By Francis Lee for the Saker Blog
It was the French politician Valery Giscard D’Estaing who first coined the phrase ‘Exorbitant Privilege’- a reference to the many advantages enjoyed by the US ownership and control of the world’s reserve currency. This was a situation dating back to the agreement reached in 1944 between the allied powers and established in Bretton Woods a town in New Hampshire; it was to become known as the Bretton Woods Agreement. During the conference key negotiators, most famously John Maynard Keynes for Britain, and Harry Dexter White chief US delegate, hammered out a blueprint for a new global and currency and trading system. Keynes explained the central idea as ‘the expansion of a currency union, based upon international money, called … bancor, fixed (but not unalterable) in terms of gold and accepted the equivalent of gold … by all members of the Union for the purpose of settling international balances.’
This didn’t go down at all well with White who was now given the nod by Secretary of the US Treasury, Henry Morgenthau, who announced ‘’He …’ White’… will be in charge of all foreign affairs for me. I want it in one brain, and I want it in Harry White’s brain.’’ Given that sort of backing White was to call the shots on monetary policy. The battle between White and Keynes would become one of the grand political duels of WW2 although it was largely buried in financial minutiae. Thus the US$ backed by gold at the parity of 1 oz gold = $35, was to become the reserve currency of the global system. (1)
But then Keynes was somewhat hamstrung in this situation since he was also angling for a sizeable US loan to the UK in the not-too-distant future which circumscribed his room for manoeuvre; and the loan of course came with strings – viz., the ending of the British imperial preferential trading system with her empire and dominion partners and the opening of these markets for US capital flows. (The loan finally came to fruition shortly after Keynes’ death in 1946.) At that time Britain was bankrupt as were the other European powers and its bargaining position was relatively weak vis-à-vis the Americans who had emerged from the war by far and away the strongest economy in the world. Little wonder then that the British and Europeans had little choice in acceding to American proposals. This was the start of the post-war US economic and political dominance of Europe – firstly in Western Europe and then later in Eastern Europe – by the United States which has continued (and even expanded) to this day.
The Bretton Woods monetary system (BWS) was based upon a relatively fixed exchange-rate with the base consisting of a dollar-gold standard. The US$ would be fixed against gold at $35 per ounce, and fully convertible. The rest of the hard currencies, UK pounds, French Francs, Italian Lira, German Marks and so forth, would have a given parity rating against the dollar albeit with limited room for changes in their exchange rate. The fixed exchange rate in fact became a currency peg whereby individual states could devalue/revalue by 1%. Both financial repression, capital controls and exchange rate controls were a feature of the system. Thus, this financial repression was a key institutional facet of the BWS – and if Keynes had had his way it would have been a permanent feature.
This system appeared to work during the period of rapid expansion in Western Europe circa 1950-70, North America, Australia and Japan, all of which experienced high levels of growth, low inflation and low unemployment. Although, undoubtedly, other causal factors included post-war reconstruction and the Marshall Plan.
The BWS also spawned the International Monetary Fund (IMF), International Bank for Reconstruction and Development (World Bank) and the General Agreement on Tariffs and Trade (GATT) now renamed the World Trade Organization (WTO) which still remain, although their present remits remain profoundly changed from the original purposes. For better or worse the BWS collapsed (or was collapsed) in August 1971 when the Nixon government ended the gold/dollar convertibility. This was to a considerable extent due to the costs of the Indo-China wars and President Johnson’s domestic spending on the ‘Great Society’ social programmes. Additionally, there was the catch-up in productivity of the recovering states, Germany and Japan in particular. These events had led to recurring US trade deficits with a concurrent outflow of US$s. The Europeans, particularly the French were cashing in their surplus US$s for gold which led to an outflow of gold from the US which the American authorities needed to stem – by drastic measures if necessary. These drastic measures amounted to a de facto default when dollar/gold convertibility on demand formally ended in August 1971. These events could be properly described, using the much-overused cliché, as being a paradigm shift.
