Financial statecraft and the declining dollar

The broader policy ramifications from a declining dollar have been ignored by the Treasury department and presidential candidates. While the declining dollar seems to be having a positive impact on manufacturing exports, the financial capital flow issues are more important. The financial power of capital flows is more important than trade because it is so much bigger.

The importance of a stable dollar goes beyond the cost of financing our debt. The power of the United States around the world will decline with the dollar. A lower dollar reduces the ability of the United States to use its financial influence or policies to affect world affairs – the use of dollar financial hegemony. Another way of putting this dollar influence is as a form of financial statecraft.

Foreign governments have less demand for dollars which are declining in value, so the financial clout of the United States is reduced. The dollar decline has strained relations for all those countries which have tied their currencies to the dollar. This is having significant implications in the Middle East where the declining dollar has cause more internal inflation and financial stress. Oil is sold in dollars but imports are often in euros. The creditability of the United States in a financial crisis will also be hurt. It is a hard to have other countries accept American advice if its high current account deficits are forcing the dollar lower. Regional and bilateral solutions will be more likely where the US does not play any role in negotiations.

What is financial statecraft? A good description can be found in the recent book by Bevan Steil and Robert E Litan of the Brookings Institute in Financial Statecraft: The Role of Financial Markets in American Foreign Policy. It is the application and extension of economic policy through capital markets. Steil and Litan provide a nice table contrasting economic and financial statecraft.

Economic statecraft	Financial statecraft
Trade privileges, tariffs and quotas	Capital flow guarantees and restrictions
Trade sanctions	Financial sanctions
Foreign Aid	Underwriting foreign debt in a crisis
Regional trade agreements	Currency Unions; dollarization

Financial statecraft for the United States is important at this time because its ability to influence the rest of world through diplomatic or military means has diminished since the Iraq War. Arab countries have been hurt internally by the declining dollar. Discussions between Asian countries have increased the likelihood of regional solutions without the United States. Latin America countries have a greater desire to take advantage of stronger growth without interferences by the IMF or the United States. America's ability to use the dollar as a source of aid is hampered by its lower value in the world market. Higher growth around the rest of the world reduces the ability of the US to use the dollar to influence economic policies.

There is not much investors can do about the implementing of financial statecraft, but being aware of the greater ramifications beyond changes in price will provide a better landscape of what could happen in financial markets. Generally, the role of the dollar will be diminished and the rationale for holding dollar assets will also decline. Portfolio adjustment will cause further dollar deterioration.