by Dr. Antony P. Mueller
The performance of the US economy in the 20th century owes much to the predominant role of the US dollar in the international monetary system, and a large part of attaining this role was the result of the political and military supremacy that the United States had gained after World War I. The position of the US dollar in the world today represents a major underpinning of the prosperity at home, and provides the basis for the expansion of the US military presence around the globe.
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.
Dr. 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.
Reprinted with kindly permission of Dr. Antony P. Mueller.