The [Federal Reserve] Dollar System & US Economic
Reality Post-Iraq War
F. William Engdahl, Remarks in Feldkirch, Austria,
It's accepted wisdom that the United States, despite
recent problems, is still the strongest growth
locomotive for the world economy, the pillar of the
global system. What if we were to discover that,
instead of being the pillar, that the United States
was, in fact, the heart of a dysfunctional economic
system, which is spreading instability, unemployment,
and depression globally?
No other nation on earth comes near to the commanding
US military superiority in smart bombs, military IT,
or in sheer force capabilities. The US position in the
world since 1945, and especially since 1971, has
rested on two pillars, however: The superiority of the
US military over all, and, the role of the dollar as
world reserve currency. That dollar is the Achilles
heel of American hegemony today.
In my view, the world has entered a new, highly
dangerous phase since the collapse of the US stock
market bubble in 2001. I am speaking about the
unsustainable basis of the very Dollar System itself.
What is that Dollar System?
How the Dollar System works
After 1945, the US emerged from war with the world's
gold reserves, the largest industrial base, and a
surplus of dollars backed by gold. In the 1950's into
the 1960's Cold War, the US could afford to be
generous to key allies such as Germany and Japan, to
allow the economies of Asia and Western Europe to
flourish as a counter to communism. By opening the US
to imports from Japan and West Germany, a stability
was reached. More importantly, from pure US
self-interest, a tight trade area was built which
worked also to the advantage of the US.
That held until the late 1960's, when the costly
Vietnam war led to a drain of US gold reserves. By
1968 the drain had reached crisis levels, as foreign
central banks holding dollars feared the US deficits
would make their dollars worthless, and preferred real
In August 1971, Nixon finally broke the Bretton Woods
agreement, and refused to redeem dollars for gold. He
had not enough gold to give. That turn opened a most
remarkable phase of world economic history. After 1971
the dollar was fixed not to an ounce of gold,
something measurable. It was fixed only to the
printing press of the Treasury and Federal Reserve.
The dollar became a political currency-do you have
"confidence" in the US as the defender of the Free
World? At first Washington did not appreciate what a
weapon it had created after it broke from gold. It
acted out of necessity, as its gold reserves had got
dangerously low. It used its role as the pillar of
NATO and free world security to demand allies continue
to accept its dollars as before.
Currencies floated up and down against the dollar.
Financial markets were slowly deregulated. Controls
were lifted. Offshore banking was allowed, with
unregulated hedge funds and financial derivatives. All
these changes originated from Washington, in
coordination with New York banks.
The dollar debt paradox
What soon became clear to US Treasury and Federal
Reserve circles after 1971, was that they could exert
more global influence via debt, US Treasury debt, than
they ever did by running trade surpluses. One man's
debt is the other's credit. Because all key
commodities, above all, oil, were traded globally in
dollars, demand for dollars would continue, even if
the US created more dollars than its own economy
Soon, its trade partners held so many dollars that
they feared to create a dollar crisis. Instead, they
systematically inflated, and actually weakened their
own economies to support the Dollar System, fearing a
global collapse. The first shock came with the 1973
increase in oil by 400%. Germany, Japan and the world
was devastated, unemployment soared. The dollar
This Dollar System is the real source of a global
inflation which we have witnessed in Europe and
worldwide since 1971. In the years between 1945 and
1965, total supply of dollars grew a total of only
some 55%. Those were the golden years of low inflation
and stable growth. After Nixon's break with gold,
dollars expanded by more than 2,000% between 1970 and
The dollar is still the only global reserve currency.
This means other central banks must hold dollars as
reserve to guarantee against currency crises, to back
their export trade, to finance oil imports and such.
Today, some 67% of all central bank reserves are
dollars. Gold is but a tiny share now, and Euros only
about 15%. Until creation of the Euro, there was not
even a theoretical rival to the dollar reserve
What is little understood, is how the role of US trade
deficits and the Dollar System are connected. The
United States has followed a deliberate policy of
trade deficits and budget deficits for most of the
past two decades, so-called benign neglect, in effect,
to lock the rest of the world into dependence on a US
money system. So long as the world accepts US dollars
as money value, the US enjoys unique advantage as the
sole printer of those dollars. The trick is to get the
world to accept. The history of the past 30 years is
about how this was done, using WTO, IMF, World Bank
and George Soros to name a few.
