International Economist on Why the U.S. Dollar Has Been Dominant

[00:00:00] Speaker 1: Just for basics here, why does a president like low rates? [00:00:04] Speaker 2: Well, low rates are good for the government because the government's the biggest borrower, but they care about home mortgages, they care about car loans, student loans, commercial loans. Low interest rates are good for borrowers. That's good for the U.S. economy. That's good for whoever's in power politically. Having low interest rates is a luxury. It's great. The trouble is, if you put interest rates too low when there's inflation pressures, it makes the price pressures go up more and get out of control. And so that's the balance that the central bank's trying to have. The central bank can control inflation, but it can't necessarily choose where the market's going to think the interest rate needs to be consistent with that. So, I mean, the whole world looks at the Federal Reserve and they think, they're setting the interest rate. My car loan, everything, it's done by the Federal Reserve. That's a gross misconception. The Federal Reserve, on the whole, most central banks are trying to keep prices stable. I don't always do a great job, okay? It's very hard to do. But that's what they're trying to do. And that means they have to ask themselves the question, "Well, if we want to keep prices stable, is the interest rate too high or too low?" And so that's what they're feeling out. And the President typically is short-term. That short-term interest rate, what's happening right now, that's what they want to deliver. And often cutting the interest rate does deliver growth in the short run. The trouble is, as inflation ratchets up, the longer-term interest rate ratchets up, all the interest rates get sucked up and you're sort of, you know, like running on a wheel, you know, trying to stand still. [00:02:02] Speaker 1: Is it fair to say that the Fed has the single most powerful tool in the economy? [00:02:09] Speaker 2: Absolutely. Controlling the short-term interest rate is the most powerful tool not available to Congress. Congress has a lot of tools, but they don't have the surgical ability to change it in the way the Fed has. The Fed has one job, basically, which is to make sure prices stay stable. I want to back up and mention that we didn't always live in this world. We used to have the dollar pegged to gold, and a lot of people think that's wonderful. We should go back to it. It's not easy to do, is all I'll say, like countries tried it and didn't. But we had that at some level until 1971, when Nixon went off gold, and he just cut the dollar loose. And part of the reason we had the inflation in the 1970s, which a lot of people think was because oil prices went up. No, no, no. It's because we didn't know what to do. We didn't have any vision of how to control inflation. It's a modern construct. The whole idea of having an independent central bank is new. That people really didn't understand the importance of it, and it took, I'd say, 15 years before we really figured it out. And it's worked really well. But the problem is that people -- it's worked so well, people forget it's necessary. I back up with a joke that kind of captures this -- there's this man, you know, looking for a parking space because he wants to go to pray at his church. And he looks up and says, "God, you know, if you'll just give me a parking space, I promise I'll start coming regularly. You know, I'll be more devout. I'll be better." And suddenly, a parking space opens up, and he pulls right in. And then he looks up and says, "Just kidding, you know." And I think that's been like that with central bank independence and inflation, where it came down, and everybody, not just Trump, I would also say the progressives, people all over the world, have forgot how we got there. And if you take away central bank independence, you're not going to get inflation overnight, by the way. It takes time. But it certainly will contribute in a big way towards the next high inflation period we've got. [00:04:42] Speaker 1: What is the cautionary tale -- I mean, you mentioned the inflation of the '70s -- but of the central banks succumbing to political aims? So, for instance, the Burns and Nixon example, and what that resulted in? [00:05:00] Speaker 2: This happens in extremes all over the world. But in the U.S. in the early 1970s, we'd gone off the gold standard, and Nixon's saying, "Oh, we can cut the interest rates. There's nothing holding us down." And Arthur Burns, who was the chair of the Fed, he pushed back, but not hard enough. And Nixon cursed him. And you can actually listen to this on the Watergate tapes. You know, he told him what he wanted to do. And Nixon ran against McGovern. I campaigned for McGovern back then, but, you know, it was in vain. He won Massachusetts, I think. And Nixon did everything possible. So Social Security. He actually doubled the size of the Social Security boost. And he told Arthur Burns, he said, "I want low interest rates. Do whatever it takes." So Burns did. Burns relented. And the reason that it happened is when the Federal Reserve makes interest rates lower than they need to be or should be, actually nothing happens right away. It takes time. Even really high inflations just take time to build up. But the problem is, once they get going, they're really hard to stop. And the '70s, this happened all over the world. We didn't have the worst inflation. England and Japan had inflation over 20 percent. And, of course, there are other [00:06:35] Speaker 1: countries that were worse. Some people just refer to it as a kind of lost decade, right? There was low growth, high inflation. And, I mean, that's the dreaded combo. Yeah. And it wasn't all caused by [00:06:47] Speaker 2: inflation. We had the Vietnam War. We had all sorts of problems. But, yeah, inflation was [00:06:52] Speaker 1: very, very damaging. I'd like to get to Trump 2.0. Early on, the Fed decided to hold rates. They'd been cutting rates, and they paused. And as we understand it, they heard about the president's ambitious economic agenda and whether it was going to be tariffs or immigration or a tax cut. And they said, best for us to pause here, wait and see. What was your view about the economy and about the