Mises Daily Articles
Financial Warfare and the Declining Dollar
With the creation of the BRICS bank and now the Asian Infrastructure Investment Bank (AIIB), the major economies of the world are hoping to lay the foundation for a multi-polar financial world beyond the unilateral control of the United States. Due to the enormous size of the US economy, coupled with the reserve status of the US dollar, the United States government has long been able to achieve strategic and military goals through flexing its financial power. This power has long allowed the US government to buy allies and friends among foreign regimes, to finance proxy wars, and to threaten the growth potential of foreign economies whenever the US government deemed it necessary.
Today, however, with an enormous debt and a rapidly inflating supply of dollars, the US has become vulnerable to financial warfare aimed at cutting off the US government’s ability to finance its debt and to keep price inflation under control. Not surprisingly, numerous foreign regimes, including the BRICS countries of Brazil, Russia, India, China, and South Africa, sense there is a chance to chip away at this global financial hegemony for the first time in decades.
Military and Financial Power
Since the Second World War, the United States has enjoyed an often untrammeled ability to project its power through both military and financial means.
The military aspect of this power was always apparent thanks to the tangible nature of intercontinental ballistic missiles, nuclear warheads, long-range bombers, and what are now called “boots on the ground.” Not even the Soviets, thanks to their underperforming socialist economy, could ever match the US in terms of first-strike capability or the means to station large numbers of troops far beyond the country’s borders. While the Soviets were forced to keep close to their own borders and look to expansionism in neighboring regions like Afghanistan and Eastern Europe, the US could intervene on the other side of the globe in places like Indochina and Korea.
Underlying much of this, of course, was the fact that the capitalist American economy allowed the US to pay for long supply lines, foreign bases, and far off wars. The Soviets may have had the Red Army, but the US had financial power.
This financial power could be used to subsidize military allies, as in the case of the Marshall Plan, and it could be used to entice Third-World regimes away from the Soviet Union and into the American orbit. But, it could also be used to threaten or ruin foreign regimes without firing a shot.
Financial Warfare and the Suez Crisis
During the first half of the twentieth century, one particularly large beneficiary of American financial power had been the British Empire. During both World Wars, the US had supported the British in financing its war spending and in helping the British inflate their money supply to cover costs. The US did this by purchasing pound sterling (or, more precisely, pound-sterling bonds) and holding them in reserves.
This proved to be a problem for the British during the Suez Crisis when British debt and a weak pound sterling sealed Britain’s fate as a second-rate power.
During the 1950s, the US had attempted to draw the Egyptians away from the Soviets by offering financial aid for constructing the huge Aswan Dam. The man behind the deal, John Foster Dulles announced the arrangement to the world in late 1955, but in 1956 — possibly for petty personal reasons — Dulles decided to withdraw the offer, humiliating the Egyptian leader, Gamal Nasser. In response, Nasser decided to restore his prestige by seizing and nationalizing the Suez Canal, which had been controlled by the British. The British, French, and Israelis then began military operations against Egypt in an effort to re-seize the canal.
For a variety of strategic reasons, and to be perceived as an opponent of European colonialism, US President Eisenhower opposed the use of military force against Egypt, and he turned to a non-military solution:
Diplomacy had not convinced the British or the French to withdraw [from Egypt]. The United States was hesitant to intervene with military force against NATO allies. As an alternative, Eisenhower employed financial warfare. With just three offensive strikes, the United States achieved its immediate policy aims of forcing Britain and then France to withdraw from the Suez Canal. The three financial warfare strikes were: (1) blocking the International Monetary Fund (IMF) from providing Britain with $561 million in standby credit; (2) blocking the US Export-Import Bank from extending $600 million in credit to Britain; and (3) threatening to dump America’s holdings of pound-sterling bonds unless Great Britain withdrew from the Suez. The credit blockade froze Britain’s ability to borrow and forced it back onto its negative cash flow, effectively bankrupting it. The pound-sterling threat significantly raised the perceived risk of dealing in British currency. That threat, if executed, would have directly affected British ability to trade internationally.
The World Hopes for a “Suez-Crisis” Moment for the US
Britain’s status as a world power ended with the Suez Crisis in 1956 because it became apparent to all that the British could not act on the global stage without the approval of the United States. The US had the power to cripple the British economy without firing a shot.
Opponents of American global hegemony today are well aware of the Suez episode, and they’re also aware that the United States, like the British Empire in 1956, is deeply in debt and relies at least in part on foreign regimes to hold American dollars and buy American debt. Without foreign demand for dollars and debt, the US government would have to pay more interest on its debt, and would likely find itself unable to pay its bills. Bankruptcy — or massive debt monetization through the Fed — would soon follow.
Is the US right now as vulnerable as the British were in 1956? That’s less clear. In 1956, the pound sterling already faced stiff competition from other currencies. The dollar had been enthroned as the world’s reserve currency by the Bretton Woods agreement in 1944. Thus, the British were limited in how much they could inflate their currency, and thus had to turn to organizations like the IMF.
The dollar does not yet face serious competition from foreign currencies — at least not in the same way. As Ron Holland suggested back in 2011, though, if the US’s oil allies turn away from the petro dollar, the situation could change very rapidly. On the other hand, the yen and the euro are both being furiously inflated by their own respective central banks.
But this is where the BRICS Bank and the AIIB come in. Given the entire history of nation states, it is extremely likely that the BRICS countries — and especially the Russians and Chinese — hope that these two new financial institutions can be used to help world powers other than the US wage financial wars of their own.
Just as the US used its control over the IMF to exert financial pressure on the British, a successful BRICS Bank or a successful AIIB can — by offering loans to indebted governments — be used in the future to apply similar pressure in other situations. Moreover, these institutions may turn to making loans in currencies other than dollars which will loosen the dollar’s status as the go-to reserve currency.
And, once these institutions have thus diminished the value of holding dollars, foreign holders of large dollar reserves and American debt (such as the Chinese) can more aggressively dump dollars and debt just as the Americans threatened to dump the pound-sterling bonds in 1956.
And of course, independent of this plan, the BRICS bank and the AIIB can be used to strategically attract developing nations out of the US orbit and into alliances with the Chinese, Russians, or whatever states can offer the most attractive terms for foreign aid (and sweetheart deals for the politicians).
It’s impossible to know the timetable on how these developments may play out. Recently, the Chinese humiliated the US government by attracting multiple European partners to the AIIB, which the US government had denounced. But even with broad support from European regimes, the AIIB still is capitalized only to the tune of fifty billion dollars. In other words, by itself the AIIB still offers only minor competition.
With multiple institutions of this kind in place, however, the rules of the game can change quickly, and major reversals of fortune have a way of appearing suddenly, as with the British in 1956 and the Soviets in 1989.
Much of the world is hoping for an opportunity to mimic Eisenhower’s Suez strategy, and unless something big changes in Washington, the world is likely to get its chance.