US Allies Join Chinese-Led Financial Institution – Is American Financial Dominance Over?
For the time being, the United States is still the World’s only financial superpower. The dollar is the international reserve currency and countries depend on US-led financial organizations like the World Bank and the International Monetary Fund. This privileged position leads to many advantages for American companies and our government. However, this era of dominance might soon be coming to an end.
Frustrated with our government’s financial irresponsibility and abuse, countries are starting to turn to China to lead the international financial system. The United States got a harsh wakeup call this month when several key Western allies applied to join the Asian Infrastructure Investment Bank (AIIB).
The AIIB is a multi-national financial agency that finances projects throughout Asia. When countries join the agency, they contribute funds. The AIIB uses this money to finance large infrastructure and transportation projects across the continent. Like the World Bank and IMF, the AIIB can help countries that are in financial trouble as well.
While the AIIB used to be only an Asian organization, in early March the UK announced that it would like to become a member. Immediately after, Germany, France, and Italy all declared that they would like to join as well. Once the major European nations join, the AIIB will move from a regional organization to a global player.
The United States is not happy. In a public statement, the American government scolded the UK for joining the AIIB saying that the organization is not transparent enough and that the UK could hurt “better” organizations like the World Bank and the IMF. More likely, the government is upset that Europe is challenging its dominance of the World financial scenes. However, they can’t be surprised considering how America has abused its position over the years.
Why countries are frustrated
With America as the only financial superpower, the rest of the World has to follow rules. This means putting up with some frustrating interference from our government. For example, the IRS recently launched an invasive new program, known as FATCA, to track down Americans who are evading taxes by keeping money overseas. While the goal makes sense, the IRS’ approach was ludicrous. The IRS demanded that foreign banks open up their private accounts for the American government to inspect. If they refused, America would fine them and block them from operating in our market. As a result, foreign banks had to follow costly new regulations that had nothing to do with their country.
In another example, the American government fined BNP Paribas, a French bank, about $9 billion dollars because they were doing business with countries that America doesn’t approve of, like Cuba and Iran. As a result, BNP had to pay this massive fine even though they’re a foreign company following the rules of their own country. Can you imagine a Chinese company threatening American companies because they broke China’s rules? We wouldn’t stand for these threats so why should the Europeans?
At the same time, America has abused its financial advantage by taking on way too much debt. By some estimates, the American outstanding debt is around $60 trillion dollars! We’ve been able to finance our ludicrous overspending because of the dollar’s status as the reserve currency. Since countries want to hold dollars, our borrowing costs are artificially cheap. However, countries are understandably getting worried about our ability to pay everything bank which is why they are looking for alternatives to the dollar as a reserve currency.
Potential cost to America
For more than 50 years, America’s economy has had an advantage because of our country’s special financial position. Once we lose this edge, the country’s in for a rude awakening. If countries and foreign investors stop buying American dollars and debt, interest rates will go up.
This will push up our government’s borrowing costs so more of the budget will have to go towards paying interest rather than paying for the military, schools, infrastructure, etc. As government rates go up, rates in the private sector will follow. This could be a disaster for American companies. The current stock boom is likely being fueled by easy credit. Many companies are only in business because they can keep borrowing money for practically nothing. If the international community stops supporting our overspending, we could be headed for a severe crash.
How investors can prepare
With China’s size and rapid growth, it really is only a matter of when, not if, they will challenge America’s role as the only financial superpower. With smart government planning, we could be able to delay this from happening, but given Washington’s disarray investors would be wise to prepare now.
As Asia becomes more dominant, investors should look abroad for their portfolio. It would be a good time to expand in international stocks, especially in the developing World, while reducing holdings in the inflated American markets.
As the dollar loses its status as the only reserve currency, the value of the dollar will fall. This is will hurt the price of dollar-backed assets like American stocks and bonds. However, it would boost the value of commodities like gold because their relative price in dollars would go up as the international value of the dollar goes down. In other words, it would cost more dollars to buy an ounce of gold. American investors can take advantage of this upcoming swing by moving more of their dollars into stores of value like gold now.
To get an idea of the impact, consider the recent collapse in the price of the Euro. Over the past year, the Euro lost about 23% of its value compared to the USD.
During this same stretch, the price of gold in Euros soared about 21%. If the dollar loses its status as the World currency and collapses in value, American investors who buy gold can expect the same type of large gain.
Our European allies joining the AIIB is just one more sign that the world is changing. One day, China could overtake the United States as the dominant power in the same way we overtook Europe. Unless the American government starts taking more responsibility, this day will come sooner than most people think.