West Point Paper -- Part 1/4

"US Dollar Primacy in an Age of Economic Warfare" - This paper was presented at the West Point Symposium on "Order, Counter-Order, Disorder" on February 9, 2023.

Introduction

US national security is now firmly focused on Great Power Competition (GPC) and how to reorient policies to face the country’s challengers. Competition with China in particular is now front- of-mind, but the list of additional challengers will likely grow. The US-led Rules-Based Order (RBO) is changing in an increasingly multipolar world. Nevertheless, US officials continually restate that the RBO must be defended.

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Rather than discuss the vagaries, evolution, and intricacies of the RBO, this paper proposes that the foundational pillar of this order is an economic pillar that rests upon the primacy of the US Dollar (USD) as Global Reserve Currency (GRC), and that this pillar must be defended at all costs to ensure national security and stability of an evolving RBO. We explore several key themes underlying this thesis: 1) economic warfare, 2) origins of USD hegemony, 3) how the USD derives its endogenous strength, 4) weaknesses of the USD system, 5) key lessons from the semiconductor industry and how they can be applied to the equally critical oil & gas industry, 6) challenges to USD hegemony and why policymakers must not be complacent, and 7) recommendations as to how the US can better align its policies (both domestic and foreign) with its geostrategic incentives, and in so doing, maintain USD hegemony in a US-led RBO.

Economic Warfare

Modern warfare is increasingly taking place outside of conventional and kinetic means and in the economic domain. The Russian weaponization of gas, the attack on the Nordstream pipeline, US sanctions and confiscation of Russian Treasury Reserves, OPEC+’s recent 2 mmbpd (millions of barrels per day) reduction of production quotas, all demonstrate the increasing importance of economic warfare.

Western national security has focused too closely on kinetic action, completely forgetting about other dimensions of security. Concepts of National Power abound, but naturally, military and strategic planners are most concerned with the application of force. China, by dint of its state-led economy, understands that economic warfare can asymmetrically target the West due its market- based economies, which can be exploited as vulnerabilities. Colonels in the PLA, Liang and Xiangsui, in their publication titled Unrestricted Warfare, provide a useful definition beyond recent western doctrinal strictures:

“[M]ilitary threats are already often no longer the major factors affecting national security...grabbing resources, contending for markets, controlling capital, trade sanctions...They comprise a new pattern which threatens the political, economic and military security of a nation of nations. This pattern possibly does not have the slightest military hue viewed from the outside...”

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All of these are non-kinetic gray-zone modes of warfare; they are now the non-kinetic extension of politics by other means. The PLA Colonels capture an inherent flaw in military threat assessment: “It is very obvious that none of the soldiers in any one nation possesses sufficient mental preparation against this type of new war which goes completely beyond military space. However, this is actually a severe reality which all soldiers must face.”

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Soldiers and national security policymakers alike must now pay far greater attention to economic warfare as a domain of competition.

Strategic Focus in an Age of Disorder

The peace dividend afforded by the end of the Cold War permitted significant flexibility in national security policy and decision-making. Now as a unipolar order gives rise to a new multipolar disorder, rather than imperial policing and wars of choice that were permitted under a relatively benign world order of the past several decades, cohesive national policies, especially economic ones, are more necessary than ever.

Of critical importance is differentiating between national security priorities versus wasteful efforts pursuing tertiary objectives. American hegemonic dominance following the end of the Cold War has allowed fundamental strategic considerations of national security to be co-opted in many cases by political posturing. Recent volatility in oil & gas markets and geopolitical threats to semiconductor supply chains are examples of the interconnectedness and fragility of a fracturing globalized economy. The Great Game is afoot once again. Policy decisions, and perhaps even wars, are no longer ones of choice, but of survival.

Origins of USD Hegemony

Two meetings at the end of the Second World War are significant when considering the foundational pillars of both the USD and the RBO that would govern the subsequent decades. In 1944, at Bretton Woods, New Hampshire, the US Dollar (USD) was established as the Global Reserve Currency (GRC); following meetings in Yalta in 1944, King Ibn Saud and President Roosevelt met on the deck of the USS Quincy, where the US guaranteed the security of the Saudi monarch for access to the most crucial commodity fueling the engine of the global economy – oil.

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Access to Saudi Arabia’s vast oil reserves would prove crucial to America’s economic dominance and success in the Cold War. Simply put, the US had the money and the military, while the Saudis had the oil. Money, oil, and security are inextricably linked.

The post-war Bretton Woods monetary agreement envisaged a world that used the USD as GRC with the understanding that the US would peg its currency to gold at a price of $35 per oz.

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But from the very beginning the Bretton Woods system had flaws. According to Francis Gavin, the Bretton Woods Agreement was unworkable for two crucial reasons: 1) “it lacked a mechanism to adjust persistent payments imbalances between countries. Exchange rate stability could only be maintained by providing ever increasing amounts of liquidity, a process that created enormous political difficulties and ultimately undermined confidence in the system,” and 2) there were flaws with “the method of applying liquidity to the system...Liquidity is simply another word to describe reserve assets that are transferred from debtor to surplus countries to cover their payments gap.”

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Consequently, the USD’s unique role in world trade and reserve creation means that the US must run a balance of payments deficit to maintain a functioning international economy.

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Gavin captures the critical dilemma inherent in this system: stability based on trust.

