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The rise and fall of the dollarGo with the flowsLessons of historyJan 20th 2011 | from PRINT EDITION               1     L...
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The rise and fall of the dollar: go with the flows | the economist


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The rise and fall of the dollar: go with the flows | the economist

  1. 1. The rise and fall of the dollarGo with the flowsLessons of historyJan 20th 2011 | from PRINT EDITION 1 Like 78Exorbitant Privilege: The Rise and Fall of the Dollar and the Future of theInternational Monetary System.By Barry Eichengreen. Oxford University Press; 224 pages;$27.95. To be published in Britain by OUP next month; £14.99. Buy from , ( dollar’s ascendance to the rank of world’s most importantcurrency is often remembered as having been slow and gradual,mirroring the decline of sterling and Britain’s historic economicdominance. In fact, it was surprisingly swift. From a standingstart in 1914, the dollar had overtaken sterling in internationalimportance by 1925. The first world war played a part, but so dida lesser-known factor. America had surpassed Britain as theworld’s largest economic power as early as 1870, but it had astunted financial system: its banks could not open branchesabroad, it had no central bank and panics were common. Allthese things discouraged international use of the dollar.This began to change with the creation of the Federal Reserve in1913, providing stability to the American banking system. Benjamin Strong, the Fed’s de factoleader in its early years, saw how the deep and liquid market for trade acceptances—the IOUsthat were used to finance shipments of goods—helped the Bank of England to manage creditconditions. The Fed used its clout to nurture a similar market in America. This hastened themigration of international financial activity from London to New York, and from sterling to thedollar.Whether the dollar will share sterling’s fate is a common question in geopolitical circles. Afterall, it is only a matter of time before China’s GDP overtakes America’s. But as BarryEichengreen shows in a fascinating and readable account of the dollar’s rise and potential fall,reserve-currency status depends on far more than GDP. It is also a function of strategic andmilitary relationships, laws, institutions and incumbency.Mr Eichengreen, who teaches at the University of California, Berkeley, is an internationalmonetary historian whose research into how the gold standard propagated the GreatDepression was the basis for his seminal 1992 book, “Golden Fetters”. His latest work is lessabout the future of the financial system than its history, and skilfully told history it is too. MrEichengreen sprinkles his economics with memorable sketches of economic and politicalleaders. Jimmy Carter, apparently, handicapped his efforts to reduce Germany’s trade surplusby addressing the more formal Helmut Schmidt, the German chancellor, by his first name.The book’s title was inspired by Valéry Giscard d’Estaing, France’s finance minister in the1960s, who once described the enormous benefit America derived from the dollar’s reservestatus as its “exorbitant privilege”. The world’s need for dollars lets America borrow at lower
  2. 2. cost. American companies are spared the hassle of transacting in another currency. Thosesuitcases of dollars so beloved of international arms smugglers and drug kingpins all representinterest-free loans to America.That the world remains so dollar-centric, given America’s shrinking share of world output, issomething of an anomaly. This could be explained for most of the post-war period by lack ofcompetition. Japan discouraged international use of the yen for fear of elevating its value andhurting its exports. The presence of the Red Army on West Germany’s borders hung over theDeutschmark, and in any case Germany regarded support of the dollar as an intrinsic part ofits military alliance with America.Mr Eichengreen does not think the dollar is about to be vanquished as sterling was. Rather, heforesees a “multipolar” system of international currencies. Reunification shifted Germany’spriorities from supporting America to binding itself more closely to Europe, resulting in thecreation of the first significant competitor to the dollar, the euro. Mr Eichengreen could havedevoted more attention to the strains that Europe’s sovereign-debt crisis have placed on theeuro. His book is optimistic, noting that political rather than economic imperatives have alwaysdriven the euro. Mr Schmidt sold monetary integration to Germany’s sceptical central bank byinvoking Auschwitz. Yet Mr Eichengreen’s recent writings betray a pessimism about the euro’sfuture that is not visible in his book.And what of China? As was true of America and the dollar a century ago, China’s currency doesnot enjoy anywhere near the clout that could be expected from the size of the Chineseeconomy. As with Japan, China has discouraged internationalisation of its currency for fear thatinflows of capital would lift its value and curb Chinese exports. It has learned, however, fromJapan’s mistakes, and is gradually liberalising the use of its currency. But China is still muchfurther behind than America was in 1914; it will be decades before the yuan rivals the dollar’sleadership.The chapter on the international financial crisis is an unsatisfying rehash of the usualexplanations, such as loose monetary policy, sloppy underwriting and derivatives. MrEichengreen underplays the role that China played, through its accumulation of dollars, infinancing America’s housing bubble. He thinks the crisis will accelerate the shift to a multipolarcurrency system, but that the dollar will not collapse. That would take profound economicmismanagement by America itself, in particular, unchecked budget deficits. It was Britain’sdismal economic performance, not the dethronement of sterling, that cost it its great-powerstatus after 1945. “The only plausible scenario for a dollar crash”, Mr Eichengreen concludes,“is one in which we bring it upon ourselves.”from PRINT EDITION | Books and Arts 1 Like 78Submitto About The Economist online About The Economist Media directory Staff books Career opportunities Contact us Subscribe [+] Site feedbackredditCopyright © The Economist Newspaper Limited 2011. All rights reserved. Advertising info Legal disclaimer Accessibility Privacy policy Terms of use Help