When President Richard Nixon closed the gold window to foreign central banks in 1971, he ended the Bretton Woods monetary system created after WWII. President Nixon effectively substituted the dollar for gold and in so doing, created an unprecedented era of economic prosperity – and a vehicle for endlessly expanding public debt in the U.S.
In his timely new book, Currency Wars: The Making of the Next Global Crisis, my friend and colleague James Rickards tells the story of currency wars going back more than a century. Rickards lays the ground work for the next phase of global beggar-thy-neighbor in this timely volume, which comes to market as the illusory stability of the post WWII era gives way to a more dynamic and volatile future in the international economy.
How many of us recall that, in addition to ending the convertibility of the dollar into gold, in 1971 President Nixon also imposed wage and price controls and tariffs on foreign goods? Unfamiliar pressures regarding growth and employment forced Nixon, who was at least nominally a conservative Republican, to embrace state intervention in the economy. But similar pressures had already forced Nixon’s predecessors to take like actions during WWI, the Great Depression and WWII, including FDR’s dreadful dollar devaluation in 1932-1933, actions which made the Depression longer and deeper.
Today similar pressures regarding employment and growth confront leaders in the US and other industrial nations. As the age of the dollar as the main global currency seems to be ending, the neoliberal orthodoxy of free trade and global markets is also receding. Thus Rickards begins his book with a bold prediction:
“Today we are engaged in a new currency war, and another crisis of confidence in the dollar is on its way… The new crisis will likely begin in the currency markets and spread quickly to stocks, bonds and commodities. When the dollar collapses, the dollar-denominated markets will collapse too. Panic will quickly spread throughout the world.”
While I agree with Jim that the post-WWII currency framework is collapsing, I do not agree with his assessment that the dollar system will necessarily implode into a crisis. A far more likely scenario, I believe, is that the willingness of investors in other nations to hold dollars is going to decline slowly, but not much because of the dearth of alternatives. Even modest change will force austerity and fiscal constraints on a US population unused to such limitations and also force change on other nations. But speaking as a conservative and unabashed nationalist, I welcome such an evolution. We will emerge from the adjustment the strongest, most competitive nation on earth.
“While the outcome of the current currency war is not yet certain,” Rickards writes, “some version of the worst-case scenario is almost inevitable.” Perhaps.
One of the strengths of this book is that Rickards takes the reader through the history of currency and trade wars over the past century and more, but it also suffers from our collective proximity to the last century of Pax Americana. Can any of us yet write about currency wars with a vision and perspective free of the distortions of the American military victory in WWII and the Cold War?
Whether you look at the US relationship with China, an area Rickards knows and treats intimately, or the present economic turmoil in the European Union, the fact is that all of our problems stem from a US-centric design for global monetary and trade flows. In this regard, the author quotes Hu Jintao, General Secretary of the Chinese Communist Party: “The current international currency system is the product of the past.”
All currency systems are, of course, a function of a bygone era and particularly of the dominant economic power at that time. Prior to the rise of the US as an economic power during WWI, for centuries before the British empire was the dominant political economy in the world. Before WWI, the City of London was the banker to the world. The pound sterling was convertible into gold and acted as a discipline on UK fiscal behavior. By the start of WWI, however, the UK was broke and no longer able to support its currency, thus the newly created Federal Reserve Bank of New York under Governor Benjamin Strong came to the rescue.
Rickards states very plainly that he expects to see nations start to explicitly back their currencies with gold and even other hard commodities, and migrate away from exclusive use of the dollar as a means of exchange and as a reserve currency for global central banks.
“What is the tipping point for dollar dominance,” Rickards asks? “Is it 49 percent of total reserves, or is it when the dollar is equivalent to the next largest currency, probably the euro?” Recent events suggest, however, that the euro is unlikely to become the replacement for the dollar as the dominant global reserve currency, though mostly for political rather than economic reasons.
The author ends his book with a conclusion that is often heard from economists, namely that “the path of the dollar is unsustainable and therefore the dollar will not be sustained.” While such predictions may be welcome grist for the hard money, gold-loving audience which follows the author and is already propelling this book to the top of the league tables, I must disagree.
Rickards posits a return to a gold-backed dollar, the financial collapse of the industrialized world and the reappearance of regional trade blocks as just some of the possible outcomes for the US currency. Such scenarios are red meat for the proponents of gold and metal-backed currencies.
But another possibility is that the U.S. will continue doing what it has done through most of its history and especially since the introduction of the fiat paper dollar during the Civil War, namely use inflation and debt to meet the current need for a means of exchange for the domestic and global economy, even if it means embracing a level of inflation that gradually impoverishes its people. The 99% of Americans who are the focus of the Occupy Wall Street protest are less victims of the rich than of the steady inflation caused by dissolute fiscal policies in Washington and accommodation of growing public debt by the Fed.
But even with the chaotic fiscal policies of America’s democracy, people around the world continue to hold dollars. Why? Rickards does not fully address or answer this key question, again perhaps reflecting the dollar-centric view that is the legacy of WWII and the cold war. But for those of us who have worked in the developing world and seen hyperinflation and political corruption up close, the answer is self-evident.
Rickards rightly notes that the Chinese, Russians and even the EU have the capacity to back their currencies with gold. But so what? The key reason that individuals in the US and around the world use dollars as a means of exchange, even if less and less a store of value, is that America is one of the few nations on earth that still believes that people should be free – to live, work and accumulate wealth. Indeed, the size of the inflating dollar enables this global embrace.
The political restrictions placed on individual freedom in the fascist, authoritarian societies of Europe and Asia makes their currencies unattractive, gold backed or not. Whether you speak to people in Berlin, Moscow or Beijing, the answer to the question — Where would you most like to live? – is almost always the US. All we need to do in the US is start to make gradual, steady changes in our fiscal behavior and we can quickly restore the attractiveness of the dollar as the preferred global reserve currency.
Americans may be crazy and ill-disciplined in matters of money, but we still allow enough personal freedom to our people that there is a chance to achieve life, liberty and the pursuit of happiness – something most of the people of the world will never see save in their dreams. As a young Chinese student named Ping related to Fox Buterfield at the end of his 1982 book, China: Alive in the Bitter Sea: “If China ever opened its doors, everybody would go. To the United States.”
Buy Currency Wars if you want to learn the history and language of the global currency markets and the political economy which they support. But don’t necessarily take as gospel the bearish tone of Rickard’s pronouncements as necessarily being the most likely outcome of this great game.
Currency Wars: The Making of the Next Global Crisis by James Rickards