A history of global reserve currencies

Michael Pettis in The FT

The US dollar, analysts often propose, is the latest in a 600-year history of global reserve currencies. Each of its predecessor currencies was eventually replaced by another, and in the same way the dollar will eventually be replaced by one or more currencies.  

The problem with this argument, however, is that there is no such history. The role of the US dollar in the global system of trade and capital flows is unprecedented, mainly because of the unprecedented role the US economy plays in global trade and capital imbalances. The fact that so many analysts base their claims on this putative history only shows just how confused the discussion has been.  

It’s not that there haven’t been other important currencies before the dollar. The history of the world is replete with famous currencies, but these played a very different role in the flow of capital and goods across international borders. Trade before the days of dollar dominance was ultimately settled in gold or silver. A country’s currency could only be a “major” trade currency to the extent that its gold and silver coins were widely accepted as unadulterated or, by the 19th century, if the convertibility of its paper claims into gold or silver was highly credible.  

This is not just a technical difference. A world in which trade is denominated in gold or silver, or in claims that are easily and quickly convertible into gold and silver, creates very different conditions from those today. Consider the widely-held belief that sterling once ruled the world in much the same way the dollar does today.  

It simply isn’t true. While sterling was indeed used more than other currencies in Europe to settle trade, and the credibility of its conversion into gold was hard-earned by the Bank of England after the Napoleonic wars, whenever sterling claims rose relative to the amount of gold held by the Bank of England, its credibility was undermined. In that case foreigners tended to reverse their use of sterling, forcing the Bank of England to raise interest rates and adjust demand to regain gold reserves.¹ 

This does not happen to the US dollar. Trade conditions under gold- or silver-standards are dramatically different from those in a dollar world in at least three important ways. First, trade imbalances in the former must be consistent with the ability of economies to absorb gold and silver inflows and outflows. This means that while small imbalances were possible to the extent that they allowed wealthier economies to fund productive investment in developing economies, this was not the case for large, persistent trade imbalances — except under extraordinary circumstances.²  

Second, and much more importantly, as trade imbalances reverse, the contraction in demand required in deficit countries is matched by an expansion in demand in surplus countries. That is because while monetary outflows in deficit countries force them to curtail domestic demand to stem the outflows, the corresponding inflows into the surplus countries cause an automatic expansion of domestic money and credit that, in turn, boosts domestic demand. Under the gold- and silver-standards, in other words, trade imbalances did not put downward pressure on global demand, and so global trade expansion typically led to global demand expansion. 

And third, under gold and silver standards it was trade that drove the capital account, not vice versa as it is today. While traders chose which currency it was most convenient in which to trade, shifting from the use of one currency to another had barely any impact on the underlying structure of trade. 

None of these conditions hold in our dollar-based global trading system because of the transformational role played by the US economy. Because of its deep and flexible financial system, and its well-governed asset markets, the US — and other anglophone economies with similar conditions, eg the UK, Canada, and Australia — are the preferred location into which surplus countries dump their excess savings. 

Contrary to traditional trade theory, in which a well-functioning trading system might involve small, manageable capital flows from advanced, capital-intensive economies to capital-poor developing economies with high investment needs, nearly 70-80 per cent of all the excess savings — from both advanced and developing economies — is directed into the wealthy anglophone economies. These in turn have to run the corresponding deficits of which the US alone typically absorbs more than half. As I have discussed elsewhere, this creates major economic distortions for the US and the other anglophone economies, whose financial sectors benefit especially at the expense of their manufacturing sectors. 

It is only because the US and, to a lesser extent, the anglophone economies, are willing to export unlimited claims on their domestic assets — in the form of stocks, bonds, factories, urban real estate, agricultural property, etc — that the surplus economies of the world are able to implement the mercantilist policies that systematically suppress domestic demand to subsidise their manufacturing competitiveness. This is precisely what John Maynard Keynes warned about, unsuccessfully, in 1944. He argued that a dollar standard would lead to a world in which surplus and deficit countries would adjust asymmetrically, as the former suppressed domestic demand and exported the resulting demand deficiency. 

The point is that dollar dominance isn’t simply about choosing to denominate trading activities in dollars the way one might have chosen, in the 19th century, between gold-backed franc, gold-backed sterling, or Mexican silver pesos. It is about the role the US economy plays in absorbing global savings imbalances. This doesn’t mean, by the way, that the US must run permanent deficits, as many seem to believe. It just means that it must accommodate whatever imbalances the rest of the world creates. 

In the fifty years characterised by the two world wars, for example, the US ran persistent surpluses as it exported savings. Because Europe and Asia at the time urgently needed foreign savings to help rebuild their war-torn economies, it was the huge US surpluses that put the dollar at the centre of the global trading system during that period. 

