Exaggerating the Dollar's Demise

The headline of the Financial Times today reads "Paris rails against the dollar's dominance."  It could have been written nearly any time in the past half century.  After all it was a former French President Giscard d'Estaing, who as finance minister in the 1960s, complained about the "exorbitant privilege" that the US drew from the role of the dollar (the phrase is often attributed to Charles De Gaulle). 

In the mid-1960s, Servan-Schreiber's book, "The American Challenge" warned that through the dominance of the dollar, the US was colonizing Europe.   In the early 70s, it was France's demand for gold in exchange for US Treasuries that strained Bretton Woods arrangement to a breaking point.  

The proximate cause of the latest reiteration of the traditional French position is the large fine imposed on one of France's largest banks for violating US sanctions.  As part of the penalty, the US took what appears to be an unprecedented step to deny the French bank the ability to clear dollar trades for a full year, starting in January.

BNP pleaded guilty to two criminal charges.  It was fined almost $9 bln (2013 profits ~$6.5 bln).  Nearly four dozen employees were disciplined.  About a dozen lost their jobs, including the COO of the US operation.  Top officials in the French government tried to lobby for a smaller penalty, including the President, Finance Minister and Foreign Minister.  They warned that it could tilt the balance away from the free-trade agreement that is being negotiated.  The central banker warned that it could accelerate efforts to diversify away from the dollar.  

In explaining its rationale for a stiff penalty, US officials cited several considerations.  First, the sheer volume of the transactions is notable.  They are estimated to be near $200 bln.  Second, was the egregious nature of the conduct and circuitous efforts to conceal the activity.  Third, the illegal activity apparently continued after the inquiry began.  Fourth, high ranking officials helped hinder the investigation.  Fifth, previous fines on international banks were not functioning as an effective deterrent. 

Russian President Putin, no fan of the dollar and US hegemony, claimed that the actions against BNP were an effort by the United States to get leverage over France to renege on its agreement to deliver two Mistrial amphibious ships to Russia.  Putin claimed that the US offered to reduce the fine on BNP if the French complied.    

There is simply no evidence for this claim, and it seems to be predicated on a naive view of the US government.  However, it has not stopped many in the blogosphere from simply repeating Putin's claim as if disinformation and attempts to sow discord is not a tool of the Russian President's arsenal. While the Department of Justice and the Federal Bureau of Investigation were involved, the NY Financial Services Department and the Manhattan District Attorney appear to be the driving force and it is not clear that they would have acquiesced to the kind of linkage Putin suggests.  

The point is that US government is not some kind of homogenous whole with uniform interests.  Consider that the nearly $9 bln fine was split between the Federal government and the state governments.  The NY Financial Services Dept received about 1/4 of the settlement and this will be turned over to the state's general fund.  The Manhattan District Attorney's office will receive another quarter of the settlement.  The bulk ($1.7 bln) will go to state and city governments, but about $450 mln, which is five times the office's budget, will be used for its anti-crime activities.   Surely, if the Federal Government tried to strong arm the local authorities, there would have been a push back and Putin would not be the only one to make the claim.  

BNP was the seventh large bank caught in 5-year investigation of the Manhattan District Attorney's office into violations of US sanctions. The investigation is ongoing, and it may include at least two other large French banks, as well as a large German and Italian bank.     For some banks and bankers, the statement by a Standard Chartered official chafing under its own fine, expresses a shared sentiment:  "You Americans," he was quoted in the press saying, "Who are you to tell us, the rest of the world, that we're not going to deal with the Iranians."

One might disagree with which countries the US sanctions, but surely it is the right of a sovereign to make such a decision.  Yet the claim that the sanctions allow the US to police business arrangement that do not involve Americans is not really true.  Given the way the financial system operates, if dollars are used for trade or investment, the transaction likely involves a US bank in the US. 

Moreover, the sanctions were not capricious, not publicized (unknown) or imposed after the fact.   The sanctions against Sudan, which is where BNP's violations were concentrated, have been in place since 1997 and  were tightened in 2006.  Press reports suggest that internal BNP documents showed that senior bank officials were well aware of the atrocities that led to the sanctions.   

Banks were also warned.  In 2006, the Bush Administration warned foreign banks doing business in the US that they would be prosecuted if they helped sanctioned countries.  According to the Wall Street Journal, BNP told employees in 2007 that it would cease sanction-busting actions.  Instead, it appears they developed an elaborate payment structure, routing transactions through satellite banks, which would strip crucial information off wire transfers as they passed through the US system and banks.  

Even though many senior BNP officials appeared to have known about the deceit, the CEO indicated that breaking the sanctions was "something that goes against the grain of the bank."  It has taken steps to strengthen internal controls and going forward, all dollar transactions will be properly routed through NY.  Reports suggest that other European banks are tightening their internal controls to ensure compliance with US rules.  

The US struggles to convert its financial power into political influence.   Consider who the US provides aid to, for example, and then look at how countries vote at the UN.   This effort becomes all the more important in an era in which the US is war weary.      The function the dollar serves in the world economy is a "public good", like protecting the sea lanes and its nuclear umbrella.  Surely, it can have some say in how that public good it provides is used.   

The US is saying that if one is going to use the public good it provides, do not do so to aid an adversary.  Do not use dollars to harm US interests, as its elected officials have defined it.  If a bank wants to function as the central bank of Sudan, as BNP was accused, it cannot use the dollar.  

Will this increase the pressure to diversify away from the dollar as Putin hopes and French officials claim?  Probably not.  The problem is the lack of a compelling alternative.  When the euro was first launched, many argued at the time, that this was the first alternative to the dollar and business and investors would jump at the opportunity.  They really haven't.  Many investors still harbor serious reservations about the longevity of the experiment in monetary union without political union.  For a brief moment  a few years ago, the possibility of a new monetary regime, based on the SDR, captured many imaginations for naught.     

The internationalization of the Chinese yuan is being heralded as the latest dollar-buster.  It is not.  The swap lines it has set up with several dozen countries have not been used.   Last month, MSCI declined to integrate Chinese shares into its global indices because of various market restrictions and lack of transparency. Investors need permission to invest in China (QFII or RQFII) and countries have to negotiate with China to set up off-shore yuan trading centers.  

Less than a year ago, some observers were arguing that the cyber-currency Bitcoin could supplant the dollar.  One large US bank even argued that central banks should put some of their reserves in it.    The desire to find an alternative to the dollar is real, but the role of the dollar in the global economy has not changed very much in recent years.    In many respects, whatever rise the Chinese yuan is experiencing appears to be coming at the expense of other currencies, not the dollar. 

The safety, liquidity and transparency of the US Treasury market know no rivals.  More than half of all cross-border loans and deposits are in US dollars.  According to the Bank for International Settlements, the dollar is on one side of 87% of all the trades in the more than $5 trillion a day foreign exchange market (up from 84.9% in the previous survey).  The dollar remains the benchmark price for oil and most commodities.  When investors want to hedge their exposures, they use a dollar-denominated derivative market instrument. 

The US often is accused being short-sighted and not playing the long-game.  Yet, at the risk of deterring buyers of its debt, the Treasury Department's semi-annual report on the international economy and foreign exchange market pulled no punches.  It wants officials to stop buying Treasuries, which it sees as a way countries evade making the necessary adjustments to reduce imbalances that the G7 and G20 have advocated.  In fining foreign banks for aiding its adversaries, the US says it will not provide the rope to the hangman.  If aiding Sudan, Iran or Cuba increases the use of the yuan, euro or Bitcoin, that is risk that the US is willing to take.