As the coronavirus crisis has imperiled public health and the global economy, countries are suffering and many are considering how to adapt policies to shore up their security. For economic and foreign policy observers, the current circumstances should put to rest worries about the survival of the U.S. dollar and U.S. sanctions—neither are in danger. The U.S. market-calming response to the crisis demonstrates two powerful conclusions about American economic power and national security. First, an agency that the national security community ignores, the Federal Reserve, acting as global lender of last resort, is successfully shoring up the resilience of the dollar system, the bedrock of American economic power. Second, compared to the Federal Reserve’s measures, even uniquely powerful national security tools like U.S. financial sanctions are only marginal in their effect on the dollar system. Their use appears to cause little harm to U.S. dollar primacy.
Will the power of U.S. sanctions falter?
In recent years, concerns about sanctions’ effects on the dollar have reached the highest echelons of government, as former National Security Advisor John Bolton recounts in his recent memoir. While Bolton played up sanctions’ effectiveness as a tool of foreign policy, Treasury Secretary Steven Mnuchin worried about sanctions’ effect on the U.S. economy and the risk that onerous restrictions would encourage China and Europe to find workarounds. (The Treasury Department has denied Bolton’s charges.)
Even uniquely powerful national security tools like U.S. financial sanctions are only marginal in their effect on the dollar system.
Despite continued warnings about “sanctions overreach” by Mnuchin, his predecessor Secretary Lew, and outside commentators (including this author), there has been little sign of the dollar’s decline. The coronavirus crisis has instead confirmed the opposite. As sanctions experts Eric Lorber and Jonathan Schanzer rightly wrote in April, the pandemic proves that the U.S. dollar is still “king” thanks—according to them—to the United States’ transparent fiscal policy and the liquidity of its capital markets.
However, this explanation is insufficient because it ignores the Federal Reserve’s groundbreaking, innovative measures that make dollar resilience possible in the first place. Understanding the specifics of how the Federal Reserve operated the levers of global finance as markets tanked and chaos spread in March 2020 is necessary to understand not just how the dollar survives, but how Washington exercises its power in the national security realm.
The Federal Reserve’s powerful tools to support the global financial system and the dollar
Faced with virus-induced economic upheaval, the Federal Reserve first turned to the so-called swap lines, a key policy response of the 2008 financial crisis. Through these measures, the Federal Reserve fulfilled the traditional central bank role, but on a global scale.
Generally, if a financial institution, say a big bank in New York, desperately needs liquidity, meaning it needs to convert its assets into dollars, the Federal Reserve can facilitate it. For example, if a bank faces deposit withdrawals but has only illiquid (i.e. hard-to-sell) assets on hand, the Federal Reserve can lend the institution dollars and take the illiquid assets as collateral. Because the central bank prints its own currency, it has unlimited cash on hand to avert the New York bank’s liquidity crunch. In the process, all parties benefit. The bank can pay its debt without having to sell its illiquid assets at fire-sale prices; the creditor gets paid back; and the central bank ensures that this illiquidity friction does not spiral out of control and damage the real economy. When it steps in, the Federal Reserve is acting as a “lender-of-last-resort” to that New York bank, a classic central bank responsibility.
The international picture is more complicated. The dollar is the currency of global finance and trade, and international financial institutions and companies tend to borrow and get paid in dollars. They do this because of the safety, convenience, and returns of dollar assets as well as the ease of transacting in dollars. There are $23 trillion in outstanding dollar-denominated international debt securities and cross-border loans, while about 50 percent of trade is invoiced in dollars as are around 40 percent of international payments. In addition to shaping global commerce and finance, these are the numbers that give U.S. sanctions their power: As long as international banks and companies borrow and use dollars on this scale, they will follow U.S. sanctions regulations.
As long as international banks and companies borrow and use dollars on this scale, they will follow U.S. sanctions regulations.
In a financial crisis, this global role of the dollar means that when foreign institutions need liquidity, they often specifically need dollar liquidity. Their central bank, however, does not print dollars. It might have some dollars available, but these will be finite. In a moment of widespread distress, like the pandemic-induced economic crisis in March, or the Global Financial Crisis in 2008, foreign central banks may be unable to serve as lenders-of-last-resort to their banks.
