Trump Takes on the Fed and Weakens the Geopolitical Position of the US

The serious confrontation between the Chairman of the US Federal Reserve, Jerome Powell, and the White House, over the consequences of the tariffs policy for the economy of the US, is not just an esoteric monetary affair.

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Trump Takes on the Fed and Weakens the Geopolitical Position of the US

The serious confrontation between the Chairman of the US Federal Reserve, Jerome Powell, and the White House, over the consequences of the tariffs policy for the economy of the US, is not just an esoteric monetary affair. The outcome will have massive geopolitical consequences for the global competition between China and the US.

The link between the monetary sphere and global geopolitics is the status of the US Dollar as the global reserve currency. Alongside the US’s dominant military power, which it can project globally, the financial dominance of the US is its other geopolitical pillar. The status of the Dollar as reserve currency enables the US to borrow with very few constraints, which in turn enables the US not only to dominate the global financial markets, but also to continue to massively invest in defence. If the US Dollar weakens, or if the credibility of its value is undermined through political interference in the independence of the Fed, which is the US’s de facto central bank, a chain of events can be triggered leading to states, central banks, and investors switching (i.e. selling) out of the US Dollar and into other currencies. This will not only weaken the value of the global reserve currency. It will also directly undermine the hard foundations of the US’s geopolitical position vis-à-vis other powers, notably China, particularly if there is a switch from the US Dollar to the Chinese Renminbi.

Currency was always synonymous with geopolitics

Lest we forget: in 1965, when the post WW2 “Bretton Woods” system was still functioning,  General Charles De Gaulle, with remarkable foresight, ordered French naval vessels to bring back the French gold deposited in the US. The Bretton Woods system required all countries to guarantee convertibility of their currencies into US Dollars to within 1% of fixed rates; with the US Dollar convertible to gold bullion for governments and central banks at US$35 per troy ounce, fine gold. It linked all currencies to the US Dollar through a fixed exchange rate, based ultimately on gold deposited in the US. The issues of then were similar to today’s as free trade relied on the free convertibility of currencies. Bretton Woods was a practical expression of the “Atlantic Charter” of 1941 after Winston Churchill, and Franklin D. Roosevelt agreed on the right of all states to equal access to trade and raw materials as well as freedom of the seas.

President Nixon, in 1971 and 1973, finally pulled the plug on “Bretton Woods” (formally the system was dissolved in 1976) and effectively replaced gold with the US Dollar as the world’s reserve currency. The so called “Fiat” money system was thus created, otherwise known as printing money. Since then, value has not been based on an underlying asset, but on trust in the system. The global financial regulatory and payment architectures have one principal aim: maintaining that trust, without which the bank “promissory note” (i.e. money we use every day) is worthless.

All of this is meant to underline how crucial the current global monetary system, centred around the US and the US Dollar, is to the geopolitical power of the US. It is clear that the Fed is concerned not only about the domestic economy, but also about the position of the US Dollar globally. It is very surprising that there seems to be less concern elsewhere about the geopolitical implications of a weaker US Dollar.

Perhaps as an attempt to mitigate this risk, the White House issued a slew of Executive Orders encouraging US-based crypto currencies. Possibly this was an attempt to offer US Dollar sellers a US alternative into which to switch, rather than buying Chinese Yuan. If that was the thinking, it is doubtful that it will work: state-backed central banks the world over, and most institutional investors, have very limited appetite for crypto, regardless of who the backer may be. Moreover, cryptos are fundamentally a libertarian, anti-state control, invention. States generally are determined to maintain a state-backed monetary system administrated through central banks.

The potential for the monetary system to become a key player in the global geopolitical balance of power is now more pronounced than at anytime since the General De Gaulle-Nixon face off of 1965-1971.

The Fed’s Dire Forecasts Upset the White House’s Applecart

Jerome Powell did not mince his words. The tariffs will cause the three most serious economic afflictions every central banker fears: rising inflation, slower growth, and a higher unemployment. The Fed can only deal with one of these three at any given moment. This is so because the main mechanism, interest rates, can work only one way or its opposite, i.e. up or down, at any given moment. If prices rise causing inflation, the Fed raises interest rates. If growth slows down, it cuts interests rates.

The Fed’s so-called “dual mandate” is based on achieving price stability and full employment. Extreme uncertainties about the tariffs make it very difficult to execute this mandate. Without price stability, the Fed cannot achieve the goal of full employment. As a former investment banker versed in the way central bankers describe the economic outlook, I have not heard a governor of a central bank speak with such explicit concerned clarity: The US economy currently is solid, but because of the tariffs the future is uncertain, with slower growth, rising inflation, growing unemployment, and the US consumer will bear part of the cost of the tariffs. This is not the canary in the mine; this is the red flag of stagflation being waved vigorously. If the US catches this kind of cold, the rest of the world will start to cough.

Conclusion: A Geopolitical role for the Euro

The European Central Bank and the EU must now look at scenarios in which the Euro will have to be treated as a geopolitical instrument and not only as a monetary tool. This is clearly not out of choice, nor is it an ideal scenario. For the first time in decades, it is likely that the great powers will fight part of their rivalry through monetary means.

China is likely to take advantage of any weakness of the US Dollar to promote alternatives to both the US Dollar as a global reserve currency as well as to payment systems such as SWIFT. Powell’s serious concerns, and unusually blunt statements, mean that the US is heading for a very bumpy ride that will impact the US Dollar. The dilemma for China is this: A global reserve currency needs to have full convertibility, as is the case with the US Dollar. To achieve this,  it will have to give up central control of its currency, otherwise the credibility in the value and in the convertibility of its currency will be weak. The distinct advantage of the US Dollar (and the Euro, Yen and British Pound) is that they float free of any government control, thus preserving that credibility.

As a practical key first step, it is imperative that the ECB develops and deploys the “Digital Euro” (digital is not crypto – it is a real Euro backed by the ECB) as the competition in the new global trading system will most likely cluster around digital currencies that enable super quick, efficient and cheap payment platforms. China is already deploying a digital system. These digital currencies and payment platforms will very likely be the single most important development in the global trading system not only to enhance the EU’s global trading position as the deck chairs are re-arranged, but also to develop a geopolitical muscle for the Euro, a key pre-requisite in this new world for a geopolitical Europe and for the EU’s strategic autonomy.

(Photo credit: Miloslav Ham?ík, Pixabay)