As the Dubai Ports World plan continues to simmer,
most congressional leaders twittering about security have ignored the potential
monetary consequences of nixing the deal. By telling DP World, a United Arab
Emirates corporation with willing investment dollars, to "go stuff it,"
we can stop worrying about the so-called threat to dollar hegemony posed by
the creators of the Iranian
oil bourse. An improbable senatorial
alliance of Chuck Schumer, Norm Coleman, and Bill Frist is beating the Iranians
to the punch.
How Twin Deficits Have Reinforced Dollar Hegemony
American consumers have run a trade deficit (importing
more than they export) for 30 years. The trade deficit propels a constant dollar
flow into the developing world's central banks. These dollars then recycle into
purchases of U.S. securities such as promissory notes (bonds) created by the
Treasury to finance the budget deficit.
Lagging financial markets in the developing world exacerbate this cycle. Capitalizing
on cheap labor pools, most emerging countries are focused on expanding their
manufacturing and export sectors. The emphasis on exports retards the creation
of U.S.-style banking, capital formation, and risk-management institutions.
This asymmetrical economic situation inhibits the access to credit and capital
in the home economy.
The Modern American Financial Market
The collapse of the Bretton Woods agreement in
1971 ushered in a capital markets revolution, marked by the birth of financial
This innovation sparked an explosion of new products. Parcels of debt (mortgages,
credit cards, small business loans) were bundled into tradable instruments.
Investments such as stocks, bonds, and real estate were packaged into securities
or trusts, then peddled to an international customer base.
As a result, a smorgasbord of credit and investment options known by such acronyms
as ARMs, S&Ps,
ETFs, and REITs
now beckons the American public. The system's wealth effect has been staggering.
Economists estimate that the cash extracted through home equity loans (HELOCs)
consumer pockets with $600 billion last year. By spending this money on
imports, the American consumer sends dollars to foreigners, who in turn spin
the dollars around to fund even more borrowing.
Given the foregoing, can the dollar's reserve currency status be vulnerable?
One possibility often mentioned is a slide in
dollar housing market, which would stanch equity extraction from homes.
The chilling effect on the economy is hard to quantify. As sophisticated as
the new marketplace is, it does not provide homeowners "price depreciation
insurance" or "put
options" on their homes. In other words, homeowners shoulder the entire
downside risk of any decline in the value of their homes (in sharp contrast
to financial intermediaries that can resell the mortgage loans).
A dip in home prices could therefore close the door on borrowing against home
values and greatly curtail consumer spending. This would reduce foreign bank
dollar deposits available to finance both public and private U.S. debt. Most
economists posit that interest rates would have to rise sharply to continue
attracting investment funds. Nonetheless, it is unclear whether such a scenario
would end dollar hegemony.
Another possibility bandied about is the switch of petrodollars to petroeuros.
This specter has been recently raised by the upcoming launch of the Iranian
oil bourse. However, futures markets depend upon transparent legal systems (especially
enforceable property rights), institutional trust, minimal state intervention,
and a level playing field between long and short players – and the IOB fails
on all counts. Furthermore, exchanges do not dictate trading terms; a euro-based
oil futures contract will only succeed when the underlying trade switches its
A third and radical possibility is the emergence of a unified Islamic financial
movement that could possibly center on the gold
dinar. When Jude Wanniski wrote about this potential in November 2004, he
cited the dinar's flawed promotion and the IMF ban on gold-backed currencies
in debtor countries as two impediments to success.
But several things have changed in the last year and a half.
First, the IMF is losing its relevancy
as a U.S. policy tool. As the world gets richer, it is starting to reject
dollar-based loans. Argentina, Brazil, and Russia have decided to pay off their
IMF loans, and Turkey – which suffered economic collapse in 2001 – has asserted
it will no longer need IMF assistance by 2008. Also, the dramatic oil price
increase has made most Islamic countries much wealthier in a short time span.
What's more, the global easing of interest rates has made access to capital
in domestic currency far easier and, at the same time, fiat currencies are quickly
depreciating against gold.
Most importantly, the U.S. is becoming increasingly protectionist. By saying
"no" to foreign investment, especially on an idiosyncratic basis,
it is throwing down the gauntlet to foreigners, daring them to jettison their
dollar-based investments. Therefore, several conditions – both financial and
political – are in place to cause a shift in global finance.
Significantly, the fastest growing global money field is Islamic financing.
Islamic bonds, or sukuks
– unlike most U.S. bonds, which pay interest – are securities that pay out revenue
streams from rents and leases in accordance with Shariah law. In its infancy,
the field claims about a half trillion dollars. If the Islamic nations were
to adopt a gold
standard as their underlying currency basis, it could have multinational
Moreover, since Islamic financing includes the mainstream retail products of
mortgages, small business loans, and consumer credit, its potential consumer
market is staggering. (A mortgage, for example, is structured as a "rent
to buy" arrangement.) Because its guidelines are religious tenets, its
scope would be transnational.
Imagine the power of an Islamic financial supermarket, rivaling the sophistication
of the U.S. market (itself only 30 years old), to channel dollar holdings into
dinars for a billion-plus people! The embrace of a pan-Islamic, gold-backed
system would create an unquantifiable financial upheaval.
Ironically, this could be the financial free market flip-side to the totalitarian
Spain to Indonesia
"caliphate" so vilified by the administration.
As U.S. lawmakers blithely vote to raise the debt ceiling to $9
trillion while angling for political points over the DP World scuffle, Dubai,
coincidently, is sponsoring a four-day International
Islamic Finance Forum for the week of March 19. It promises to feature the
basics of converting conventional debt into Islamic financing, the techniques
of Islamic securitization, and the training of Shariah scholars. Chuck,
Norm, and Bill
would do well to attend.