Analysis & Opinions - Belfer Center for Science and International Affairs, Harvard Kennedy School

Complacency, Not China, is America’s Enemy Number One

| June 30, 2020

China is not the main threat to United States global competitiveness – the enemy is lurking within. U.S. complacency regarding the dollar global reserve currency status could be the ultimate Achilles Heel for the United States in the years ahead. For far too long, the U.S. has rested on its financial system’s laurels and weaponized the dollar since 9/11 to fulfill its geo-economic goals. When wielded effectively, the utilization of U.S. sanctions to underpin the power of the dollar have weakened targets like Iran and North Korea without impacting the global economy. But, against authoritarian heavyweights like China, they have been less effective and may no longer be the best course of action. America’s policy options using the dollar are narrowing— the U.S. can no longer afford to sit back and blindly thrust the dollar upon its enemies and global competitors in a time when Central Banks representing 20% of the world’s population are likely to issue digital currencies not pegged to the dollar. The time is now for the US to innovate, adapt, and be creative as the global reserve leader. It can utilize its leadership position to trailblaze with financial and multilateral power instead of creating barriers or increasing opportunities for countries to create alternatives to the dollar.

With certain hardship ahead for the international financial system, it remains to be seen how the dollar can yield influence in a growing, deglobalized world where many countries have embarked upon strategies based on the aspiration of breaking from the dollar. The dollar has maintained much of its prominence over the past decade due to an active Federal Reserve leadership that emphasizes its stewardship over the global dollar system. Swap lines, designed to provide dollar access to other global central banks in the Great Recession, were readily deployed at the onset of this crisis. The dollar’s role in the international economy is guaranteed by extraneous factors, including the strength of institutions like the Federal Reserve or the liquidity of the Treasuries market.

The U.S. began using sanctions as a serious deterrence tool after 9/11. The Patriot Act gave the executive branch tools to pressure foreign financial institutions that threatened the integrity of the U.S. banking system. Specifically, Section 311 allows the U.S. Treasury to monitor and prohibit correspondent banking with financial entities that sponsor terrorism. Correspondent banking allows a financial institution in one country to do business in the currency of another. Since the dollar is the world’s pre-eminent reserve currency, most nations need dollar-denominated corresponding banking rights to conduct the great bulk of international trade. Financial institutions that do not have access to correspondent banking are blocked from transacting in the dollar. The thinking was such that, if Washington could deny access to correspondent banking for certain bad actors, it could incentivize them to act with – instead of against – the U.S. This thinking is beginning to age and collect dust. The U.S. can no longer rely on these past powers and its successful track record of financial deterrence.

Broad-stroke penalties have made and will continue to make countries feel hostage to the dollar. The less U.S. sanctions appear tied to matters of national security and more to politics, the more other economic powers will take steps to circumvent U.S. markets and undercut the dollar’s reserve-currency status by turning to digital currencies operating outside the dollar system. Instead, the U.S. needs to implement targeted solutions that achieve American interests while creating little impact on our markets and to collaborate multilaterally. Targeted solutions currently exist: the Treasury has the legal authority to seize funds stored in offshore accounts. Civil asset forfeitures can single out specific foreign correspondent accounts denominated in dollars instead of cutting off entire financial institutions, but this should be done in concert with our allies.

Blunt U.S. financial sanctions have achieved major successes as was the case with Iran, but they may also have reached the apex of their effectiveness. Without careful calibration, broad use of sanctions pose serious macroeconomic risks for markets. As such, there needs to be a new, apolitical national security strategy detailing the deployment of more calculated, ‘scalpel-like’ tools and sanctions that would not alienate our allies. These can protect U.S. interests globally without any negative downstream effects. In a world that is becoming ever more connected, these new tools will enable the U.S. to protect and keep favor of its allies while punishing only truly bad actors.

Given the current tenuous U.S.-China relationship, sanctioning, for example, the People’s Bank of China, would most likely be unfeasible due to extreme political and economic costs. Unlike economic targets in Iran, the People’s Bank is one of the largest forex reserve holders in the world and much of it is concentrated in dollar-denominated Treasuries. Such an action could not only affect reserve managers’ use of the Treasuries marketbut also trigger significant instability in the Chinese banking market and the value of the RMB. Given China’s significant contribution to global growth and multinationals’ profits, such a move could precipitate an international financial crisis. Keeping the rest of the world on the side of the dollar will be important to maintaining its global reserve-currency status and preserving U.S. leverage. A good starting point would be a national security strategy focused on leveraging the global reserve status by partnering with allies rather than unleashing economic war.

Statements and views expressed in this commentary are solely those of the author and do not imply endorsement by Harvard University, Harvard Kennedy School, or the Belfer Center for Science and International Affairs.

Michael B. Greenwald is Director at Tiedemann Advisors. He is a fellow at Harvard Kennedy School's Belfer Center for Science and International Affairs and a Senior Fellow at the Atlantic Council. From 2015-2017, Greenwald served as the US Treasury attaché to Qatar and Kuwait.

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For Academic Citation: Greenwald, Michael.“Complacency, Not China, is America’s Enemy Number One.” Belfer Center for Science and International Affairs, Harvard Kennedy School, June 30, 2020.