By the 1960s and 1970s, however, Europe and Asia had largely rebuilt their economies and, rather than continue to absorb foreign savings, they wanted to absorb foreign demand to propel domestic growth further. Absorbing foreign demand means exporting domestic savings, and because of its huge domestic consumer markets and safe, profitable and liquid asset markets, the obvious choice was the US. Probably because of the exigencies of the cold war, Washington encouraged them to do so. Only later did this choice congeal into an economic ideology that saw unfettered capital flows as a way to strengthen the power of American finance. 

This is why the end of dollar dominance doesn’t mean a global trading system that simply and non-disruptively shifts from denominating trade in dollars to denominating it in some other currency. It means instead the end of the current global trading system — Ie the end of the willingness and ability of the anglophone economies to absorb up to 70-80 per cent of global trade surpluses, the end of large, persistent trade and capital flow imbalances, and, above all, the end of mercantilist policies that allow surplus countries to become competitive at the expense of foreign manufacturers and domestic demand. 

The end of dollar dominance would be a good thing for the global economy, and especially for the US economy (albeit not, perhaps, for US geopolitical power), but it can’t happen without a transformation of the structure of global trade, and it probably won’t happen until the US refuses to continue absorbing global imbalances as it has for the past several decades. However it happens, a world in which trade isn’t structured around the dollar will require a massive transformation of the structure of global trade — and for surplus countries like Brazil, Germany, Saudi Arabi, and China, this is likely to be a very disruptive transformation. 

1. Nor was sterling even the leading trade currency in the 18th and 19th centuries. More widely used in much of Asia and the Americas were Mexican silver pesos, whose purity and standardisation were much valued by traders and so formed the bulk of trade settlements. 

2. One can argue that the closest comparison to today was 17th century Spain, when Spain ran large, persistent trade deficits, but of course these were the automatic consequences of huge inflows of American silver, and Spain didn’t accommodate foreign imbalances so much as create them, to the benefit especially of England and the Netherlands. In a recent conversation George Magnus also noted how the famous sterling balances of the 1940s illustrated another — very different — example in which the structure of trade could not be separated from the use of its underlying currency.  

Why We Can't Retire

 

The con behind every wedding

Anon in The Guardian

A lavish wedding, a couple in love; romance was in the air, as it should be when two people are getting married. But on the top table, the mothers of the happy pair were bonding over their imminent plans for … divorce.

That story was told to me by the mother of the bride. The wedding in question was two summers ago: she is now divorced, and the bridegroom’s parents are separated. “We couldn’t but be aware of the crushing irony of the situation,” said my friend. “There we were, celebrating our children’s marriage, while plotting our own escapes from relationships that had long ago gone sour, and had probably been held together by our children. Now they were off to start their lives together, we could be off, too – on our own, or in search of new partners.”

It’s bittersweet, this clash of romantic hope and lived experience. I am living it now, yo-yo-ing between the wedding plans of my daughter and son, both in their 20s, and the fragility and disappointment of my own long marriage. My days seem to be divided between excited chat about embryonic relationships that are absolutely perfect, and definitely going to last for ever, and remote and cold exchanges with a husband who has disentangled himself emotionally from me, and shows no signs of wanting to reconnect (I have suggested Relate many times; he is simply not interested).

To some extent, this juxtaposition of young love and old cynicism was ever thus: throughout time, weddings have featured, centre-stage, a loved-up duo who believe their devotion to one another will last for ever, while observing from the wings are two couples 30, 35 or more years down the line, battle-scarred by experience, and entirely devoid of rose-tinted spectacles – the parents of the bride and groom. And in the generation of “silver splitters”, these sixtysomethings are more likely than ever to be in the process of uncoupling, at the precise moment when their offspring are embracing the dream of lifelong partnership.

So how do we reconcile our cynicism – or, at best, our scepticism – for marriage and long-term love, with our offsprings’ enthusiasm to tie the knot, and embark on a life of seeming marital bliss? On one level, the phenomenon is heartwarming. It is testament, you could argue, to the resilience of the human spirit: however difficult our own marriages turned out to be, we war veterans look at our kids staring into each other’s eyes, and we melt inside. Yes, we think to ourselves, we made mistakes; we took paths that turned out to be wrong. Even, we think, we made fundamentally bad choices: we married the wrong men.

As a result, love was seriously skewed for us: but in the next generation – we nod our heads vigorously to this, while cheerily agreeing to a no-holds-barred expensive wedding – things will be different. True love will be theirs; the fairytale that eluded us will work for them, at last.

