The fading of the stock market’s “Trump bump” has been accompanied by a steady drop in the value of the U.S. dollar.
And it is the greenback’s decline that has UC Santa Barbara professor Benjamin “Jerry” Cohen worried. He’s concerned about the future of the dollar as the world’s “ultimate safe haven.”
Cohen, a political scientist, is an expert on international monetary affairs and he holds the Louis G. Lancaster professorship at UCSB. Just two years ago, his book “Currency Power: Understanding Monetary Rivalry” (Princeton University Press, 2015) explored dollar alternatives and concluded that after nearly a century of hegemony, there was no competitor in sight for the world’s preeminent currency.
However, in a commentary written for the website Project Syndicate, where he is a regular contributor, Cohen has revisited his forecast. He warned that it “may no longer be the case” that the world automatically piles into U.S. Treasuries and other dollar-denominated assets when a financial crisis erupts. “President Donald Trump’s chaotic administration has severely undermined confidence in the greenback,” he wrote.
Over lunch in Santa Barbara on Aug. 15, Cohen expanded on the topic, stating that the loss of confidence may not be “irreversible” and that there is not a single alternative currency that can replace the dollar.
But he warned that the games of political and international brinksmanship that the president has been playing could have the long-term effect of putting the dollar’s exclusive role in jeopardy.
While there is no immediate replacement for the dollar available, he said markets could move toward a “multi-currency system” where international institutions diversify into the Japanese yen, the Chinese yuan, the Euro, the pound or the Swiss franc for international trading and reserve holdings.
The long-term effects of a diminished role for the dollar in global finance are not trivial. The dollar’s “quasi-monopoly” gives the U.S. the “exorbitant privilege” of running large fiscal deficits and deploying the tools of monetary policy without restraint. Loss of that privilege could force the U.S. into a combination of sharply curtailed government spending and sharply higher interest rates in order to keep the dollar from collapsing.
“We have grown complacent about exorbitant privilege,” he said. A slow erosion of confidence in the dollar “could turn into a flood,” he added.
Cohen is careful to hedge his bets about the future of the dollar. He told me that it will be a “long, long time before any currency other than the dollar can be truly global” in its scope and geographic domain. But not everybody benefits from the dollar’s dominance.
Emerging market economies suffer when a strong dollar weakens their citizens’ buying power and makes it expensive to pay off dollar-denominated debts. That’s what happened in the financial crisis of 2007 when global players rushed to U.S. Treasuries even though it was Wall Street’s excessive lending to the mortgage market that caused the housing bubble in the first place.
What has Cohen worried the most is a diplomatic crisis followed by a military action that upends the world’s financial markets. Conventional wisdom would suggest a flight to the dollar and Treasuries but Cohen suggests that’s no longer something policymakers can take for granted.
“Markets have been signaling their distrust of Trump for months now. At this point, fear of a new crisis could precipitate capital flight away from the dollar, at which point the U.S. would have to deal with a dollar crisis in addition to a potential military conflict,” he wrote in his commentary.
One of my worries is that the Trump administration’s inability to work with Congress could lead to a fall deadlock over the debt ceiling and a government shutdown, which then undermines the U.S. government’s credibility and sends the dollar into a free fall.
It’s hard to predict whether any single event will could trigger a dollar crisis, said Cohen. But, he warned: “We are approaching a tipping point.”
• Reach Editor Henry Dubroff at [email protected]