This set the stage for a new world of floating currencies, uncontrolled capital flows, privatisation, deregulation and the rest of the neo-liberal ideological policy baggage. But even before the momentous events of August 1971 there was considerable resentment at what was a de facto subsidy to the US from the rest of the world. The US still continued to run massive trade deficits after all the brouhaha with the abandonment of dollar/gold convertibility. But there were problems from the outset with this policy.oHo When a country runs quasi-permanent trade deficits there will be a downward pressure on the value of its currency. This might be enough to dissuade global investors to view holding dollars or dollar denominated assets such as US Treasury Bonds as being problematic. The US was able to circumvent this obstacle, however, when Henry Kissinger cut a deal with the Saudis in 1973/74, in which it was agreed that the Saudis would invoice their oil sales in US$s only. This meant that since oil was on the shopping list of nearly all states, the dollar was also in demand, and this demand pushed up the value of the greenback. Thus, the Petro-dollar was born. The US was able to carry on with running deficits on current account, consuming foreign products at subsidised prices. An exorbitant privilege indeed.
Consideration of the many advantages of the US$ as the world’s reserve currency is generally understood by the term ‘seigniorage rights’, this is the name of the privileges which this position gives, and which had accrued from the Bretton Woods system still remain; perhaps the most important is that of the US being able to print dollars which are recognised as viable stores of value universally. As Barry Eichengreen points out:
‘’A … controversial benefit of the dollar’s international currency status is the real resources that other countries provide the United States in order to obtain our dollars. It costs only a few cents for our Bureau of Engraving and Printing to produce a $100 bill, but other countries have to pony up $100 of actual goods and services in order to obtain one.’’ (2)
Moreover, there are the savings in what economists’ call ‘transactional costs’ of doing business. For example, take a European or south American business firm who want to borrow to finance investment or receive payments for goods exported these business activities will be intermediated by the US$. If a French firm wishing to export goods to Pakistan and receives payment in US$s they will have to convert those dollars into Euros, and this implies an additional (transactional) cost for the French firm. If the firm was American, however, the payment will be in dollars as will any other debt repayments. The United States can nominate debts in its own currency and save itself from conversion costs.
At a higher level, if a non-American business wants to borrow dollars in the US money markets for investment purposes he will be exposed to any movement in the value of the dollar. Consider an investor in Thailand who borrows in dollar and invests in a particular project in a medium-term enterprise. But woe betide this entrepreneur should there be a rise in US interest rates and consequent rise in the exchange rate against the borrower’s domestic currency, since he will now have to find additional monies in his own devalued currency to pay back the enhanced value of the dollar loan. This is a problem which plagues emerging market economies who are using a foreign currency which they do not print and cannot control.
Furthermore, central bank liquidity around the world was 60% held in dollars and dollar-denominated assets, principally US Treasuries. China and Japan being the biggest holders although China is now quietly diversifying its foreign asset portfolio (more of China in due course). But the dollar dominance retains its position due to historical factors which no longer pertain; in this sense it owes this position through incumbency; it is there, because it is there, or put another way, it benefits because of first mover advantage. These advantages include the following.
‘’The dollar remains far and away the most currency for invoicing and settling international transactions, including exports and imports which do not touch America’s shores … The principal commodity exchanges quote prices in dollars. Oil is priced in dollars (see below, the Petro-Yuan). The dollar is used in the majority of all foreign exchange transactions worldwide. It includes nearly half the global stock of international debt securities.’’ (3)
Moreover, insofar as the demand for dollars from foreign firms and banks has been absolute the price of these dollar denominated assets – in the case of Treasuries – has seen buoyant prices and lower rates of interest for the foreign holders due to the fact that bond prices and interest rates move in opposite directions. Foreign institutions holding dollars will get 2 to 3 % points lower interest than American holders of American financial securities.
Here we have a situation where the US is not only gaining from securities trading but also because as foreign buyers of US Treasuries – overwhelmingly China and Japan – had been recycling their export dollar earnings back into the US and therefore keeping long term US interest rates at record lows. Moreover, even when the dollar declines in value there is no serious impact on the dollar since the US denominates its debts in its own currency. Dollar holdings of foreign assets actually increase in value as the dollar falls due to a relative revaluation of these assets. Moreover, we are also reminded that in times of crisis there is always a ‘flight to safety’ by investors into the dollar particularly including US Treasuries.
