Exorbitant Privilege: The Rise and Fall of the Dollar and the Future of the International Monetary System
By Barry Eichengreen
A student audience at Peking University laughed in the face of Timothy Geithner, US Treasury secretary, two years ago when he insisted that China’s holdings of US Treasury bonds were “very safe”. Polls showed that 87 per cent of Chinese disagreed with the Geithner view. You can see why they might. The dollar has been the world’s reserve currency since the second world war. That brings prerogatives and responsibilities, and the US has often been keener to exploit the former than to fulfil the latter.
When other countries must acquire your currency to trade, and must keep your money in reserve to protect the value of their own, your securities sell at a premium. You can thus run modest trade and budget deficits painlessly – but not the monster deficits the US has run in recent years. In the wake of a finance crisis, and with a majority of US bonds in the hands of foreigners, Washington might be tempted to inflate away part of its debt. The Chinese are not the only ones with the jitters.
Barry Eichengreen, an economist and political scientist at Berkeley, weaves anecdote and analysis to ask whether the US remains a “worthy steward” of the top currency and, if not, what options the world has. His book is a rare combination of macroeconomic mastery, historical erudition, good political instincts and the sort of stubborn common sense that is constantly placing familiar problems in a new light.
On the eve of the first world war, Eichengreen shows, the Dutch guilder, Belgian franc and Austrian schilling were all more important as reserve currencies than the dollar. The US forbade interstate banking and discouraged an international market in the dollar. This was partly the legacy of President Andrew Jackson, who had thought, correctly, that a national bank would serve elites, an outcome he was willing to pay a high price in economic efficiency to avoid.
The establishment of the Federal Reserve in 1914, and the wobbling of sterling as the war dragged on, changed that. Washington aggressively promoted New York as a financial centre – Eichengreen sees parallels to Chinese efforts to promote Shanghai now – and lobbied European governments to meet their postwar financing needs in the US. “From a standing start in 1914,” Eichengreen writes, “the dollar had already overtaken sterling by 1925”. The view that the pound kept its pre-eminence long after Britain went into eclipse is, Eichengreen shows, an illusion. Sterling looked stronger than it was, partly because imperial reserves were held in it.
Eichengreen stresses “how exceptional was the half-century after 1945 when the dollar reigned supreme”. Unlike today, the most important US currency relationships were with allies – dependent ones at that. Inflationary US policies chased funds into Germany, forcing rate increases that sucked money out of its European neighbours. Otmar Emminger of the Bundesbank described dealing with the dollar as “being in a boat – or a bed – with an elephant”. Dependent on the US military alliance, Europeans had little choice. But US dollar policy eventually became so heedless that, in Eichengreen’s telling, the euro was set up in self-defence.
While Eichengreen does not predict that any rival will soon oust the dollar as a reserve currency, he does think the euro, for all its problems, could dent its predominance. He considers the political concessions the euro’s designers made to national sovereignty (no eurobonds, no country-to-country transfers) untenable over the long term. Some European authority will need to undertake “stronger oversight of national budgets” he says. He may underestimate public resistance to such handovers of sovereignty.
China is further away from threatening the dollar. US protectionism and Chinese military adventurism could both lead to spats, Eichengreen grants, but neither is likely so long as China is so dependent on a strong dollar. In theory, Eichengreen insists, the renminbi’s rise as a global currency is no less implausible than was the dollar’s around 1920. In practice, China would need far more liquid and open financial markets. That would mean a rupture with the tested Chinese model of focusing state capital on export champions.
Right now, the main country threatening the dollar’s pre-eminence is the US. It probably has “less time than commonly supposed” to close its budget deficits and avert a debt crisis, Eichengreen warns. Whether the dollar continues as top currency rests in American hands, he concludes, sounding ambivalent about whether that is good news or bad.
The writer is a senior editor at The Weekly Standard