Virtually all of the recent financial-industry earnings calls included a question on Trump’s trade war followed by earnest assurances that it’s bad in general but no worry to the institution or its investors, at least not for any near-term quarter anyone now cares about. Really? Are financial markets so much more impregnable than those in manufactured goods and services? In fact, geopolitical risk has a habit of transmitting itself far more quickly through financial markets than any tariff can work its way through the value chain. Even more worrisome, a large nation with a big book of USG obligations has an awesome weapon with which to humble or even defeat an adversary. It’s a double-edged sword, but a determined, sophisticated adversary might well use at least some of it to drive home a point against the U.S. and, if it can, reassert a role for other currencies – its own very much included – as the global reserve go-to. Done with skill and speed, this would make the 2013 “taper tantrum” look like just a toddler’s sniffles.
Status as the global reserve currency goes hand-in-glove with the position a nation takes on the geopolitical stage, conferring with it the “exorbitant privilege” about which former French president Valéry Giscard d’Estaing complained decades ago. But, complain as others might, the U.S. position on the global stage was so dominant and so vital that no threat to the dollar’s reserve-currency status has ever been credible. Then, of course, came President Trump.
With so many “foes” now designated for so many reasons in so many disputes, the global status of the United States is under unique siege from within. This creates an unprecedented opportunity for countries with imperial destinies and dreams. China is of course first, foremost, and by far the most likely among them to exploit an unexpected opening to reinvigorate its long-standing campaign to undermine the dollar’s status. And, carefully done, an attack on the dollar could be a good deal cheaper than another island in the South China Sea and a good deal more useful in the immediate future.
In 2009, at the height of the great financial crisis, China took a determined run at the dollar. Exploiting a uniquely vulnerable moment, China proposed revising the IMF’s special drawing right (SDR) basket of currencies to include its own. SDRs are essentially figments of the IMF’s imagination, with no market impact. However, the move then was understood – and rightly so – as an effort by China’s government to assert itself on the global economic stage. This campaign has continued in many ways in many places, each time backed by continued, aggressive efforts by China to do what it can when it can to challenge the dollar and, thus, the United States.
As of this writing, China is the largest holder of U.S. Treasuries, with its book clocking in at about $1.2 trillion. At a time of growing inflation worries, rising supplies of Treasury obligations, uncertain Congressional action on key fiscal deadlines, and a bit of Fed tapering, how much would China have to dispose of to make a point? What if it just chose to buy Euros instead of dollars for even a little bit? More worrisome still, what about a geopolitical calculation that, even though the odds of dethroning the U.S. dollar are remote, bloodying the currency is so useful on the geopolitical stage that its central bank can afford to fire off more than just a warning shot?
In 1979, I was a very young officer at Bank of America with the dubious responsibility of corporate political scientist. Accompanying a group of corner-office executives to Washington, I hesitantly warned that events were not going particularly well in Iran and the nation might well default on its financial obligations. The men all gently but firmly put me in my junior place, with the CEO memorably telling me that he knew Iran’s finance minister well and whomever it was at the time would never do anything like that to him. Good friends and assurances over dinner are comforting, but geopolitics – not what the financial market thinks of as good sense – has a nasty habit of upsetting financial forecasts. It’s still early days in the global trade war, but far from all quiet on the eastern front.