Thus, global dollar dominance is not just about economics but also includes a significant geopolitical dimension. American financial and economic power rests on the nexus of the Fed/The Treasury Department/Wall Street/Silicon Valley nexus, and the cultural/political legs; a dominance which not only survived the collapse of the Bretton Woods System and the great blowout in 2008. US hegemony is, in Europe at least, not a theory, but a fait accompli.
Janet Yellen has been central to this configuration. First as Chairperson of the Fed which is a private banking consortium. And lately, Secretary of the Treasury which is a department of state. Could there possibly be a conflict of interests here? Just asking?
‘’The central political fact is that the dollar standard places the direction of the world monetary policy in the hands of a single country which thereby acquires great influence over the economic destiny of others. It is one thing to sacrifice sovereignty in the interests of interdependence; it is quite another when the relationship is one-way. The difference is that between the EEC(EU) and a colonial empire. The brute fact is that the acceptance of a dollar standard necessarily implies a degree of asymmetry in power which, although it actually existed in the early post-war years, had vanished by the time that the world was sliding into a reluctant dollar standard.’’ (4)
All very peachy for the US$.
However, given the existence of human frailties it is commonly understood that you can have too much of a good thing, or that a privilege which is open to abuse will be abused. And this is exactly what has been happening to the US and its global dollar policy. To cite an example the ‘Fed’s’ method of dealing with record levels of debt and deficits has been simply to create more debt, through rolling over existing debt and adding new debt. This of course is the definition of a Ponzi scheme; and all Ponzi schemes eventually meet the same fate. US Sovereign debt which was 40% GDP in 2000, 105% of GDP in 2018, and 108% in 2021. It has been argued by prominent US economists Reinhart and Rogoff that when an economy reaches a growth to debt ratio of 90 percent or above it will start to lose traction and enter a long decline. This has been disputed by other academic economists who seem to think that the situation of growth can be maintained, albeit with occasional disruptions, in perpetuity. But nothing lasts for ever; at some stage, the debt has to be liquidated since it has become a permanent impediment to further growth. There must be an unprecedented and massive event, or series of such events, needed to bring about this restructuring. Whether this will be the final crisis of capitalism is a moot point. I for one am not prepared to put a date on it.
Moreover, In addition to US Sovereign US$ 21 trillion debt, total debt in US including municipal debt, household debt, personal debt, and corporate debt rose to 60 trillion dollars, by 2014 – bear in mind also that these figures exclude unfunded future liabilities such as Social Security, Medicaid and Medicare, which according to a recent article by John Maudlin in Forbes magazine October 2018 is somewhere between US$47 trillion and US$210 trillion. Total US household debt at present stands at $12.58 trillion, almost as much in nominal terms as right before the 2008 financial crisis, which was triggered by the failure of the mortgage-backed securities market. Most of these figures are out of date but it would be reasonable to assume that they have if anything not been able to stop their dizzying ascent, and even the Fed’s report anticipates that these levels will be surpassed sometime in the coming years. Then there is the trade debt owed to overseas purchasers of US Treasuries which becomes payable as these bonds reach maturity.
None of this would matter if national income (GDP) were growing faster than debt, but unfortunately the reverse is true: debt is growing faster than national income GDP. Instead of growing its way out of debt, the US is actually growing its way into deeper debt. (David Ricardo’s dreaded law of diminishing returns seems to be in play here.)
The US budgetary position is heading toward a critical denouement with spending deficits spiralling out of control, against a background of weak economic growth.
Of course, these debts will never be repaid, and a huge default is on the cards. This will take the form of an outright refusal to honour the debts in question, or more likely, a default by the back door – inflation.
