America first

Last month, The Economist published a couple of articles highlighting the extent of the extraterritorial reach of US policy and its implications. There has long been a supposition that the wave of bank fines issued by US regulators since the financial crisis has fallen disproportionately hard on foreign institutions, and The Economist cites evidence suggesting that over three-quarters of the $25bn it has levied in fines have been aimed at European banks. The evidence also seems to suggest that anti-corruption fines fall hardest on non-US companies, with eight of the top 10 fines levied under the Foreign Corrupt Practices Act falling on non-US companies.

The Deepwater Horizon disaster in 2010 added to suspicions that the playing field may not altogether be level. BP was fined more than $20bn for "gross negligence and willful misconduct”, in addition to $45bn of outlays in compensation and clean-up costs. Meanwhile, Houston-based Transocean, the company that owned and operated the oil rig which exploded, was hit with a fine of $1.4bn and Halliburton – the company responsible for doing the cement work which was the primary contributor to the well blow-out – escaped with a fine of $1.1bn.

As The Economist points out it is hard to prove that “America treads more lightly at home than abroad.” US firms generally have a pretty clean track record. But a very insightful piece into the murky takeover of French company Alstom by GE suggests that there are some dark forces at work. Alstom was already the subject of an investigation by the US Department of Justice into allegations of corruption when a senior Alstom official was arrested by the US on bribery charges. He entered into a plea bargain on the understanding that his jail term would be significantly reduced, but in the event served five years in detention. Shortly after the guilty plea, Alstom began to explore the possibility of a deal with GE. The Economist suggests that the DOJ’s investigations “distorted Alstom’s sale process, giving an edge to a potential American purchaser.” But “in order to be legitimate, a legal process must be transparent and independent – and be seen to be so. In this case, the legal process and the commercial one become uncomfortably intertwined.”

All of this goes to the heart of one of the biggest economic concerns underpinning the current shift towards economic nationalism – the idea that countries are increasingly prepared to use their leverage to secure their own interests rather than uphold the rule of law. The US is better placed than most to flex its muscle given the dollar’s position as the global reserve currency. Under the Obama Administration, which increasingly started imposing secondary sanctions, the US began a policy of issuing sanctions against any non-US individual or business which did not adhere sufficiently to US sanction regulations. Since dollar transactions ultimately almost always have to be conducted via US banks, the US authorities are in a position to obtain information on virtually all global dollar transactions and can use their leverage over access to the dollar payments system to extend their judicial reach.

I first became aware of this at a seminar three years ago which discussed business opportunities in Iran following the end of sanctions. Despite the optimism that Iran was once again being welcomed back into the international fold, many of the bankers present warned that they were very uncertain as to their position in the event they were required to provide dollar funding for Iranian projects. Although sanctions against Iran had formally ended, the US authorities even then were less willing to provide the green light. The election of Donald Trump suggested that all parties were wise to be circumspect given subsequent efforts to renew the sanctions.

Such apparently capricious policymaking raises a question of what this might do to the status of the US dollar as the world’s reserve currency? The choice of reserve currency is determined by three main considerations:

1. Size. Large economies generate a lot of foreign exchange transactions which puts a lot of currency into circulation; 
2. An advanced financial system which offers liquidity and a range of ancillary services;
3. Stability. The currency needs to act as a store of value. Political stability is another prerequisite.

The dollar continues to fulfil all these requirements. But increasingly, the likes of the euro zone and China have to weigh up whether the advantages of using the dollar are sufficient to outweigh the associated political costs. There is also a question mark on the US side. The Triffin paradox, which was first outlined in the 1960s, highlights that in order to meet global demand, the issuer of the reserve currency must be prepared to run a current account deficit. But as the current account deficit increases, so the external value of the reserve currency declines, thus reducing the willingness of creditors to hold it. In a world in which President Trump appears unwilling to sanction a rising external deficit, logically the flow of dollars into the rest of the world might be expected to slow.

Just because the dollar remains the dominant reserve currency today does not mean that it always will be. Prior to 1918, the US dollar accounted for a negligibly small share of global foreign debt with the UK accounting for 90% (chart). Within the space of five years, however, the dollar increased its share of global reserves to almost 40%. The US gained at the UK’s expense due to having a bigger economy, less indebtedness and a quantum leap in sophistication of financial markets following the foundation of the Fed in 1913. Between 1918 and 1945 there was not one single global reserve currency: The US and UK shared the burden.Who can say that we will not move towards a multipolar world in future?

I am not suggesting that we are yet at anything like the watershed moment of a century ago. But history suggests that changing trade patterns and a shift in the balance of economic power may be setting up the dollar for a reduction in status as other currencies take up some of the slack. Wielding the big stick, as President Trump is doing today, might hasten the search for alternatives.