What has evolved is a mechanism more effective than
any the British Empire had with India and its colonies
under the Gold Standard. So long as the US is the sole
military superpower, the world will continue to accept
inflated US dollars as payment for its goods.
Developing countries like Argentina or Congo or Zambia
are forced to get dollars to get the IMF seal of
approval. Industrial trading nations are forced to
earn dollars to defend their own currencies. The total
effect of US financial and political and trade policy
has been to maintain the unique role of the dollar in
the world economy. It is no accident that the
greatest financial center in the world is New York.
It's the core of the global Dollar System.
It works so: A German company, say BMW, gets dollars
for its car sales in the USA. It turns the dollars
over to the Bundesbank or ECB in exchange for Marks or
Euros it can use.
The German central bank thus builds up its dollar
currency reserves. Since the oil shocks of the 1970's,
the need to have dollars to import oil became national
security policy for most countries, Germany included.
Boosting dollar exports was a national goal. But since
the Bundesbank no longer could get gold for their
dollars, the issue became what to do with the mountain
of dollars their trade earned. They decided to at
least earn an interest rate by buying safe, secure US
Treasury bonds. So long as the US had a large Budget
deficit, there were plenty of bonds to buy.
Today, most foreign central banks hold US Treasury
bonds or similar US government assets as their
"currency reserves." They in fact hold an estimated $1
trillion to $1.5 trillion of US Government debt. Here
is the devil of the system. In effect, the US economy
is addicted to foreign borrowing, like a drug addict.
It is able to enjoy a far higher living standard than
were it to have to use its own savings to finance its
consumption. America lives off the borrowed money of
the rest of the world in the Dollar System. In effect,
the German workers at BMW build the cars and give it
away to Americans for free, when the central bank uses
the dollars to buy US bonds.
Today, the US trade deficit runs at an unbelievable
$500 billion, and the dollar does not collapse. Why?
In May and June alone, the Bank of China and Bank of
Japan bought $100 billion of US Treasury and other
government debt! Even when the value of those bonds
was falling. They did it to save their exports by
manipulating the Yen to dollar to prevent a rising
Because the world payments system, and most
importantly, the world capital markets---stocks,
bonds, derivatives-are dollar markets, the dollar
overwhelms all others. The European Central Bank could
offer an alternative. So far it does not. It only
reacts to a dollar world. German banks destroy the
German economy as they rush to imitate US banks. The
Dollar System is destroying the German industrial base
. German national economic policy as well as
Bundesbank and now ECB policy is oriented on the far
smaller export sector, to maximize trade surplus
dollars, or to the big banks, to attract as many
dollars as possible.
China plays a key role today
The biggest dollar surplus country today is China.
Globalization is in fact just a code word for
dollarization. The Chinese Yuan is fixed to the
dollar. The US is being flooded with cheap Chinese
goods, often outsourced by US multinationals. China
today has the largest trade surplus with the US, more
than $100 billion a year. Japan is second with $70
billion. Canada with $48 bn, Mexico with $37 bn and
Germany with $36 bn make the top 5 trade deficit
countries, a total deficit of almost $300 billion of
the colossal $480 deficit in 2002. This gives a clue
to US foreign policy priorities.
What is perverse about this system is the fact that
Washington has succeeded in getting foreign surplus
countries to invest their own savings, to be a
creditor to the US, buying Treasury bonds. Asian
countries like Indonesia export capital to the US
instead of the reverse!
The US Treasury and Greenspan are certain that its
trade partners will be forced to always buy more US
debt to prevent the global monetary system from
collapsing, as nearly happened in 1998 with the Russia
default and the LTCM hedge fund crisis.
Washington Treasury officials have learned to be
masters at the psychology of "monetary chicken."
