The Rise and Fall of the Dollar
[Mark Thornton is available for interviews. Send him email.]
Over the last century America’s money—the dollar—has come to dominate the global monetary system. It is used not just by Americans, but in other countries, in the global black market, and by importers and exporters. And it is the primary reserve currency for central banks. This status is what Barry Eichengreen calls an “exorbitant privilege,” because it confers numerous benefits to individuals, companies, and governments. Collectively, it also confers the ability for Americans to consume beyond our ability to produce.
Professor Eichengreen in his book Exorbitant Privilege: The Rise and Fall of the Dollar and the Future of the International Monetary System, chronicles the rise of the dollar to world dominance, and what it means for the US. He then explores the possibilities of its demise and possible crash. The author should be commended for at times thinking outside the mainstream box, where such issues are often ignored.
He believes that the world is heading toward a state in which there are several reserve currencies, notably the euro and the Chinese renminbi. He maintains that a reserve currency status is based on economic strength: Europe has it and China and India are gaining it rapidly.
Eichengreen says that this is the type of change to expect, and even applaud, because it would mean the end of America's reserve currency monopoly and force the Federal Reserve to behave better. He does not foresee a complete breakdown of the dollar, because that is not in the interests of countries like China. He (p. 8) finds that the only thing that could create a flight from the dollar is “serious economic and financial mismanagement by the United States.”
The book begins with a quick history of money, banking, and trade. The author has a theory that economic dominance leads to monetary dominance. Yet it is noteworthy that the US became the world economic power by the end of the 19th century, while the dollar had virtually no international role well into the 20th century.
In fact, the US was only able to make its “debut” after having established a central bank to help organize the money markets and after WWI had made a US role a necessity. I was glad to see the author’s openness and honesty when describing the people who established the Federal Reserve and their motives. Eichengreen (pp. 24-25) openly described it as a conspiracy by “big finance” against the general public.
After WWII, the US dollar was far and away the dominant currency. It used this influence to establish the fundamentally flawed Bretton Woods system. This system established the dollar as the world’s reserve currency convertible into gold at $35/ounce. This system was abused by the over-issue of dollars which started to generate pressure for convertibility as early as the late 1950s.
Ludwig von Mises was a leading opponent of the Bretton Woods system and the leading proponent of returning to a real gold standard. This is an important point because one of Mises’s followers was Jacque Rueff, the popular economic advisor to French President Charles de Gaulle. Eichengreen (pp. 52-53) correctly describes the French as leading the opposition to the Bretton Woods:
Rueff acquired de Gaulle’s ear. He also acquired the public’s (due to his successful inflation-fighting policies). When de Gaulle attacked the dollar at a press conference in early 1965, castigating the Bretton Woods System as “abusive and dangerous” and arguing that the world should return to a gold-based system, he was channeling Rueff.
Of course the French would continue to pressure the dollar and eventually force it from its perch. The rest of the chapter on the dollar’s dominance provides a concise history of the 1960s and 1970s. Here the author provides real value by drawing attention to the similar problems that China faces today, like what to do with all their depreciating dollars.
The next chapter discusses the improbable euro. While the book makes Americans look like arrogant brutes, this chapter makes Europeans look like immature wimps, and Germans as dupes. Overall, it provides a convincing indictment against the idea that government should run the monetary system.
Given the post-WWII history of government management of money and banking, it was astonishing to me that Eichengreen blamed the current economic crisis on inadequate regulation and too much competition. There are over 100 regulatory agencies that supposedly oversee the financial industry and over 12,000 financial regulators in Washington, DC, alone. At the state, federal, market, and international levels virtually everything in financial markets is regulated by multiple agencies often resulting in turf warfare.
Eichengreen is correct to criticize the Federal Reserve for adding too much fuel, i.e., money and credit, to the economy. It should be obvious that this was the primary problem—the necessary condition.
However, there are two more big problems with the Fed. First, by continuing to bail out financial markets for decades, it has created an enormous moral hazard problem, encouraging participants to incur too much risk in their investments and operations. Second, by acting as a cheerleader for credit default swaps and collateralized debt obligations, the Fed created a moral suasion problem by directly encouraging their use amongst inexperienced participants.
When it comes to the conclusion we find that the dollar still dominates the world. The euro is an existing rival and the Chinese renminbi is a future rival. This rivalry should make the dollar a more responsible currency. If this book goes into a second edition, then this chapter will require some editing.
He does mention gold, but only to dismiss it. “Finally, there are some minor alternatives to be dismissed. Gold has its bugs” (p. 147). It is dismissed largely on grounds that gold is “inconvenient” and because central banks have not shown interest in it. There is really nothing inconvenient here. Gold, silver, and copper coins minted in various weights could easily serve as money, could be title-transferred electronically, and could be transferred either in its own denominations (i.e., 5 gram, 10 gram, 25 gram, etc.) or in other denominations (e.g., dollars, euros, etc.).
Eichengreen seems to downplay the possibility of a crash of the dollar and the loss of its currency reserve status. He cites three situations that could bring about a crash of the dollar: China dumping the dollar, loss of confidence by investors, or continuous runaway government spending. He also reasons why each of these situations is not highly probable.
In contrast, I view the three situations as connected and to be a higher probability. Continuing runaway government spending seems to be firmly baked into the cake of future events. Ballooning deficits and an exploding national debt being monetized by the Federal Reserve are shaking investor confidence in the long-term value of the dollar and this includes other central banks, such as the Bank of China.
There is valuable information in this book, also including an interesting discussion of oil markets and the military and the roles they play in the reserve currency status. The main problem with the book comes in the area of interpretation, where the author fails to fully challenge the status quo.
 The reviewer believes that events occurring between the time this review was written and submitted and the time it went to press have increased the probability of monetary crisis, and that the crisis will come sooner rather than later.