In the international sphere, the hegemony of the U.S for over four decades has been largely predicated on the U.S dollar’s de facto reserve currency position. To understand why and how we must return to our good and trustworthy friend President Nixon. But first…. 1944.
As WWII was winding down and Hitler headed for the bunker, the top international leaders were already preparing to rebuild the international economic system. At the Mount Washington Hotel in Bretton Woods, New Hampshire 730 delegates from the 44 Allied nations convened to design and shortly thereafter implement the new monetary arrangements that would serve as the backbone of the international economy.
What emerged was a monetary system based on two things. Gold and the U.S dollar. The dollar was pegged to the value of gold, and other currencies were pegged to the U.S dollar’s value. Seemingly foreshadowing a not-too-distant future centered solely around the ‘greenback’.
That moment came in 1971 under Nixon. Exacerbated by huge spending on the Vietnam War, the U.S experienced its first significant deficit in their balance of payments. That is, more money flowing out of than into the country. The war effort spurred increased foreign purchases of food, finished goods, and goods to be used as inputs for domestic defense production.
The bottom line: US dollars were spreading rapidly across the globe.
Inherent to the Bretton Woods system was America’s obligation to convert dollar holdings into gold upon request. As the number of dollars (particularly held by foreign central banks) continued to increase in relation to the relatively fixed supply of gold, the assurance of gold convertibility waned. Especially as foreign governments depleted the U.S gold reserves, culminating in the abandonment of the quasi gold-standard in 1971.
The dollar became a non-convertible fiat currency, backed by pure faith and confidence in the American government and economy. Equally important was the introduction of freely floating currencies, that is, allowing supply and demand dynamics to dictate currency values. And for the past 40 years, the U.S has reaped tremendous benefits from the fiat dollar.
They did so by relegating themselves to ‘consumer of the world’. Running chronic trade deficits with China, Japan, Germany, and other manufacturing, export-oriented powerhouses. What the U.S lost in manufacturing jobs and industrial base they gained in financial prowess and consumer privilege. As this trend continued during the neoliberal era, foreign central banks found themselves flooded with US dollars.
Prompting the question: What to do with ALL THESE DOLLARS?
There exists a general need for dollars on the global stage, for settling international trade and also to repay debts- as many foreign loans are denominated in dollars.
Those needs aside, If foreign central banks were to sell their US dollars on the foreign exchange market and purchase their domestic currency-for practical purposes, this would exert upward pressure on their currency. Which for an export-led nation a strong currency is a death sentence; pricing themselves out of world markets.
Rather than keep inert dollars, it was rational to earn a yield (income) by using them to purchase highly-liquid US Treasury bills. That is short-term U.S Government debt obligations. Thus, birthed the T-Bill Standard.
In a sense, the U.S funds its own debt by spending abroad for commercial and military purposes, where foreign nations are vehicles that have restricted choice but to recycle their dollar holdings into US government debt. A debt I will add, that yields closer and closer to 0% as interest rates remain at all-time lows. And that right there folks… is the secret to the SAUCE.
But how much longer does the King have to reign?
Next we will take a look at recent developments across the Pacific Ocean that seek to subvert, or at least reduce America’s dominant international monetary position.