Treasury Secretary Snow used an implied threat of
letting the dollar collapse, after the Iraq war, to
warn Germany about the risk of trying to be too close
to France with the Euro. Some weeks after the dollar
had fallen sharply, and German export industry was
screaming pain, Snow reversed his stand and the dollar
stabilized. Now the dollar again rises as foreign
money flows back in.
But debt must be repaid you say? Does it ever? The
central banks just keep buying new debt, rolling the
old debts over. The debts of the USA are the assets of
the rest of the world, the basis of their credit
The second key to the Dollar System deals with poorer
debtor countries. Here the US influence is strategic
in the key multilateral institutions of finance-World
Bank and IMF, WTO. Entire countries like Argentina or
Brazil or Indonesia are forced to devalue currencies
relative to the dollar, privatize key state
industries, cut subsidies, all to repay dollar debt,
most often to private US banks. When they resist
selling off their best assets, they are charged with
being corrupt. The growth of offshore money centers in
the Caribbean, a key part of the drug money cycle, is
also a direct consequence of the decisions in
Washington in the 1970's and after, to deregulate
financial markets and banks. As long as the dollar is
the global currency, the US gains, or at least its big
This is a kind of Dollar Imperialism more slick than
anything the British Empire even dreamed of. It is a
part of the current America "Empire" debate no one
mentions. Instead of the US investing in colonies like
England to earn profits on the trade, the money comes
from the client states into the US economy. The
problem is that Washington has allowed this perverse
system to get out of all control to the point today it
threatens to bring the entire world to the point of
collapse. Had the US instead promoted long-term policy
of investing in the economic growth and
self-sufficiency of countries like Argentina or Congo,
rather than bleeding them in repayment of unpayable
dollar debts, the world would look far less unstable
The internal debt bomb in the USA
The question is if the Dollar System is reaching its
real limits? The Dollar System for the past 30 years
has been built on growing dollar debt. What if the
rest of the world decides it no longer wants to give
its savings to the US Treasury to finance its deficits
or its wars? What if China decides that it should
diversify its risk by buying Euro debt? Or Japan or
Russia? That day may come sooner than we think.
In addition to colossal debts to the rest of the
world, the US internal debt burdens have reached
alarming levels in the past three decades, especially
the past decade.
The total US debt-public and private-has more than
doubled since 1995. It is now officially over $34
trillion. It was just over $16 trillion in 1995, and
"only" $7 trillion in 1985. Most alarming it has grown
faster than income to service it, or GDP.
Since the Asia crisis in 1998, the US debt situation
has exploded. The heart of the debt explosion is in US
private consumer debt. And the heart of consumer debt
is the home mortgage debt growth, helped by two
semi-government agencies-Fannie Mae and Freddie Mac.
Since 2001 and the collapse of the stock market
wealth, the Federal Reserve has cut interest rates 13
times to a 45 year low.
US Households took on new home mortgage debt in the
first six months this year at an annual rate of $700
billion, double the debt growth in 2000. Total
mortgage debt in the US totals just under $5 trillion,
double the debt in 1996. It has grown far faster than
personal income per capita. That is larger than the
GDP of most nations.
The aim has been to inflate a housing speculation
market in order to keep the economy rolling. The cost
has been staggering new debt levels. Because it was
created with record low interest rates, when rates
again rise, millions of Americans will suddenly find
the burden impossible, especially as unemployment
rises. Fannie Mae and Freddie Mac combined guarantee
$3 trillion in US home mortgages. The US banking
system holds much of their bonds. When the housing
bubble collapses, a new banking crisis is
pre-programmed as well, with JP Morgan/Chase, Wells
Fargo and BankAmerica the worst.
The US economy has only managed to avoid a severe
recession since the collapse of the stock market three
years ago, by a record amount of consumer borrowing.
"Shop until you drop" is a popular American
expression. The Federal Reserve has pushed interest
rates down to 1%, the lowest in 45 years. The aim is
to keep the cost of the debt low such that families
continue to borrow, in order to spend! Some 76% of the
US economy GDP today is consumer spending. And most of
that is tied to a record boom in home buying.
