Tectonic Shift

Spearhead Analysis – 24.09.2013

By Enum Naseer
Research Analyst, Spearhead Research

American DollarThe economies of the world looked on with great anxiety as the global leader made a spectacle of its chronically divided political system.  With its unwillingness to reach a compromise on the issues of taxation, government spending and borrowing, it is best suited to lead an army of pygmies. Having said that, America is least pushed to mend its ways and with good reason to some degree.  The odds are in its favor as the global economy has remained shaky allowing the hegemon the leverage to be irresponsible and even reckless, so far.

Too big to fail, the US insists on testing the limits of its invincibility repeatedly- not too long ago, it was the epicenter of an international financial crisis that shook up the world economy in 2008. Global panic is not entirely unfounded: the Chinese media has substantial reason to call the shutdown a crisis of America’s own choosing and the country has much to lose in case of a default as its share of US foreign debt in dollar reserves amounts to nearly $1.3 trillion. The stand-off between the Republicans and the Democrats on the debt ceiling is not a rare novelty but the shutdown has tarnished the USA’s reputation. S&P had already downgraded America from AAA to AA+ back in 2011 stating political instability as the reason. Fitch, another key rating agency recently announced a downward revision of the outlook for the U.S.A.’s AAA credit rating from stable to negative.

A tectonic shift is in the making, even though the American narrative clearly rules out any possibility of a “de-Americanized world” asserting that it would take years for even the world’s no. 2 economy to fill up America’s shoes.  But again, the narrative is flawed because it is backward-looking and does not take into account the psychological divide between the US and the rest of the world. Sure, Europe is in a far more vulnerable state as the future of the euro stands on a flimsy collage of compromises and it would be hard to rise up to the occasion but there’s always China slowly working its way up- opening its economy, beefing up its presence overseas, rising from a nation of peasants to be classified as an emerging leader of the future.

China is hoping to replace the dollar with renminbi and given the magnitude of China’s consumption of fossil fuels and raw materials, it might be able to do so. According to Wood Mackenzie, China will account for 52% of base metals demand by 2017, compared with 46% of the 96m-tonne international market in the current year given that it is able to sustain the kind of growth that made it one of the most promising economies of the future post membership in the WTO in 2001. The confidence in the role of the U.S. dollar as the preeminent global reserve currency has been undermined and this has warranted a discussion regarding alternatives.

The likelihood of a new world order taking form is greater than ever. The signs are becoming clearer by the minute: China has continued to dump the dollar through bilateral trade agreements in addition to embarking on a gold-buying spree; even the IMF is seen to be continuously pressing for the end of the dollar’s world reserve status and the institution of special drawing rights (SDRs) as a replacement. How long will it take for the members of the OPEC to finally warm up to an alternative to the dollar? It is important to point out that these countries include the sanction-constrained Iran too. As for China’s strategy to replace the dollar, it could very well create a network of interlinked commodity markets based in the global financial hubs of Hong Kong and London.

Despite the fact that the US economy has stood the test of time and is still poised to grow at 2% in the fourth quarter, with the future of the dollar in jeopardy as it hit an 8-month low in recent days, there is reason to worry. Both political parties seem more interested in setting a power-play to serve their interests and with that goal topping the agenda, more disagreements and bickering in the coming months become inevitable. The only premise of such crass recklessness is the belief that there’s no alternative to persisting U.S. world economic and monetary leadership.

Delusional or not, that the demise of the dollar is a part of popular discourse, is suggestive of a possibility. The sense of superiority and self-confidence might meet a deadly end in wake of the psychological disconnect between the hegemon and the rest of the world.  In the longer run, as America carries on and trashes possibilities of being replaced- whether sooner or later, it falls prey to the allure of nostalgia. In the worst case scenario, it might wake up one day and find the reins of the global economy in the hands of the children of a lesser God.