wisdom of [00:07:26] Speaker 2: sort of wait and see at that point? Well, the president was doing things which normally would push the market rates up. So, for example, the big, beautiful bill was this massive spending bill. We're getting, I don't know, six, seven percent of income deficit, like a massive deficit. The president was deregulating, which in some cases is good, but a lot of cases is problematic. But in all cases, stimulates the economy. And that was pushing prices up. He wanted the best economy ever, the greatest show on earth. Some of the actions were just not consistent with low inflation at the existing interest rates. I mean, I don't want to get into the particular dynamics of when they were high or low, but it didn't feel like a situation where the next move would be to cut interest rates. They had gotten quite high when Trump took office, so there was some room for them to come down. But I don't know if you recall, Trump wanted to bring them from over five percent to one percent tomorrow. And actually, that would have been OK tomorrow, maybe the next day, maybe the next month, but eventually would have been a disaster. It would have led to, I think, a lot of demand and a lot of inflation. And so the Federal Reserve was just trying to hide during this period. We have this, you know, very muscular presidency wanting to do so many things all at once. And I'm not saying the Federal Reserve, you know, was against having the US economy great. It isn't against having the greatest economy on earth. It's just that part of having the greatest economy on earth is having a currency you can rely [00:09:10] Speaker 1: on, the whole world can rely on. What was your view of the firing of Lisa Cook? I thought he was [00:09:18] Speaker 2: shooting over the bow of the whole Federal Reserve saying, I control the CIA. I control the NSA. I control the FBI. I can read all your emails. I can find something on you. So if you're not listening to me, you're going to regret it. And that's what that felt like it's about. I mean, it was really, you know, show me the man and I'll show you the crime. And a little bit ironic, Trump exercising that. But I felt it was telling central, other central bank governors, I can get you. And we may see that still. I don't rule that out of looking for pressure points, looking for things. I mean, you know, at the end of the day, I mean, you're describing a shakedown. Yeah. Yeah. Well, that's how I viewed it. In fact, I have been surprised the Fed has been as resilient as it has in the face of somebody who controls so much power. They don't. I mean, the Supreme Court's worried enough about staying independent of the president. They're in the Constitution. The Fed isn't. If President Trump had the support of Congress, he could make the Fed disappear in a week, bring it back into the treasury. That's how most governments used to work. In fact, if you go back into the, I think, into the 30s, the Fed had an office inside the treasury, had a room inside the treasury. Nobody thought of it as this giant important thing. The Bank of England only became independent from the UK treasury in the late 1990s. So, you know, there are a lot of people who want to do that. And I think it's a big mistake. Of course, if it's brought back into the treasury, Trump controls it. And I just have to add, the progressives have been kind of anxious to do that also. So let's just understand this is a real threat to Federal Reserve independence. But I think it's, I think it's a [00:11:24] Speaker 1: terrible mistake. You've been in your profession, in the highest realms of your profession for a long time, including as the chief economist for the IMF, for the International Monetary Fund. Is, was this move something you ever expected to see in the United States of America? No, I, I did. I mean, in fact, [00:11:45] Speaker 2: my book, Our Dollar, Your Problem was written before Trump got elected, just at the cusp of the presidency. And I saw how there's this widespread view that the central bank can be used for many things. It should be at the discretion of the people. There are many variations of this. And I saw it all over the world, not just in the United States. So I think like in many things, Trump is this radical change agent, but catching, you know, the drift or the current of something that's out there in the zeitgeist. And weakening central bank independence is a very popular idea around the world. It's not just, you know, crazy rulers. It's not just autocrats. It's also the left in many countries. Trump hates central bank independence. And they have some, they have some interesting arguments. I don't want to dismiss it. It's just out of hand. We could get into that. But I think it's a mistake. [00:12:47] Speaker 1: Did you watch the Powell statement when he announced and revealed that he was under a criminal investigation? [00:12:55] Speaker 2: I mean, I watched it later. It was very eloquent, what Powell did. I mean, I think Powell's been a great Federal Reserve chair and will be remembered as such. He's gone through a lot of difficult periods, partly in dealing with Trump, but also in the pandemic, the war in Ukraine, and many other things that he's had to face. I think he's done a, he's done a very good job. But having to be told that, you know, somehow you're being corrupt was an absurdity. I mean, again, not to say they got everything right and the specifications of how to remove asbestos and the buildings, but they're trying to follow a procedure. Anyway, I mean, I, you know, it's, I think he's done a great job and he's been forceful and eloquent when he had to be. [00:13:47] Speaker 1: So you'd written a piece in Project Syndicate. This is after Powell, after Lisa Cook. It's all kind of in motion and you've got Greenland, you've got tariffs. What, what were you warning about at that [00:13:59] Speaker 2: point in time? Well, we depend on others trusting us. Part of the reason our interest rates are as low as they are is that the dollar's held all over the world. It's held by our friends. It's frankly held by our enemies. They trust the dollar. They trust it for a lot of reasons. Foreigners trust the United States because they think our inflation will be mostly low and stable. They also think if the U.S. government