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Dollars and Politics
By Antony Mueller
Antony P.
Mueller is a professor of economics at the graduate business school of the
University of Caxias-do-Sul (UCS) in Brazil. He is an adjunct scholar of the
Ludwig von Mises Institute and president and founder of The Continental Economics
Institute.
After each of
the two world wars in the 20th century, the United States emerged as the
largest creditor country, with economies ruined in the countries of war-time
enemies and major allies alike. After the end of the Cold War, this pattern
would experience a repetition. The United States, so it seemed, was now the
only remaining superpower. In the 1990s,
the dollar experienced a new flourishing, and the US economy went through
magical rejuvenation. However, this time the economic and political fundament
gave much less support to the assumed role of the dollar in the world. In
contrast to the time after World War II, the basis for the dollar's global expansion
in the 1990s was not economic strength, but debt creation. With debt creation
providing the basis for the dollar's spread, and the dollar's expansion
providing the basis for the economic performance and the military position of
the United States, the structure that has emerged is outwardly powerful but
inherently fragile. It is not economic strength that provides the foundation of
the role of the US dollar in the international monetary system, but it is the
US dollar's role that provides the basis for the United States to maintain and
extend its global activities. While after 1919
and after 1945, the United States emerged not only as the largest international
creditor, but also as the major industrial power, the US has become an
international debtor and is confronted with a weakening industrial base. Also
in contrast to the earlier world wars and the other conflicts, the economies of
Russia, Western Europe, and Southeast Asia did not lay in rubbles when the Cold
War ended. As to their productive capacity and financial resources, these
regions now are on an even footing with the United States. For a while it
appeared as if the international monetary system that emerged in the 1990s
could be interpreted as a new version of the older Bretton Woods System whose
structure foresaw a central role for the US dollar in the post-World War II
era. While the parallels fit insofar as the current system provides similar
benefits to the participants, the present structure is even more flawed than
the older scheme, which broke down due to its inner contradictions. Like the earlier
Bretton Woods System (BW1), the current system (BW2) is characterized by the
pegging of foreign currencies to the US dollar. This time it is mainly
Southeast Asian countries, particularly China, that practice this policy in an
informal way. Through this arrangement, these economies in Southeast Asia
receive a similar advantage to the one enjoyed by Western European countries
when undervalued currencies gave them a competitive advantage that helped to
rebuild their industrial base. Once this reconstruction stage was completed,
the BW1 system fell apart, and the Europeans began to build their own currency
system. The decoupling of the European currencies from the dollar progressed
step by step and finally led to the introduction of the euro in 1999. As of
now, the euro is equal to the US dollar in the size of its financial market,
not counting use as an international reserve currency, where the US dollar
still dominates. It is mainly
central banks in Southeast Asia that in the recent past have accumulated US
dollars as their international reserves. However, there is little doubt that
central banks' willingness to finance US deficits and to hold on to a weakening
currency will not last forever. As happened in Europe before, once the prime
goal of these countries is fulfilled - industrial development based on exports
with the help of undervalued currencies - relative advantages change and the
countries of Southeast Asia will move out of their dollar linkage. The Bretton
Woods System as it was established by the end of World War II bestowed a
singular privilege to the United States when the dollar became the point of
reference for the international currency system. With the other member
countries fixing their currencies to the US dollar, and the US dollar
officially fixed to gold at $35 per troy fine ounce, it seemed as if an ideal
construction was found in order to avoid international monetary disruptions and
to provide the framework for global economic expansion. The gold anchor
was meant to curb an excessive production of US dollars. When foreign countries
had a trade surplus, they were legally allowed, according to the Bretton Woods
Treaty, to exchange the excess dollars for US gold. With a stable parity
between dollar and gold, this would have restricted dollar creation. France
took the agreement literally and demanded gold from the United States instead
of accumulating dollars as international reserves. The main export surplus
countries such as Japan and West Germany refrained from that option. With their
exchange rates kept competitive, Japan and West Germany embarked upon an
export-led growth strategy that sped up their economic recovery and made them
industrial powers again. For the United
States, the BW1 system provided a special privilege and it did not take long
for the United States to abuse it. Pursuing the goal of expanding the welfare
state along with ever-more-active foreign military involvements, the United
States expanded the money supply drastically. The discrepancy began to widen
between the stock of gold and the dollars in circulation and it became obvious
that the US government no longer had the means to fulfill the original
agreement of making foreign currencies exchangeable into gold. By the late
1960s, the dollar shortage of the 1950s had turned into a dollar glut. World
price inflation began its rise. Originally in
the BW1 treaty it was stipulated that the change of currency parities should be
an exception rather than a rule. But in the 1960s, the international monetary
system entered into a phase of high instability when fixing and re-fixing of
foreign currencies to the dollar became an almost daily concern. The perverse
monetary system that emerged created a bonanza for currency speculators. The
candidates for exchange rate revaluation - such as Germany or Japan - were easy
to identify. By taking out a dollar loan and changing the money at a fixed rate
into German marks or Japanese yen and then depositing the amount, leverage could
be applied and profits were guaranteed when the revaluation of the foreign
currencies occurred - as it was not hard to foresee. The risk was minimal and
largely confined to bearing the cost of the interest rate differential between
