Chokepoints: American Power in the Age of Economic Warfare

by Edward Fishman

Great powers once rose and survived by controlling geographic chokepoints like the Bosphorus. American power in the globalized economy relies on chokepoints of a different kind. Among them is the U.S. dollar, the default currency for international trade and finance.

The United States has used its hold over these chokepoints to pioneer a new, hard-hitting style of economic warfare. The result has been a stunning resurgence of state power in a world supposedly governed by market forces.

The episode points to an enduring problem in economic warfare: the harm it inflicts does not always elicit the hoped-for policy changes, and its unintended consequences can sometimes precipitate the very outcome it aimed to prevent. Indeed, the failures of economic warfare are better known than its successes.

At the Paris Peace Conference that year, U.S. President Woodrow Wilson and other leaders conceived of a new organization called the League of Nations, whose purpose would be to preserve world peace. Under the auspices of the League, states would collectively commit to punish any would-be aggressor with devastating economic sanctions. If all member states unified behind such sanctions, they could, in Wilson’s words, unleash “something more tremendous than war.” Aggressors would back down without a shot being fired. “A nation that is boycotted is a nation that is in sight of surrender,” Wilson declared. “Apply this economic, peaceful, silent, deadly remedy and there will be no need for force.”

Valued at over $50 trillion, the U.S. bond market also dwarfs those of the rest of the world. And when firms anywhere turn to international capital markets for cash, they almost always borrow in dollars: 70 percent of foreign-currency debt is denominated in dollars.

Banks typically hold significant stocks of only two currencies: the currency of their home country and the U.S. dollar.

This explains why the U.S. dollar is involved in nearly 90 percent of foreign exchange transactions even though the United States accounts for less than 10 percent of global exports.

At the heart of Bretton Woods were fixed exchange rates: the dollar was pegged to gold at $35 an ounce, and all other currencies were pegged to the dollar. These exchange rates were adjustable only within a narrow band; anything beyond a 1 percent move required consultations with the newly created International Monetary Fund (IMF). Bretton Woods also included restrictions on the movement of money across borders, walling off a key route through which financial instability had spread during the Great Depression. The dollar was now at the center of the world economy. But by fixing exchange rates and limiting cross-border capital flows, the Allies created a heavily constrained international financial system—which is exactly what John Maynard Keynes, the renowned British economist and a principal architect of Bretton Woods, thought was necessary.

In a manner that today’s cryptocurrency enthusiasts could only dream of, the Eurodollar market started as an unauthorized monetary experiment and then evolved, with the blessing of the U.S. and British governments, into a piece of critical infrastructure for the world economy.

Nixon declared that the United States would no longer honor requests to convert dollars for gold. In one fell swoop, the announcement cut down the central pillar of Bretton Woods and essentially forced the global financial system to adopt floating exchange rates. Under Bretton Woods, currency values had been set by agreement among governments; after the “Nixon shock,” they were set by the market. It was the dawn of a new era for the world economy—one in which financial markets, contrary to Keynes’s wishes, would reign supreme.

America’s share of global GDP fell from 40 percent in 1960 to 25 percent in 1980, roughly the level it stands today. But in an ironic turn, this decline marked only a new phase of U.S. economic dominance. America’s preeminence in manufacturing and trade was fading, but its supremacy in international finance was about to begin.

In July 1974, Simon boarded a plane at Andrews Air Force Base and headed for the Saudi coastal city of Jeddah. En route, he indulged in copious amounts of whiskey. By the time he got off the plane, he was noticeably drunk. The liquor had no apparent effect on his negotiating ability, however. Simon was no Kissinger; he was not schooled in the art of diplomacy. But he was a damn good bonds salesman, and he left the desert kingdom with a deal in hand: In exchange for American military assistance and continued oil purchases, the Saudis would funnel their oil money into U.S. Treasury bonds, which they would be permitted to buy in secret outside the normal auctions. Simon had secured a commitment by a foreign country to finance American deficits—and the petrodollar was born.

As Lawrence Summers, Clinton’s treasury secretary, confessed, “Any honest Democrat will admit that we are all Friedmanites now.”

Clinton also completed Reagan’s deregulation of the financial sector, allowing the banking industry to become bigger and more globalized than ever. He signed the law that repealed the Glass-Steagall Act, which had walled off commercial banking from investment banking since 1933. For the key post of Federal Reserve chair, Clinton twice renominated Reagan appointee and fellow neoliberal crusader Alan Greenspan, whose command over U.S. monetary policy thus stretched into a second decade.

Today, foreign exchange trading eclipses $7 trillion each day—a staggering volume that is more than eighty times the daily value of world trade. (If you don’t have a calculator handy, that’s equal to an annual market volume of around $2.5 quadrillion.) A whopping 90 percent of these foreign exchange transactions involve the dollar.

The UAE and Iran are deeply linked by people, culture, and geography. Scores of Iranians fleeing the 1979 revolution settled across the water in Dubai; others stayed but moved their businesses there. Today, the UAE is home to one of the world’s largest Iranian diaspora communities.

The Saudis were big supporters of America’s campaign to curb Iran’s nuclear ambitions. Their leader, King Abdullah, had even urged American officials to “cut off the head of the snake” and bomb Iran’s nuclear facilities.

General Keith Alexander, a longtime head of the NSA, called China’s cybertheft of intellectual property and trade secrets “the greatest transfer of wealth in history.”