Swap lines solve this problem. Through swaps, the foreign central bank can exchange its own currency for dollars directly with the Federal Reserve. Central banks can therefore trade with the Federal Reserve the unlimited resource they have, their own currency, for the resource their troubled banks need, U.S. dollars. Then, the foreign central banks lend these dollars to their banks and stabilize the system. This way, the Federal Reserve can help countries avoid liquidity crunches of their own and prevent these local stresses from in turn damaging the U.S. economy. At the end of May, the Federal Reserve had almost $450 billion in outstanding swap lines.
The Federal Reserve cannot help but consider foreign policy
The entire world uses dollars, but not every country gets a swap line. After the experiments during the 2008 crisis, the Federal Reserve created permanent swap lines arrangements with the European Central Bank, as well as with the central banks of the UK, Japan, Canada, and Switzerland. In March 2020, it then revived temporary swap lines with Australia, Brazil, Denmark, Mexico, Singapore, South Korea, Norway, New Zealand, and Sweden.
Who gets a swap line is a sensitive question. The Federal Reserve can single-handedly ensure a country’s financial stability—or not. David Adler and Andres Arauz, critics of this unchecked U.S. power, call it “monetary triage … deciding which nations will weather the crisis, and which will be condemned to suffer its gravest consequences.” Instead, they argue, international organizations like the International Monetary Fund should be stabilizing the global economy.
The Federal Reserve justifies its swap-lines decisions on the basis of protecting the U.S. economy, a primarily domestic policy rationale. But any decision to employ these measures cannot help but entail foreign policy considerations. During the Global Financial Crisis, then-analysts at the National Intelligence Council Mathew Burrows and Jennifer Harris highlighted how countries hinge their support for U.S. alliances like NATO on such U.S. monetary support. Not supporting Europe, in addition to clear economic consequences, could not help but sunder the transatlantic compact.
As important as who gets swap-lines is who does not get them. Notably, the list of recipients omits China and Russia. Though experts have called for such measures, they have conceded that the current political climate makes such cooperation impossible. Like other transnational problems such as climate change and public health, stabilizing the global economy is an area where rising “great power competition” may hinder cooperation.
Unlike in 2008, during this crisis the Federal Reserve created a new tool to help countries that do not get a swap line: the temporary repurchase agreement facility for foreign and international monetary authorities (FIMA Repo Facility). Through this mechanism, foreign central banks can temporarily exchange U.S. Treasury securities for dollars, getting access to dollar liquidity for their financial institutions without needing to rely on high-pressure sales. Council on Foreign Relations expert Brad Setser, who had proposed such a facility, noted that the FIMA facility allowed the Federal Reserve to “better serve as a dollar lender of last resort.”
On the one hand, this initiative is more inclusive. Any central bank with a New York Federal Reserve account (nearly all of them) would have access to this program. This includes China and Russia. On the other, the relief is circumscribed. While swap-lines promise unlimited liquidity, here the support would at most be equal to the central bank’s reserves of Treasury securities.
U.S. economic power remains very strong
As these initiatives suggest, the dollar system is vast, very well networked internationally, and absolutely fundamental to the economic health of most of the global economy as currently built. It is not a brittle set of private decisions that U.S. sanctions policymakers are constantly on the verge of breaking. And rather than constantly looking for the exits every time the United States adds an anti-money laundering rule or sanctions restrictions, international players are instead flocking to the Federal Reserve asking for support. Washington is a maker, not just a taker, of the global dollar system. And that means that Washington continues to have enormous power to impose economic pain through sanctions.
The dollar system is vast, very well networked internationally, and absolutely fundamental to the economic health of most of the global economy as currently built.
Leaving the Federal Reserve out of the economic statecraft picture discounts the active role that Washington plays in managing global finance and undersells American economic power. Sanctions can shape business and investment patterns (significantly, as the Iran and Russia sanctions experiences suggest) and affect the humanitarian conditions of targeted populations. But the Federal Reserve’s actions are farther-reaching. They ensure the correct functioning of every aspect of the global economy. These Federal Reserve policies are so central that the Bank of International Settlements listed them as the “safety nets” of the global financial system.
