National Security and the Dollar

The National Intelligence Director Michael McConnell provided his annual risk assessment recently to the Senate Intelligence Committee. In addition to the usual threats of terrorism, nuclear proliferation and the like, McConnell expressed concern about the US dollar. Such strategic concerns are misplaced and suggest that the Bush Administration continues to have difficulty in defining US national interests.

Far be it from a currency strategist to disagree with US intelligence agencies over the threats to the US, but of all the potential threats to US security, the dollar is simply not one of them. Contrary to all the hand wringing in the press about the dollar, the Federal Reserve Board’s broad trade-weighted index and the Atlanta Fed’s measure (includes 15 major countries) makes clear that the greenback’s depreciation in recent years is simply an unwinding of its gain in the second half of the 1990s.

McConnell voiced concern about the impact of a weaker dollar, noting that some global oil suppliers, like Syria, Iran and Libya, have asked to be paid in other currencies beside the US dollar and that some others, like Kuwait, no longer peg their currency to the dollar. Since McConnell’s testimony, Russia’s Putin indicated that he would like the ruble to be used more in energy trading. “Continued concerns about the dollar’s depreciation could tempt other producers to follow suit,” McConnell argued.

Syria, Iran, Libya and Russia’s decision have little to do with the US dollar weakness. And the cover the dollar’s weakness does provide for such action is an obviously facile excuse. Is there really much of a doubt at the higher echelons of the US government that those country’s actions are driven nearly exclusively by political considerations?

McConnell gives us a warmed over domino theory as if Syria, Iran and Libya have abandoned the dollar and others will follow suit. Hardly. Such an assessment seems to exaggerate the role of these countries. They are not leaders or path setters among oil producers. Indeed these still seem like pariah states. The other oil producers and most notably Saudi Arabia have indicated no desire to shift the benchmark for oil away from the dollar.

It is true that Kuwait which had pegged the dinar to the US dollar, switched last May to a basket regime. They ostensibly did this to allow their currency to appreciate faster to help combat inflation. The currency has appreciated by about 6% since then, though it has been flat over the last couple of months. Inflation still appears to be rising and the Kuwait central bank has cut rates in response to the Fed rate cuts this year as have other Gulf Cooperation Council members who still peg their currencies to the dollar.

Judging from US official comments, it had been at least previously recognized that more flexible currency regimes was in the US national interest. And various G7 statements suggest it is in the interest of the world economy that countries allow their currencies to help address the global imbalances. How can this really be a threat to US security that it can be cited in the same breathe as terrorism and nuclear proliferation? Please.

Perhaps the thinking behind the director’s claim was more fully articulated by Judy Shelton, an economist and author, in a recent op-ed piece in the Wall street Journal (Feb 15). She asserted that “The dollar’s primary role in the world financial system is the most vital non-military instrument of our national power.”

This seems to reflect a confused understanding of the nature of power in general and US power in particular. An international monetary regime of floating currencies is not a threat to US power and influence in the world. Insofar as a more flexible currency regime would help ease concerns about global imbalances without resorting to protectionism might very well be a world in which the US finds that it is even more competitive rather than less. In addition, Shelton’s assessment seems to denigrate other important aspects of US soft power.

In the more than 3 decades since the breakup of Bretton Woods, when nearly all countries had pegged their currencies to the dollar, the US did not see its influence in the world diminish. To the extent it has diminished in recent years, as some might argue, the disregard for the opinion of our allies and the resort to increasing unilateral action seems to provide a more compelling explanation than the decline in the US dollar or Syria, Iran and Libya’s desire to limit their dollar transactions.

McConnell also noted that US intelligence agencies have “concerns about the financial capabilities of Russia, China, OPEC countries {sic} and the potential use of their market access to exert financial leverage to political ends.” This concern is shared by many Americans. A Public Strategies Inc pool found that an overwhelming majority of Americans are wary of foreign governments, especially China and the Middle East buying stakes in US companies. By a 2 to 1 margin, Americans opined that sovereign wealth funds have a negative effect on the US economy and nearly 80% thought it was negative for national security. Particularly notable, Saudi Arabia, not Russia or China, had the highest negatives, with the greatest number of respondents opposing any purchase of a US company by that nation.

American policy makers are fond of making a distinction between economic or commercial goals on one hand and political objectives on the other. Yet, the distinction is not that robust. Recall that Adam Smith, David Riccardo, Alfred Marshall, all giants in economic theory, thought they were doing political economy. McConnell noted that Russia was positioning itself to control energy supply and transportation from Europe to Asia. He wants to say this is political and no doubt there is an element, but surely it is also commercial. He claims that China’s global engagement is driven by the need to access markets and resources. Fair enough, but that sounds commercial in nature and similar to why the US also began engaging the world at the end of the 19th century.

It is more helpful to think that other sovereigns have levers of power and influence. Some are economic. Some are political. Some are cultural. As other parts of the world grow and develop, they will have greater financial capabilities. This is wholly desirable. President Bush noted in the 2002 national security strategy that the main threat to the US and its allies was emanating from weak countries not strong ones as had previously been the case.

Realpolitik considerations dictate that the US be concerned about all the levers of power that both its friends and adversaries possess. However, it needs to embrace the interdependency of the world and recognize that it is not zero sum. The increasing wealth of China, Russia and developing countries in general does not make the US poorer. And if McConnell does not want to make an oxymoron out of National Intelligence, he should rethink the extent to which the dollar’s decline is threatening national security.