Why the world still bows to King Dollar

Think the U.S. dollar is on its way out? Think again

Interview requests

Paul Blustein’s new book, King Dollar, is both an accessible and timely read. While it’s not about the turbulent events of Donald Trump’s second presidential term, it does speak to the central role American economic policy plays in the world.

Before the Second World War, the American dollar had already surpassed the British pound as the most internationally accepted currency. And after Europe’s wartime physical devastation, it became the indisputable lynchpin of the global financial system. As such, it’s the world’s primary reserve currency, meaning it comprises the majority of foreign currency reserves held by the world’s central banks and functions as the main lubricant of international trade.

To quote Blustein: “Although U.S. economic output accounts for about one-quarter of global gross domestic product (GDP), and U.S. imports and exports account for only eight percent of world trade, data shows that the dollar figures widely in transactions that don’t touch U.S. shores or involve Americans at all.”

There’s no law that says this has to be the case. But exporters of oil, computer chips, pharmaceuticals and so forth invariably want to be paid in a “hard” currency—one they can subsequently use to buy something from someone else. Money, after all, is a “social construct,” and its value depends entirely on general acceptance.

The American dollar isn’t the only “hard” currency, but, for two reasons, it sits at the top of the hierarchy.

One reason is the “unrivalled depth, breadth and liquidity of U.S. financial markets.” In practical terms, this means that dollar-based securities, such as U.S. Treasury bills, can be bought or sold in large quantities without causing prices to move up or down dramatically. Highly liquid assets are invariably superior to relatively illiquid ones.

The other reason is inertia. The dollar is the international currency that most people have become accustomed to using.

The contours of the postwar financial system were laid out at the 1944 Bretton Woods conference, which established the International Monetary Fund (IMF) to oversee a system of fixed exchange rates. The fundamentals of this system were simple. All countries would peg their currencies at a set rate against the U.S. dollar, and the U.S. would in turn peg its dollar to gold at $35 per ounce, thereby providing a traditionally accepted, confidence-building anchor to underpin everything.

For a decade or two, this arrangement worked splendidly. America was the world’s economic powerhouse, American goods were in high demand and all countries were happy to borrow dollars to buy them, and also stock their central bank reserves with whatever spare dollars they could get their hands on. However, the balance began to shift as Europe and Japan recovered economically and needed fewer American goods. Meanwhile, Americans developed a taste for imports, which they paid for with dollars. And if necessary, they just printed those dollars, regardless of whether they had the gold reserves to back them up.

Blustein describes it this way: “With so many dollars sloshing around the world, rumblings resonated about whether the gold in U.S. vaults was adequate to back all that currency.” By 1965, French President Charles de Gaulle was calling for a return to the traditional gold standard in order to restore integrity to the financing of international commerce. The Americans, so the French argument went, shouldn’t be able to pay for imports by the simple expedient of printing money.

It all came to a head in August 1971. Following years of erosion, American gold reserves had dwindled to about 25 per cent of foreign dollar liabilities. A significant run on the dollar—meaning other countries demanding to redeem their dollars for gold at the promised rate—could’ve wiped out American gold reserves.

So on Aug. 17, U.S. President Richard Nixon announced that the U.S. would no longer convert dollars into gold at $35 per ounce, thus severing the connection underpinning the postwar system. As Blustein colourfully puts it, “Bretton Woods was kaput.”

Although it was Nixon who made the decision, Treasury Secretary John Connally was the immediate driving force. Connally (1917 to 1993) is now largely forgotten, but he was hot stuff for a while in the 1970s. He was a former Democrat turned Republican, Nixon’s preferred successor and often tipped for the White House.

When other countries protested, Connally dismissed their objections: “The dollar is our currency, but your problem.” Like Trump decades later, Connally was completely comfortable with dramatic unilateral action in pursuit of ruthless negotiation. As he once put it, “My view is that the foreigners are out to screw us, and therefore it’s our job to screw them first.”

The demise of Bretton Woods ushered in the current era of floating, as opposed to fixed, exchange rates, at which point some commentators took to calling the dollar a “sick currency.” In the words of an MIT economics professor, “The dollar is finished as international money.”

Then came the 1973 oil embargo and the consequent dramatic rise in oil prices. Sitting atop one-quarter of the world’s then-proven reserves, Saudi Arabia suddenly had far more money than it could handle. And it chose to invest much of it in U.S. Treasury securities.

King Dollar was back on the throne.

Troy Media columnist Pat Murphy casts a history buff’s eye at the goings-on in our world. Never cynical – well, perhaps a little bit.