Whenever there is a crisis, theories emerge about why the U,S. dollar will soon lose its hegemony. In his recent article for Gzero (“The dollar is dead, long live the dollar”), Ian Bremmer summarizes this phenomenon well. Despite having only 4 percent of the world’s population, the U.S. economy accounts for a quarter of global Gross Domestic Product (GDP), and 88 percent of all foreign exchange transactions in the world are conducted in dollars. Central banks denominate 60 percent of their reserves in dollars, 20 percent in euros, 5 percent in yen, and 3 percent in yuan. As Bremmer points out, a weighty reason why the dollar will not cease to be predominant is that there is no alternative. After World War II, the dollar replaced the dominant British pound from the 19th century when the U.S. economy became half of global GDP. Today, no currency has a similar profile to displace it.
The supremacy of the dollar rests on the depth of the U.S, capital markets (which Europe does not have, for example) and the openness of its economy (which China lacks), among other factors. As former U.S. Treasury Secretary Larry Summers said in 2019 (exaggerating, or not so much), the dollar will continue its dominance because Europe is a museum, Japan is a nursing home, China is a prison, and bitcoin is an experiment.
But after the Covid-19 pandemic, we have seen a worrisome expansion in the balance sheet of the Federal Reserve, the U.S. central bank. Today, the Fed’s balance sheet is 10 times larger than it was just before the 2008 Global Financial Crisis. It is surprising that 45 percent of it is parked in Treasury bonds with maturities of more than 10 years -US $4 trillion- and only US $ 41 billion of capital. If it were a commercial bank, the Fed would make Silicon Valley Bank’s duration risks look like child’s play. Other countries’ central banks must be in a similar situation.
The U.S. fiscal deficit will amount to US $1.4 trillion this year, and deficits of US $2 trillion are expected on average each year in the next decade (only 25 percent of U.S. government spending is non-discretionary). Therefore, let’s face the fact that a radically different global environment is coming. The cost of money will increase significantly. For countries, companies, and savers, it will be essential to make good use of their resources. They should take care of the profitability of investments and avoid depending on credit which will become substantially more expensive.
The US government will pay nearly US $400 billion in interest on its debt this year, nearly 7 percent of its total spending. To put it in perspective, these payments reached 15 of total spending in the 1990s. The worst case in the world is that of Pakistan which spends more than 60 percent of its fiscal budget on interest. Given that so many countries increased their indebtedness due to the pandemic, governments will displace companies and individuals from credit markets (what economists refer to as a “crowding out effect”) making it significantly more expensive. If we add to this the estimate that the four U.S. largest commercial banks -J.P. Morgan, Bank of America, Citi, and Wells Fargo- lost US $100 billion in deposits (which surely moved to Treasury bonds) due to the recent banking crisis, the availability of credit will be lower and its cost higher.
The U.S. economy will slow down (exactly what the Fed was aiming for with its rate hikes) and the possibility of a recession at the end of this year will increase. It is precisely this changing economic environment that the López Obrador administration in Mexico has opted to ignore by deciding to squander valuable fiscal resources. In addition to the MXN $332 billion cost in which López Obrador’s incurred by cancelling the construction of Mexico City’s New International Airport (NAIM), we must add a similar amount to pay for building the state-owned Dos Bocas oil refinery in the president’s home state of Tabasco. To this we should add the MXN $300 billion to pay for the construction of the Mayan Train, another ludicrous presidential pet-project that is devastating the Yucatán Peninsula’s rainforest and the MXN $120 billion to pay for the government’s decision to buy several gas-fueled power plants from the Spanish company Iberdrola (money which the firm will use to fund renewables projects in Brazil), plus whatever comes next. In total, we are talking about one trillion of Mexican pesos that could have been invested intelligently in smart public works that would have triggered complementary private investment in Mexico (as for example, investment in high-quality clean energy that the country urgently needs), increasing Mexican competitiveness and positioning Mexico as a natural destination for reshoring investment in North America.
Many generations of Mexicans will pay for the ignorance and arrogance of the current administration that, in the search for change, has only known how to walk backwards.
* Jorge Suárez-Vélez is an economic and political analyst. He is the author of The Coming Downturn of the World Economy (Random House 2011). A Spanish version of this Op-Ed appeared first in Reforma’s newspaper print edition. Twitter: @jorgesuarezv
