Today's date:
Fall 1987

Adventures of the Dollar

Howard Wachtel - Wachtel is professor of economics at the American University, Washington, D.C. and author of The Money Mandarins: The Making of a New Supranational Economic Order. Using the dollar as the symbol of American power, the following article traces the role of the dollar from postwar guarantor of security and growth to an unstable currency whose value is no longer Justified by America's competitive strength.

The Bretton Woods conference in 1944 established the post-war international monetary order. Although no position was taken on which nation's currency should prevail, the undamaged industrial strength of the US set the stage for the dollar to dominate its only rival, the British pound.

Trying to live an economic preeminence that had been wining for 50 years, the British financed a fiction by raising interest rates. But foreigners felt it wasn't worth holding on to the British currency even at high rates because there was less the world needed that Britain could produce. The British kept the pound too strong, too long until it ultimately collapsed in 1948-49 when the markets told Britain, "You're not an economic powerhouse anymore."

The Bretton Woods framework of dollar hegemony worked successfully for about 25 years because it was premised on the unparalleled economic strength of the US, and the idea that the world economy would grow fastest in an environment of stability and predictability.

For the first 15 years of Bretton Woods, the name of the game had been to obtain dollars in order to trade. But, starting in the late 1950s, central bankers around the world woke up and said, "We seem to have a lot of dollars around" because Europe and Japan had recovered. Since these bankers had grown up with the instabilities of the 1930s, even a slight hint that there were more dollars than really needed to support world trade was frightening. They feared that the US would not hold to the fixed value of the dollar and they would lose money.

Vietnam and the Gold War
As this realization set in, the central bankers began to exercise their right under the Bretton Woods Treaty to convert dollars for gold. They came to the US, which then held 75% of the world's supply of gold, and demanded an ounce of gold for every $35 they held. Only 15 years after Bretton Woods, the system had begun to fracture. In that remarkably short period, we went from a point at which there were not enough dollars in the world system, to a point where the markets signaled that there were too many dollars to justify the export position of the US.

In 1959 and 1960, the desertion of the dollar for gold became headlines. The Gold War had begun. In 1963, French President Charles DeGaulle, feeling that the glory of France could not be rebuilt as long as the American dollar remained paramount, announced he would undermine the dollar by cashing in all of his dollars for gold. That set off a panicky series of crises throughout the '60s that resulted in a hemorrhage of American gold.

The war in Vietnam exacerbated the problem by accelerating the outflow of dollars from the United States. Many of the dollars which financed the US buildup in Vietnam found their way into the coffers of French banks which had an historical connection to Indochina. No matter how much gold he bought, DeGaulle always seemed to have more dollars. When Kennedy came to office in 1960, the US had $18 billion in gold. By 1968, we had lost half of our gold stock, falling for the first time below the psychological barrier of $10 billion. Lyndon Johnson had lost the Gold War because the rest of the world economic players were saying the value of the dollar was not justified by the relative competitiveness of the US economy.

The Nixon Adjustment
On August 15, 1971, Richard Nixon announced that America would no longer honor the gold conversion provision of the Bretton Woods Treaty. This move signaled US acceptance of a privatized, deregulated market in which the dollar would float and find its value vis-à-vis other currencies on a day-to-day, hour-to-hour basis. It also signaled withdrawal from the concept that stable exchange rates would produce a psychology of orderliness and predictability for the growth of world commerce.

The Nixon period can now be seen as a watershed for Pax Americana. Nixon implicitly recognized the shifting position of US hegemony by delinking the dollar, seeking to end the Vietnam war, and pursuing detente with the Soviet Union and an opening to China.

As the Nixon gold shock was absorbed, everyone thought a triumvirate of currencies from the three blocs - the US, Japan and German-led Europe - would evolve, reflecting the rough disposition of economic power in the world. But that didn't happen.

Eurodollars and the OPEC Detour
In 1973, OPEC raised oil prices, quadrupling their income from a little under $4 a barrel to $12 a barrel. Since the OPEC countries only accepted payment in dollars, countries which needed oil once again had to scurry about to get dollars. As a result, although the US trading and economic position did not justify the preeminence of our currency, the inflated dollar-denominated oil prices meant we were back to the situation of the 1950s.