Ignoring the Federal Reserve’s role leads to a distracting focus on “soft” economic factors like predictability, credibility, and reliability at the expense of a more clear-eyed view of how global finance works. The post-2018 Iran sanctions experience has already shown that even universally condemned unilateral U.S. measures can have major economic impacts so long as Washington controls the levers of global finance. The same applies to the Federal Reserve’s actions during the coronavirus crisis. As historian Adam Tooze has argued, though the rest of the U.S. pandemic response may have been a leadership, public health, and public diplomacy failure, as long as the Federal Reserve is in charge, Washington still runs the global economic show.
How to make better sanctions policy
A clearer view of international monetary affairs and the Federal Reserve’s actions can improve sanctions policy. Too often, the debate about a specific sanctions program has focused on its potential threat to dollar primacy rather than on an evaluation of the policy itself. Opponents of Iran sanctions, for example, invoked the risk that the parties still committed to the nuclear deal would chip away at the dollar system. The EU’s difficulties in setting up the Instrument in Support of Trade Exchanges (INSTEX), a mechanism to get around the dollar and continue non-sanctioned trade with Iran, have dispelled those worries. Now, the Federal Reserve’s actions are confirming that the dollar remains the unavoidable mechanism of global finance.
The focus on sanctions themselves, rather than on their collateral effects, suggests two lessons. First, proponents of using economic sanctions for new, far-reaching goals, for example to fight kleptocracy or address climate change, can take comfort and not worry about endangering dollar primacy with their ambitious plans. Second, opponents of sanctions can still oppose sanctions on the merits: “maximum pressure” on Iran may not have ended dollar primacy, but it still has failed as a coercive economic policy and caused major humanitarian damage.
The Federal Reserve’s crisis-fighting role should also make national security policymakers rethink the boundaries between foreign and domestic policy. The Federal Reserve already straddles this division. It primarily justifies its actions on domestic policy grounds, i.e. protecting the U.S. economy. However, the first-order effect of its measures is protecting foreign economies—with major foreign policy implications. In other areas, like climate change, the boundary between domestic and foreign policy interventions is similarly porous.
The Federal Reserve is not the only example of a U.S. agency with a domestic mandate but with meaningful international ramifications. Analysts recognize that domestic regulatory power can allow Washington to write “global rules” and shape national security. Last year, Senator Marco Rubio proposed using the Public Company Accounting Oversight Board, a U.S. regulator, as a tool to require greater transparency from Chinese companies. Inversely, domestic policies abroad can shape national security in the United States. For example, Matthew Klein and Michael Pettis have argued that economic inequality abroad can threaten geopolitical stability.
Finally, the economic policy response to the pandemic illustrates the difficulty in separating national security and “pure” international economic policy, like trade agreements and financial stability. This may not be all that much of a distinction anymore. The Federal Reserve’s March actions prove how policies chosen for purely economic goals can interact with national security considerations (such as the question of who gets a swap-line). This ought to suggest greater integration between the two approaches. This would be a welcome extension of the lesson of the Trans-Pacific Partnership, when policymakers who promoted the agreement for national security reasons learned that ignoring the domestic political economy implications of the deal could result in its failure to pass.
Foreign policy professionals will have to understand what the Federal Reserve is doing and how it affects U.S. national security.
The past decade has seen the two custodians of U.S. dollar power, the Federal Reserve and the Treasury Department, rise in importance. This is clearly true in the economic domain and recognized widely by experts and non-experts alike. The national security community, which has tracked the explosion in use of sanctions over recent years, is aware that the Treasury Department has become more important to U.S. power. Because it is independent and tries to present an apolitical face to best carry out its mandates, the Federal Reserve has escaped this same scrutiny. But now, to understand sanctions, including their utility and power, foreign policy professionals will have to understand what the Federal Reserve is doing and how it affects U.S. national security.
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