‘’The fate of the dollar hinges, in this case, on US budgetary policy. And here there are grounds for concern. First there is the overhanging deterioration in the fiscal position even before the 2008 blowout … Next there are the eye-popping deficits resulting from the 2008 crisis. Budget deficits were unavoidable given the circumstance; tax receipts collapsed. But the resulting deficits were enormous: the 11% of GDP in 2009 was not just unprecedented in peacetime; it was larger than the national income of all but six other countries in the world … (Now) there is the prospect of even larger deficits as the baby-boomers start to retire in large numbers raising health and pension costs.’’ (5)
That was then. Now we have a crisis of considerably greater dimensions, and as we have seen, the whole show will only be kept going by artificially supporting the price of oil. To keep the permanent demand for dollars going, oil sales must remain in dollars. But will they? At this point China enters the fray. Chinese trade policy is based upon gradually weaning itself off holding US Treasuries. It has been a slow but inexorable process. In addition, China along with Russia and Iran are pricing their energy trade in their own currencies. Moreover, this increasingly integrating and coalescing Eurasian counter-hegemonic alliance has been amassing gold to enable its currency diversification away from the dollar fiat standard. It would not be an overstatement to suggest we are witnessing the beginnings of a new Eurasian gold standard.
The term ‘existential threat’ to US hegemony now has significant meaning with the emerging Eurasian bloc and the economic power of China as realised in the ascent of the Yuan and a Petro-Yuan currency. These developments should not be overstated, but unquestionably we are at the beginning of that process.
Moreover, there is a little problem that goes by the name of the ‘Triffin Dilemma’ to be considered. Robert Triffin, a Belgian economist, postulated that the country which issues a reserve currency – at the present time, the US – has to run trade deficits to ensure there is a satisfactory supply of the reserve currency for it to function as such. There is a complacent assumption by the Americans that this is a continuing process, which will always ensure demand for the reserve currency. A type of perpetual motion machine not too different from any of the get-rich-quick, something for nothing rackets currently touted. But as Professor Triffin pointed out, possession of a reserve currency is a short-term expedient that creates a longer-term problem. There is also the problem that the dual role of the dollar to 1. Function as a flexible domestic currency, and 2. Function as a global anchor currency, which means that it must remain invariant – but these roles are mutually exclusive. That is the Triffin dilemma.
‘’Turning to the Triffin problem faced by the dollar. Just at the moment when the role of the petrodollar is being undermined by the new yuan contract, and the non-American world is still awash with dollars following the last financial crisis, President Trump increased the budget deficit, and consequently we can expect the trade deficit to increase further as well.
There can only be one result, and that is substantial and sustained selling of the dollar on the exchanges. It is reminiscent of the situation in the mid to late 1960s, when returning dollars led to three distinct failures: a failed attempt to absorb dollar sales for gold by setting up the London gold pool, a failed devaluation of the dollar from $35 to $42.22, and finally the collapse of the Bretton Woods Agreement in August 1971. That was the last great Triffin unwind, and now the next one is in prospect.
Foreign holders of dollars, including China, will wake up to the threat, if they have not already done so. So far, China has been reluctant to undermine the dollar by threatening its reserve status. She is, after all, a very large holder of both dollars and US Treasuries. But China’s priorities are now changing, and the outlook for the dollar has suddenly become a less urgent priority.
The nettle that China must grasp is that her mercantilist plans for the Asian continent are leading to the decline of American influence. There comes a point where she cannot pursue her own objectives without undermining the dollar, and with the introduction of the yuan-settled oil future, that Rubicon has now been crossed. (6)
Anticipating the usual sneering response from the Atlanticist financial crowd, i.e., China cannot and will not dump the dollar since that would mean a big hit on those dollars and Treasuries that China already holds; they would do well to note MacLeod’s observation that ‘China’s priorities are changing, and the outlook for the dollar has become a less urgent priority.’’ Quite so.
History moves on, with new political and economic cleavages and fusions emerging together with an increasing momentum in the decline of the post-1945 World Order. How long will the rest of the world put up with the free lunch of the global dollar or the protection racket that is NATO is a matter of conjecture. Unquestionably, however, these two pillars of the Anglo-Zionist empire look to be increasingly unstable and frankly parasitic.
We shall wait, and we shall see.
(1) Robert Skidelsky – Volume 2, John Maynard Keynes – Fighting for Britain -pps.222/239
(2) Barry Eichengreen – Exorbitant Privilege – The Rise and Fall of the Dollar – p.3
(3) Ibid. Eichengreen)
(4) John Williamson – The Failure of International Monetary Reform 1971-74 – 1977)
(5) (Ibid. Eichengreen)
(6) Alasdair MacLeod – The Yuan-Oil Future and Gold 29 March 2018 – Goldmoney)