The OPEC price increases vastly elevated the role of the Eurodollar system - a private money system of dollars held in banks outside the US. The OPEC countries deposited their hundreds of billions in accounts from the Cayman Islands to Geneva. They were afraid that in the case of war with Israel, their assets might be seized if deposited inside the US. The Eurodollar system became a freewheeling, private, unregulated world monetary system which circulated about $100 billion in 1973. Today, it circulates in the range of $2 trillion - an amount as large as the domestic money supply in America!

Since the function of even unregulated banks is to lend money, new outlets had to be found for the hundreds of billions on deposit. An obvious market to which the OPEC funds soon flowed was the Third World. These countries, especially the rapidly growing nations of Latin America like Brazil and Argentina, were still developing an industrial base that required tremendous capital investment. Around $400 billion was recycled into Third World debt.

Back on Course
By the late 1970s, there was a huge increase in the dollars floating around the world economy - the rate of growth in dollars between 1973 and 1980 was 20 times the growth in volume of trade. Dropping oil prices and the Latin debt problem again unmasked America's relative loss of competitiveness. Money was ballooning on a very small base of trade and real economic activity. Something had to give.

As could be expected, something did. Holders of dollars decided they weren't going to take a bath and stay with a currency that surely would devalue.

They moved into Swiss francs, German marks, Japanese yen, gold or silver. The dollar fell in value as those currencies and commodities rose. In the face of this predicament, Paul Volcker did exactly what the British had done 30 years earlier. In a dramatic set of events, he embraced monetarism, rapidly reduced the rate of growth of the internal money supply and let interest rates rise as high as 21% in the space of a year and a half!

Instead of choosing to export competitively in order to justify the value of the dollar, the Carter Administration chose to import more capital by bringing the dollar home with high interest rates. So, the fate of the US economy became joined to the rollercoaster fortunes of the Eurodollar market, and the supranational monetary order became the key influence over America's economic future. As in Britain decades earlier, high interest rates sent money chasing money in speculation rather than production.

Now, while the US had been turning into a financial facade, the Japanese had cleverly manufactured and promoted high-quality products. They had also kept the yen low enough to make their products attractive internationally. As a result, they accumulated an enormous war chest of dollars but they ran out of places to put those dollars. So, they too turned to financial manipulations. In 1987, Nomura Securities surpassed Toyota as Japan's most profitable company. It took the British 50 years to move from an industrial economy to a financial facade; it took us 20 years. It may take the Japanese only 10.

Meanwhile, in the '80s, Treasury Secretary Donald Regan saw the strong dollar as a symbol of the resurgence of American power even though our industrial base was doubled over by competitive pressures. That worried James Baker, the next Treasury Secretary, who saw clearly that we were headed toward an enormous trade deficit. So, Baker took the position that the dollar was overvalued and resolved to negotiate its decline.

But the trade deficit hasn't closed, and it won't close until the US improves its export competitiveness by rebuilding its industrial base. The next turn of events is that the dollar will likely take a beating and then interest rates will once again rise.

What Is To Be Done?
America must get back on track as a power sharing nation that can sustain a high wage employment base and export to the rest of the world. The first thing we need to do is extend the kind of regulation of growth that the Federal Reserve now exercises over dollars in the United States to Eurodollars. Second, we need to develop a stable target zone for exchange rates so that a reasonable level of predictability exists in world commerce. Third, we need closer coordination of interest rates among the industrial nations so that productive activity is nor buffeted and resource allocation is not driven by freewheeling speculative forces. Fourth, we need to set up an international debt authority that would purchase Third World debt at a discount from private banks and provide development capital to help debtor countries grow out of debt.

But most importantly, we need to return to the priorities which made the postwar period the most prosperous ever. Since the loss of the Gold War, purchasing-power-led growth has given way to a low-cost monetarist strategy that calls for depression of wage increases and lowering real purchasing power around the world. In a global economy where America must rely on exports to avoid a falling standard of living, we must return to the notion that the way to achieve growth is through higher purchasing power and income, both at home and abroad.

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