“How stable and cooperative could a system be that only worked if the world’s largest economy ran persistent deficits in its balance of payments? When foreign central banks held dollars for reserve and transaction purposes, it enabled American consumers to receive foreign goods and services without having to give anything other than a promise to pay in return. It was like an automatic credit or, if the reserves built up indefinitely, like getting something for almost nothing. This arrangement, which is the benefit of “seigniorage” could be maintained as long as the dollar was “as good as gold,” or when holding dollars in the form of short-term interest-bearing securities was probably preferable to buying gold. The danger emerged when overseas holders of dollars worried that the dollar was not as good as gold or, for non-economic reasons, preferred holding gold to dollars.”

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The diplomatic history of Bretton Woods often ascribes a purely a “top–down” construction by the great powers. It proposes that trust underlies this currency arrangement and that this trust was initially provided by gold. After the Nixon Shock of 1971 removed gold convertibility, trust was imposed through power, and the rise of the “Petrodollar System” described an arrangement whereby the US would continue to provide military security for the Saudi kingdom in exchange for access to its oil, which would be priced in USD.

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While this diplomatic history is well covered, it has a fundamental flaw in that it is a purely “top-down” interpretation and ignores the “bottom-up” evolution of USD adoption that appears to challenge the “top-down” theory. As Perry Mehrling, quoting Harold James, offers, “Bretton Woods was the intellectual sugar, covering and masking the bitter taste of the pill of Realpolitik dollar hegemony.”

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We propose that National Power is the true source of endogenous trust in the USD – not simply the “intellectual sugar” that rationalizes trust as gold backing or security guarantees for oil access. National Power has deeper roots.

USD Hegemony Depends Upon National Power and Vice Versa

The US-led RBO rests upon USD primacy, and USD primacy rests upon a bedrock of National Power, but USD Primacy also influences National Power. The two are inextricably intertwined. Virtuous circle dynamics have produced a superpower flywheel for the US, but there are challenges that threaten to upset it; the decline of British hegemony and the loss of GRC status by the Pound Sterling is a sobering reminder of the implications of losing that superpower flywheel.

Broader conceptions of National Power have been found in the West but have been somewhat forgotten. Proposed in April 1918, the US Army War College (USAWC) published a model of National Power whereby the “strategic equation” of war has four factors – combat, economic, political and psychologic.

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Following the Second World War, the US military refined this framework into the “DIME” model, which became prominent during the Cold War.

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The DIME Framework of National Power consists of Diplomatic, Information, Military, and Economic. Classical realist Hans Morgenthau further segments National Power into Nine Elements: Geography, Natural Resources, Industrial Capacity, Military Preparedness, Population, National Character, National Morale, Quality of Diplomacy, and Quality of Government.

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This paper borrows from both frameworks and focuses on the key Economic pillars of National Power: Geography and how it influences Military Preparedness, availability of Natural Resources, and Industrial Capacity.

CONTINUE TO PART 2/4:

West Point Paper -- Part 2/4

1. U.S. Department of The Treasury. “Joint Statement by Secretary of the Treasury Janet L. Yellen and Japan Finance Minister Suzuki Shunichi,” January 20, 2023. https://home.treasury.gov/news/press-releases/jy0858.

2. Qiao Liang and Wang Xiangsui, Unrestricted Warfare (Beijing: PLA Literature and Arts Publishing House, 1999). p.108.

3. Liang and Xiangsui, Unrestricted Warfare. p.176.

4. Memorandum of Conversation Between the King of Saudi Arabia (Abdul Aziz Al Saud) and President Roosevelt, February 14, 1945, Aboard the U.S.S. “Quincy”, February 14, 1945. https://history.state.gov/historicaldocuments/frus1945v08/d2

5. Michael Howell. Capital Wars: The Rise of Global Liquidity (Basingstoke: Palgrave Macmillan, 2021). p. 13.

6. Francis Gavin, Gold, Dollars, and Power: The Politics of International Monetary Relations, 1958-1971 (Chapel Hill, NC etc.: University of North Carolina Press, 2004). p. 21.

7. Gavin, Gold, Dollars, and Power: The Politics of International Monetary Relations, p. 22.

8. ibid, p. 23.

9. “Franklin Roosevelt Administration: Letter to King of Saudi Arabia Regarding Palestine,” President Roosevelt Letter to King of Saudi Arabia Regarding Palestine (April 1945), accessed December 14, 2022, https://www.jewishvirtuallibrary.org/president-roosevelt-letter-to-king-of-saudi-arabia-regarding-palestine-april- 1945. For a detailed discussion of this grand-bargain, see Daniel Yergin, The Prize: The Epic Quest for oil, Money & Power: With a New Epilogue (New York: Free Press, 2009). p. 403-405.

10. Perry Mehrling. Money and Empire, (Cambridge, UK: Cambridge University Press, 2022), p.137.

11. The Functions of the Military Intelligence Division, Military Intelligence Division of the US Army General Staff (October 1, 1918).

12. Robert D. Worley. Orchestrating the Instruments of Power: A Critical Examination of the U.S. National Security System (Lincoln: Potomac Books, an imprint of the University of Nebraska Press, 2015).

13. Hans Morgenthau. Thompson, Kenneth, Politics among Nations: The Struggle for Power and Peace (New Delhi: Kalyani Publishers, 2018).