But the rate of new debt growth among families is
rapidly reaching alarm levels, while the overall
manufacturing economy continues to stagnate or
decline. Today US factories only operate at 74% of
capacity, near historic lows. With so much unused
capacity, there is little chance companies will soon
invest in new factories or jobs. They are going to
So Greenspan continues to rely on foreign money to
prop up his consumer debt bubble, at low interest
rates. Were foreign money to stop propping the US
economy, now at some $2.5 billion daily, the Federal
Reserve would be forced to raise its interest rates to
make dollar investments more attractive. Higher rates
would trigger a crisis in consumer debt, mortgage
defaults, credit card and car loan failures. Higher
rates would plunge the US economy into a depression.
This may be about to happen, despite poor George
Bush's desires to get reelected.
There is a limit how much debt US families can pay to
keep the economy afloat.
There is no US recovery, merely a debt spending boom
based on this home buying explosion.
Total US household debt reached a high in June of $8.7
trillion, double that of 1994. Families are agreeing
to longer debt payments for basics like homes or cars.
The length of new car loans now averages 60.7 months,
and the amount of car debt financed increased to
$27,920, and the average new home costs $243,000.
With rapidly rising unemployment and a real economy
that is not growing, at some point there will come a
violent reality clash, as the market for home lending
reaches its limit. At that point the danger is the
consumer will stop buying, and the manufacturing
economy will not be able to create new jobs and a real
recovery. The jobs have gone to China!
We might already be at or very close to that point. In
the past six weeks, US interest rates have risen
sharply, as owners of US bonds have started to sell
in panic levels, fearing the bonanza in real estate
may be over, and trying to get out with some profit
before bond prices collapse. The European Central Bank
is advising member banks to not buy any more US
Freddie Mac or government agency debts.
The problem is this process of creating debt, domestic
and foreign, to keep the US economy going, has
gathered so much momentum it risks destroying what
remains of the US manufacturing and technology base.
Henry Kissinger warned in a conference of Computer
Associates in June, that the US risked destroying its
own middle class, and its key strategic industries via
outsourcing to China, India and other cheap areas.
Today only 11% of the total workforce is in
manufacturing. In 1970, it was 30%. Post-industrial
America is a bubble economy about to pop.
Fed chief Greenspan even warned China about the rate
of its trade increase with the US, pressuring China to
upvalue the Renminbi to make its goods less
competitive in dollar markets, and slow the job loss.
But this is dangerous. China holds $340 billion in US
Treasury bonds and other reserve assets. The US needs
the Chinese dollar savings to finance its soaring
It is caught in its own web: American jobs, hi-tech
jobs as well as factory jobs, are vanishing
permanently as US factories source to China, India or
other cheap areas. If Washington pressures China and
others to cut back exports they risk to kill the goose
that lays golden dollar eggs. Who will buy that
growing Government dollar debt? Private bond traders
are desperately trying to sell their US bonds. Germany
can only buy so much dollar debt, also Japan.
The US waged war in Iraq not out of fundamental
strength but fundamental weakness. It is economic
weakness however, not military.
Oil and food, and money as strategic weapon
The fundamental reason for the Iraq war, beyond
agendas of Richard Perle or other hawks, is hence,
strategic in my view. US economic hegemony in this
distorted Dollar System increasingly depends on a
rising rate of support from the rest of the world to
sustain US debt levels. Like the old Sorcerers'
Apprentice. But the point is past where this can be
gotten easily. That is the real significance of the US
shift to unilateralism and military threats as foreign
policy. Europe can no longer be given a piece of the
Third World debt pie as in the 1980's. Japan has to
cough up even more, as does China now.
Even ordinary Americans have to give up their pension
promises. If the Dollar System is to remain hegemonic,
it must find major new sources of support. That spells
likely destabilization and wars for the rest of the
Could it be that in this context, some long-term
thinkers in Washington and elsewhere have devised a
strategy of establishing US military control of all
strategic sources of oil for the one potential power
rival, Eurasia, from Brussels to Berlin to Moscow and
Beijing? The dollar vulnerability and debt problems
are well known in leading policy circles.
As Henry Kissinger once noted, "Who controls the food
supply controls the people; who controls the energy
can control whole continents; who controls money can
control the world."
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