by industrial capitalists, who had much more power at that time. But once imported goods started flooding the market that were lower priced (= made by workers with lower wages = lower living standards) US workers' wages also started to decline. There was one key industry where this didn't happen, both from necessity and conscious US policy (known as "Guns and Butter") - arms manufacturing. The US only fights wars using its own weapons, because it will never allow one of its vassals to develop an arms industry that could threaten its own. This also puts industrial laborers in the arms industry on the side of US warhawks - Michael Hudson mentions this, that some industrial unions were cheering on the Vietnam war and fighting against the anti-war movement because it was the source of their paychecks! So, the US imported raw materials from other countries, paid those countries in dollars, those dollars went straight back to the US as loans, and the US workers used the materials to build the arms to encircle those countries.

The other key component of this process that arose in the earlier stages of the US pumping out all those dollars, was the use of dollars as 'reserve currency'. Essentially, the main problem of international trade is ensuring trust throughout the process of actually sending goods from one owner to another. The person selling the goods needs to know you're actually able to buy them, but the buyer doesn't want to pay for the goods until they've arrived and can be inspected for quality. The buyer therefore needs a way of setting aside a given amount of monetary value, held safely between the moment the goods leave the seller and are accepted by the buyer. The problem is choosing a storage method - if the store of money loses value over time, then the buyer has just wasted money during the transit of the goods. Even worse, if the store is too volatile it could even become completely worthless in the mean time, ruining the trade for both parties. But lo and behold, at this time exists a way of storing value with an absolutely rock solid backing - US dollars. So, everyone trading anything, anywhere, chose to use US dollars as the 'reserve currency' for international trade. This had the effect of driving a constant demand for dollars, allowing an effectively unlimited amount to be printed - because any growth in international trade also resulted in a growth in the need for dollars.

Such a system had actually existed before, imposed by the British on the "Commonwealth" that forced its members to trade exclusively in Pounds Sterling, allowing the Pound to maintain value. However, as part of the aftermath of WW2 this region was swallowed by the Dollar (and Hudson marks this as one of the decisive moments of the end of the British Empire). So its implementation wasn't just an accident, but intentionally helped along by US policy, as seen in one aspect more than any other - the petrodollar. By order of the US, no country is allowed to buy oil in any currency other than US dollars, and until literally last year this was an almost-undefiable iron law. It's not a coincidence that immediately before the complete destruction of both Iraq and Libya, Saddam and Quaddafi had each made plans to sell oil in currencies other than dollars. The necessity for the existence of a saving account denominated in dollars for the trade of even a single drop of oil anywhere on the planet is (was) a cornerstone of the dollar's domination as reserve currency, and the US used the very military might that other countries' resources had built to keep those countries in line.

This domination of world trade by the need for dollars also gave the US another enormous power: its financial institutions could essentially dictate the economies of other countries. By holding the right to create loans in dollars, the IMF and World Bank can decide what businesses are allowed to be financed. Going to underdeveloped (overexploited!) countries that have been victims of colonialism, that have had their own industries destroyed and so need dollars to import vital goods, the IMF can exclusively fund industries that turn the most profit for the US. Probably the most important factor in this is agriculture - the IMF has never funded a project to allow countries to grow their own food, only to grow cash crops for sale to the US/the West. This means they have to rely on US food production (another key strength of the US' geography, and heavily subsidized besides) - ideally given in part for free as 'aid' in order to completely destroy the market for local food producers. This results in unequally trading cash crops for food, so the US gets to eat AND enjoy luxury goods, while the poor country survives but never consumes any of its own products. The other crucial benefit of this for the US is vulnerability to sanctions - if you only produce cash crops, the US can simply starve you at will. Which is why Hudson remarks that the IMF is just a room in the basement of the Pentagon. This, incidentally, was completely lost on the failsons currently commanding the Empire when they tried to sanction Russia, the largest exporter of grain in the world: you can't withhold your corn from an enemy that wasn't buying it in the first place.

So for all these reasons, the dollar has been the essential lifeblood of international commerce for over half a century, and its position is maintained through institutional inertia, soft power and extreme violence. Trading in dollars has just been the default option for so long, and so many countries' central banks' savings are dominated by dollars that rearranging matters would be extremely complicated even if the dollar wasn't also directly controlled by an incredibly powerful, violent state that wants to keep things just as they are. Even so, in the wake of the sanctions against Russia there are now huge volumes of trade being done outside of dollar control (and the SWIFT banking system - completely forgot to mention that). Even oil is now being sold in rubles and yuan. China is pioneering digital currencies (actual ones, not blockchain bullshit), which could avoid the need for holding currency reserves for international trade at all. But there's still a huge hill to climb, and the US still has plenty of counter-maneuvers available.

Thanks for the answer to the original questions. This is very interesting. I've actually studied a lot of classical economics in a previous life, but I have never until this very moment been able to get in the right mindset to think about how currency works. I always hated it.

You've very welcome. The most important thing for understanding currency for me was David Graeber's Debt, the First 5000 Years and the related chapters in Hudson's Killing the Host that discuss the origin of money in ancient Mesopotamia. It's absolutely fascinating and also clarified a lot about the actual nature of money, so I highly reccommend them both - though the Killing the Host chapter is a lot shorter and more direct.

This took a while to write, and I stayed up a little past my bedtime, so you may notice it start to get less coherent towards the end, in punctuation if nothing else. I hope it's helpful!

Rod_Blagojevic

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My dude, thank you. I actually didn't know what reserve currency was, so even just explaining that was huge. The time value of money and risk (as an economic idea) is something I do understand pretty well, so the need for a stable reserve currency makes a lot of sense. I'll have to do some reading. My list isn't that long, but I don't have enough time. I need to get through some more Marx first. Sleep well.