What hokum. As the survivor of a difficult marriage, this much I know: the biggest burden is the disappointment. And it is a disappointment born on my own wedding day in 1985: more than three decades later, the hopes of that morning still glint from the shadows. The expectations heaped on us, including by my in-laws whose own miserable marriage still had another two decades left to torture them, are the ghosts around the sad embers of our once-glowing fire.
So what can we do differently? Here’s the truth of it, as a wise friend said to me recently: in the 21st century, in a world in which women as well as men have choices and independence and long lives (all good), it will be increasingly difficult for one individual to answer the emotional, spiritual and physical needs of another, across many decades. Life is different now: we have bigger imaginations, we have higher expectations, we have more opportunities and, crucially, those opportunities continue well on into our 50s, 60s and 70s – and for all I know, into our 80s and 90s too. Even more significantly, we women have these opportunities: for men, they are less of a novelty. But their more widespread existence is the agent of seismic change in intimate relationships. We no longer need to put up with misery; we can alter the way we live.

I suggest that we, the parental generation, take a subtle lead in being honest with our twenty- and thirtysomethings about the realities of relationships, and love, and longevity, and choices. That we stop buying into the burgeoning and ever-more-elaborate wedding industry, a giant luxury liner that sails full-steam ahead, oblivious to the lifeboats and shipwrecks all around it in the water. At least begin to ask questions of the commercial interest that operates that liner, of its intentions and its fallout (not to mention its profits). There is more than coincidence, surely, in the way we seem to invest more and more resources in marriages that are less and less likely to survive.

How we introduce these notes of caution into our children’s lives is a much more difficult task. As parents, we want nothing more than happiness for our offspring: none of us wants to burst their bubble, at the precise moment it is so expanded.

As so often with parenting, though, we have to take the longer view. Sometimes I think that, even though my children may not understand or welcome some of the messages they get from me now, with me in my mid-50s and them in their mid-20s, there may be moments in the future when what I said, or how I behaved, suddenly makes sense. Parenting means filling your children’s backpack with supplies, and some of the supplies down the bottom of the bag may not be needed for many years to come.

One important factor in all this was raised by Sylvia Brownrigg in these pages earlier this year, and it is this: children are not interested in their parents’ relationships. They’re not interested in their parents’ marriage (beyond hoping that it is incident-free, and as calm as possible) and they are certainly not interested in their parents’ other relationships, if those happen or are ongoing. So we cannot weigh them down with the detail of why our marriages are failing, or unhappy, or disappointing – and yet, we must somehow signal to them that life is a long journey, and that it may be a mistake to invest too much in one central relationship on into the far distant future.

We are pioneers, us fifty- and sixtysomething mothers; we are walking a tightrope, and it is difficult to get the balance right. Sometimes we wobble; sometimes we fall right off. But the fact that we are walking the tightrope at all is the important bit. We are trying to be authentic, to our burnt-out marriages and to ourselves, as well as to our children and the realities of their future.

And choices cut both ways, too. Remember those mothers at the wedding party? My friend, as I say, is now divorced; but the bridegroom’s parents are having counselling, and have not ruled out the possibility of sharing their lives again.

Being more ambitious for ourselves doesn’t mean our marriages can’t survive, but it does mean a bad marriage can only survive if it can change. And that surely is the message, and the hope, we want to give our children, as they taste the realities of long-term love, or long-term what-was-once-love, and what just possibly might be love once again.

How far can privatisation go? Perhaps government itself could be outsourced

The 'selling of the family silver' that began in earnest under Thatcher is still in train; sometimes I wonder if the entire political class should be put out to tender

• 
• • Ian Jack
  • The Guardian, Friday 6 December 2013 18.30 GMT

Widespread privatisation was a key pledge in Margaret Thatcher’s 1983 election manifesto. Photograph: Chris Capstick/Rex Features

The phrase "selling the family silver" became the most celebrated if not the deepest criticism of Mrs Thatcher's privatisation programme, though Harold Macmillan never used those exact words. At a dinner of the Tory Reform Group – wets, moderates, Europhiles, none of them "one of us" – the former prime minister devised a more extended metaphor that drew on an aristocratic lifestyle that had been failing since its heyday in his Edwardian childhood. When individuals or estates ran into financial trouble, he said, they would commonly sell a few of their assets. "First the Georgian silver goes [laughter, applause]. Then all that nice furniture that used to be in the saloon. Then the Canalettos go [laughter, applause]."

He began to wander a bit. "And then the most tasty morsel, the most productive of all, they got rid of Cable and Wireless, and having got rid of the only part of the railways that paid, and a part of the steel industry that paid, and having sold this and that, the great thing of the monopoly telephone system came on the market. They [sic] were like the two Rembrandts that were still left [laughter] and they went, and now we're promised in the king's speech a further sale of anything that can be scraped up. You can't sell the coalmines, I'm afraid, because nobody will buy them [laughter, prolonged applause]."