or even a U.S. firm says they're going to pay us, either they'll be able to rely on the U.S. government or some kind of court system that would give them a fair hearing. Companies will default sometime, but they'll get a fair hearing. We can rely on this decentralized justice system to give us fairness. If I'm a French person and I buy an apartment in New York, maybe I'll have some special tax. Maybe I'll have some special problem, but probably someone from New Jersey who buys the apartment in New York will have to worry about that. In the Trump administration, they have openly flirted with selectively defaulting on foreigners. In other words, foreign central banks, foreign institutions, we will partially default on our debt. I mean, that's just mind numbing. But the first head of President Trump's Council of Economic Advisors got the job by arguing for that. So all of these things which undermine faith in our inflation and our rule of law have led to less confidence in the dollar. It's not something that's going to happen overnight, but I'm of the view that the world was already moving partially away from the dollar, not completely, but to be less dependent. And the Trump administration is going to be an accelerant. Some of the problems have to do with we use it for sanctions. We use it to punish countries. We use it to spy on them. Everyone, even the Europeans, hates that. But also there's some sense in which the rot is from within, like the old Roman Empire. Our debt is unsustainable. We have an uneasy relationship with central bank independence, not just Trump, also the left. And foreigners are worrying about it. And that's why I believe that, say, 10 years from now, the dollar will have declined much faster in its dominance than it did the past 10 years. I view the dollar as having peaked around 2015 and sort of been in steady decline. That's probably going to accelerate. [00:16:43] Speaker 1: So why should ordinary Americans, why should any of us care whether the dollar declines? [00:16:50] Speaker 2: So the dominance of the dollar that it's used in everything, it's the lingua franca of the global financial system, benefits us a lot of ways. So one easy thing to understand is it makes our interest rates lower. Why? Because you can place dollar debt all over the world. If you just had to put it in the United States, they're less bidders and you have to pay a higher interest rate. So we get what's sometimes called the exorbitant privilege of being the reserve currency thanks to this. It makes our interest rates for mortgages, car loans, everything about one percent lower than it would be otherwise. And that is quite a benefit. But there are other benefits. It gives us outsized control over the global financial system. The size of our economy, the importance of the dollar, frankly, our military power means that a lot of the plumbing of the international financial system runs through us. Why do you care? Well, if you were a European or Chinese, you care because Donald Trump can see a lot of what you do. They hate that. On the other hand, for us, we can spy on them. This is one of our sources of information. We can see that thanks to being at the center. But perhaps even easier to understand than that is it lets us put on financial sanctions. It lets us say, you can't use our system. And our system is so important to trade, not just between us and other countries, but say when Argentina is trading with Australia, often they're using our financial system. And if we weaken our dominance, as I think is going to happen, we'll move away from that. So sanctions won't be as effective. Our interest rates will be higher. And sanctions sounds very abstract. But I'll tell you, you know, I was a teenager during the Vietnam War era. I had older friends who had to go to Vietnam who were drafted. I worried about getting drafted. I hope that doesn't happen again. One of the reasons we had military interventions is we didn't have this option of sanctions. So we have used sanctions very promiscuously. I think we have them on over 20 countries, on countless individuals. And it's been an alternative to military intervention. And it doesn't always work, but it helps. It's what we did to the Europeans even over Greenland. And if we made the dollar weaker, it would be much less effective. Think if the only credit card you could use was MasterCard. There was no other credit card. MasterCard says, we don't like you. You're in big trouble. But if you can use Visa, American Express, Diners Club, you don't care. The dollar financial system is like that situation where there's one credit card you can use. There aren't other options. And we are pushing everyone to develop. We are incentivizing others to develop options. And I think when Trump, you know, does these things about Greenland, the tariff wars, other things, nobody trusts us. Everybody's moving faster to try to diversify away from the dollar. [00:20:21] Speaker 1: You see the attacks on Federal Reserve independence as part of this. [00:20:25] Speaker 2: No, absolutely. So one of the reasons people feel comfortable with the dollar system is that they think inflation will be low. And attacks on the Federal Reserve undermine that. I mean, there are other things that the Federal Reserve can do which could be painful. For example, the Federal Reserve makes short-term loans, sometimes hundreds of billions of dollars in loans, to other central banks when we have a COVID crisis, a global financial crisis, to smooth things over. If the President has full control, he can go say to Mexico, yeah, well, last time we helped you out when there was a crisis. That helped you a lot. We gave you a loan. We gave you dollars when you needed it. If you don't let us come in and put our army, you know, in your northern border, our southern border, that's not going to happen next time. Well, you could have a crisis in Mexico right away. This may seem abstract, but there's fear that this over-dependence on the dollar is making them vulnerable. There's this fear of other governments in other countries that they have become too dependent on the dollar and our banking system and our financial system and left themselves vulnerable to the whims of the United States when we want to weaponize it against them.