the rate of the dollar loan and that of the deposit rate in the German or
Japanese money markets. In the late
1960s, the international monetary system had transmogrified into a source of
global liquidity creation that originated from the United States, but also
forced other nations to import this inflation. Inflation-fighting central banks
could not effectively apply restrictive instruments. Given that the interest
rate differential was the prime risk factor for currency speculators, a
restrictive monetary policy with higher interest rates in the revaluation
candidate would attract even more hot money and would have made the speculation
even less risky. Central banks abroad, particularly the German Bundesbank and
the Bank of Japan, massively accumulated US dollars as international reserves
when they held their exchange rates fixed to the dollar at the undervalued
parity, yet by buying up the excess offer of US dollars with their own
currency, these countries expanded their own monetary base and laid the
foundation for inflation at home. In 1971, with
the so-called "Smithsonian agreement", a final attempt was made to
save the old system when the United States devalued its currency against gold
and a series of other currencies. However soon thereafter it became obvious
that for the old regime there was no chance of revival. In 1973, with the
adoption of the new rule that each country could choose its own currency
arrangement, the Bretton Woods System was officially dead. Since then the
US dollar has entered into a long decline, interrupted by two episodes. Under
the Reagan presidency, the Cold War entered into its final period, and the
dollar became the currency of refuge for some time. The US victory in this
battle appeared as a replay of the endings of World War I and World War II with
the United States emerging for a third time on top of the world. In the 1990s,
the triad of global dominance seemed well in place for the United States:
unrivalled military might, a booming and innovative economy, and the status of
undisputed issuer of global currency. The US dollar experienced another period
of strength. Since 2002, however, the long-term trend towards a weaker dollar
is back in place. In the 1990s,
the monetary policy of the United States became an instrument of a grand
geostrategic enterprise. The neoconservative movement took the constellation as
it showed up in the 1990s for granted and implemented a policy that was based
on a philosophy that assumed with almost religious confidence that it was the
duty and right of the United States to be the hegemon in the 21st century. In
contrast to the time after the two world wars, however, the rest of the world
outside of the United States did not lay in ruins. While after the two world
wars, it was the US industrial base that laid the foundation for the role of
the US dollar, now it was not the superiority of the US industrial base that
provided the basis for the global role of the United States but its insatiable
appetite for private and public consumption. The current underpinning of the geostrategic
supremacy play of the United States is the US dollar by itself in its role as
the major international reserve and trade currency. It is a system without a
proper foundation similar to traditions that live on for some prolonged period
of time even when the reasons for their existence have vanished. Imperial
politics requires expansive monetary policy, and the consequence of it shows up
in persistently high trade deficits and a deteriorating external investment
position. The easy monetary policy of the United States has accelerated the
de-industrialization at home and has fostered industrialization abroad
(predominantly in China and in the rest of Southeast Asia); it has produced a
situation that stands in sharp contrast to the end of World War I and World War
II. Under the new BW2 system, the United States is no longer the largest
creditor with the largest industrial base, but instead has become the largest
international debtor and is confronted with a weakening industrial base. Being the issuer
of a global currency provides huge benefits that come with a curse. Increased
private and public consumption possibilities come from the privilege of getting
goods from abroad without the necessity of producing an equivalent amount of
tradable export goods. While other countries have to export in order to pay for
their imports, the sovereign who emits a global currency is exempt from
adhering to the most fundamental law of economic exchange. This sets domestic
resources free for the expansion of the state, particularly military power. The
more such an imperial power extends its military presence around the globe, the
more its currency becomes a global currency, and thereby new expansionary steps
can be financed. Expansion becomes a necessity. Over time, however, the
divergence widens more and more between the weakening industrial base at home
and the extended global role. With goods coming from abroad for which there is
no immediate need to pay with sweat and effort, the domestic culture changes
and power-hungry political elites emerge. In the private sector, the production
of goods at home is substituted by fancy activities. This cycle has been the
fate of all empires. The current
global position of the United States is similar to that of Spain in the period
of its decline. Already economically hollow, Spain tried desperately to hang on
to its outposts and "possessions" around the globe while the domestic
economy became a public-service and militarized economy. In the end, it was
the United States that gave the coup de grace to the Spanish
Empire by taking away Cuba, Puerto Rico, and the Philippines. A new phase of US
geographic expansion and dominance had begun and in 1898 the stage was set for
the United States to become the imperial power of the 20th century. History,
and in particular economic history, always shows both: common features and
differences, and indeed, the American Empire is different from some of the
former empires. Yet what the United States has in common with the former
imperial states is that at some point the military extension becomes too
complex to be handled efficiently and thus the project becomes too expensive. The
discrepancy between the relative position of the US economy in the world on the
one hand and the relative position of the United States as to its military
presence and the role of the US dollar on the other hand is moving towards a
cracking point. This leads to the conclusion that in a world where the economic
strength of the United States is diminishing relative to other countries and
regions, there will be less and less of a place for US dollar privilege. |
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