The dollar is not just America’s means of payment but also the global currency of choice. Dollars are created by the Federal Reserve System at negligible cost, but can be used to purchase goods around the world. While serving as Charles de Gaulle’s finance minister in the 1960s, Valery Giscard d’Estaing referred to this as America’s “exorbitant privilege.”
Giscard thereby both summarized succinctly the benefit to Americans of producing the global currency and provided University of California Professor Barry Eichengreen with a punchy title for his book on the international monetary order.
Eichengreen is an excellent writer and makes intricate issues of money, banking, and trade accessible to the ordinary reader. He has a knack for making the mundane interesting and even at times entertaining. I sing his praises not because I agree with everything he writes; I do not. Nor will readers of The Freeman. If they read the book, however, they will be better informed about international monetary issues.
The book recounts the history of the dollar from humble origins (it evolved from Mexican silver pesos circulating in the colonies) to global dominance, and then possible eclipse. For much of the nineteenth century Britain was the dominant economy and London the world’s dominant banking and financial center, especially for financing international trade.
The rapidly growing U.S. economy gained ground on Britain in the nineteenth and early twentieth centuries. Its banking system, however, remained primitive compared to Britain’s, chiefly due to legal restrictions and regulations. Eichengreen views the creation of the Federal Reserve System in 1913 as a watershed event. I am less inclined to do so, and much more inclined to identify World War I as the transforming event. (Eichengreen gives weight to both.) After the war the dollar became a dominant international currency in a modified gold standard.
After World War II the entire international monetary system was reconstructed around the dollar. The Bretton Woods system defined the dollar in terms of gold and all other currencies in terms of dollars. For the first decade other countries were chronically short of dollars. By the 1960s the United States began abusing its privilege. Dollars were issued in excess, first to finance the Vietnam War and the Great Society’s social programs. Then the Fed under Arthur Burns pursued an inflationary policy to ensure President Nixon’s reelection.
There were chronic budget deficits and balance-of-payments deficits. The great French economist Jacques Rueff remarked that America was able to run balance-of-payment deficits “without tears.”
Eventually, Bretton Woods collapsed when Nixon suspended the conversion of dollars into gold in August 1971. The dollar was now officially a fiat currency, what Wall Street iconoclast James Grant describes as “faith-based” money. To believe in a fiat currency, one must have faith in politicians and central bankers. Such faith has seldom been rewarded.
What followed has been a series of crises, a downward spiral of the dollar interrupted by the Reagan reforms of the 1980s and by overall sound economic policies in the Clinton 1990s. Yet the dollar remains dominant today around the world by almost any measure. Much of the book is devoted to asking why that is so.
Eichengreen repeatedly reminds us that the key question for currency dominance is, “Compared to what?” There are just a few serious candidates to displace the dollar. The euro is the most serious contender, but Europe has more problems than even the United States. The Chinese renminbi is not even a convertible currency. The Japanese yen has never lived up to its potential to rival the dollar. The Swiss franc is a strong currency, but Switzerland is too small a country to produce global money. A few stalwarts believe a return to the gold standard is possible, but Eichengreen gives little credence to such a possibility.
He considers a number of scenarios in which the dollar is replaced by another currency and concludes that only truly bad U.S. policy could cause such a global monetary eruption. (Remember: U.S. policy must be worse than that of its competitors.) The most likely outcome is a multipolar global monetary system: greater use of other currencies, most likely the euro, but continued importance of the dollar. In the context of current events I would call Eichengreen’s thesis the case for dollar optimism.
Exorbitant Privilege is a timely contribution to the discussion of the international monetary order. I recommend it highly.