When Macmillan made the speech, on 8 November 1985, he was 91 and had just over a year left to live. He still cut an attractive figure – the inverted V of his bow tie matched the weary droop of his moustache and eyebrows – though his reference to the king's speech suggested that a few marbles were coming unstuck in what was once one of the sharpest minds in British politics. The audience loved him. He was the last British prime minister to have served in the first world war, where he was badly wounded, and the last born during Victoria's reign; a "born actor", people said, because he was always so effortlessly droll. His references to oil paintings and precious tableware, his correct but vintage use of the word "saloon": this kind of thing endeared him to the public for much the same reasons as Downton Abbey did 25 years later – as an amusing and slightly camp version of a previous age.

He disavowed the speech only a few days afterwards, telling the House of Lords that he'd been misunderstood. All he was questioning was the government's wisdom in treating the capital raised by privatisation as income; as a Conservative he was "naturally in favour of returning into private ownership … all those means of production and distribution which are now controlled by state capitalism". But the metaphor had made its mark, and the fact is that Macmillan's "family silver" and British Gas's "Tell Sid" slogan are probably the most-remembered phrases from the early years of the war against public ownership. Oddly, given that privatisation was to have such profound effects on British life, both in their different ways raised a smile; did we know what was coming?

At the time of Macmillan's speech, privatisation had hardly begun. British Rail's ferries and hotels were the first to go (how strange it now seems that the best hotels in almost every city outside London were owned and run – usually well – by public servants in the most literal sense). But British Telecom, British Steel, British Airways, British Shipbuilders and Rolls-Royce – all of them listed as targets in the Tories' 1983 manifesto – had still to complete their journey from the public sector, and the big privatisations that that would affect every household had yet to come. Gas, water, electricity: people puzzled as to how the same stuff flowing through the same pipes and wires could be owned by different companies, and yet somehow it became so in the name of competition. Then came the British Airports Authority and British Rail and large chunks of the Ministry of Defence, while many public institutions such as local authorities and the NHS outsourced much of their activity and shrank sometimes to the role of regulator. Nigel Lawson triumphantly announced "the birth of people's capitalism", but many private companies sold out to foreign ownership; others were taken over by private equiteers; others again subsumed into octopus-like businesses such as Serco and G4S, which picked up the contracts for outsourced work ranging from Royal Navy tugboats to nursing assistants.

This landscape is familiar to us, but what would Macmillan have made of it? What kind of country-house metaphor would be equal to the modern situation where the electricity is owned in France, the football clubs by emirs and the publishing houses (including Macmillan's own) in Germany and the US? Or a state that has recently sold off the Royal Mail too cheaply (a habit that began with British Rail's hotels 30 years ago), that has privatised its blood plasma service and is about to sell its profitable stake in cross-Channel trains, and which has its eye on all kinds of small treasures (air traffic control, Ordnance Survey, the Royal Mint) that in future may raise a few bob and enable a tax cut? Comparisons with the sale of silver sugar tongs and Canalettos hardly seem adequate. Surely the crumbling house itself has a For Sale sign nailed to it at a crazy angle, with stickers attached to the inhabitants – the dowager, the servants, even the dogs – for they too have a value as the consumers of the stuff their new owner will sell them.

The words of the novelist and reporter James Meek ring ever truer. "The commodity that makes water and roads and airports valuable to an investor, foreign or otherwise, is the people who have no choice but to use them," Meek wrote last year in the London Review of Books. "We have no choice but to pay the price the toll keepers charge. We are a human revenue stream; we are being made tenants in our own land, defined by the string of private fees we pay to exist here."

But why not take it further and outsource the air force, the army and the navy? Mercenaries from poorer countries would be cheaper, accepting even worse rates of pay than the average British infantryman. Why not outsource the police, given that prison warders are already privatised? Why not outsource the government? It has cut so many parts from itself that it does no more than bleed on its stumps. Finally, why not outsource the political class that without interruption since 1979 has promoted the denigration of public service while upholding the idea of private profit, or at best done nothing to stop it. How interesting it would be to oversee the tendering process for the last – to weigh up the rival claims of political teams from, say, Finland, Germany and Iceland to transform the House of Commons into a more intelligent and courteous debating chamber that had outgrown the Oxford Union. How good it would be if the shouters and petty point-scorers could be replaced, on the male side at least, with grave pipe-smokers who spoke in charming English and wanted only the best for the country they had come to supervise – a colony almost, deserving enlightened rule.