The Buck Stops Here?

By Daniel Berchenko, 5 August 2009
Image: Man contemplates relationship between energy and currency exchange in 1970's America


Amidst late-noughties currency fluctuation, Daniel Berchenko considers the history of the dollar's haphazard rise to global currency standard, its geopolitical consequences and the difficulty of breaking its hold

In a briefing at the Council on Foreign Relations last March, US Treasury Secretary Timothy Geithner admitted that he was ‘open' to a Chinese proposal to replace the dollar as the world's reserve currency. Within moments, Geithner's offhand remark appeared on Bloomberg monitors around the world, roling currency markets. Geithner retracted his statement almost immediately - but not before the value of the dollar slid by 1.3 percent. Ironically, the greatest victim of Geithner's gaffe was the Chinese central bank. The endorsement of their own proposal by a US Treasury Secretary threatened to destroy more than $20 billion of China's massive dollar reserves.1

This episode highlights the double bind facing opponents of American financial hegemony. Under the so-called ‘Dollar Standard', most nations invest their reserves in dollar-denominated US assets. Because they are considered to be less risky than equities or corporate debt, treasury bonds account for the bulk of these reserves. China alone is thought to hold upwards of $1.4 trillion in US assets,2 including $800 billion in treasury debt.3 Over the course of the last three months, the dollar has declined in value by more than 10 percent - meaning that the value of dollar-denominated reserves has also declined by more than 10 percent.4 This trend is likely to continue as total US indebtedness exceeds 100 percent of GDP in coming years. America's trading partners can look forward to almost certain losses on the treasury bonds that they receive in exchange for goods and services rendered.

As we saw above, challenges to the Dollar Standard exacerbate these losses by weakening the dollar further. The Financial Times recently estimated that China's efforts to diversify its reserves have cost it more than $80 billion since 2007.5 The proposal that sent the dollar skidding in March was written by Zhou Xiaochuan, governor of the People's Bank of China. In it, Mr. Xiaochuan argues for the creation of a new international reserve currency - one ‘that is disconnected from individual nations and is able to remain stable in the long run, thus removing the inherent deficiencies caused by using credit-based national currencies.'6 This new currency would instead be based on Special Drawing Rights (SDRs) issued by the IMF. SDRs were introduced in 1969 as a unit of account. Their value is indexed against a basket of major currencies. Mr. Xiaochuan's proposal calls for the creation of a system that would allow all national currencies to be converted into SDRs. A portion of each nation's SDRs would be entrusted to the IMF for the purpose of settling trade deficits. Gradually, SDRs would replace the dollar as the world's reserve currency of choice.7

China is not the first nation to attempt to cut the Gordian knot of US financial hegemony. Efforts to overthrow the Dollar Standard were underway almost as soon as it came into existence in the early 1970s. Previously, international trade was conducted under the system of exchange rates and trade agreements known as Bretton Woods. The system takes its name from the town in New Hampshire where delegates from 44 nations met in 1944, on the eve of Allied victory in Europe, to design the post-war financial order. The Bretton Woods agreement banned tariffs and other protectionist measures. It also pegged major currencies to gold (and thus, to each other) at fixed rates of exchange.8 By ensuring gold convertibility, this system limited the ability of each nation to run up large trade deficits. If any nation imported more than it exported, its trading partners would cash in their excess currency for gold. Over time, trade deficits would deplete the nation's gold reserves. Interest rates would rise in order to attract investment (and hence more gold) from abroad. Credit contraction would lead to a recession, causing prices to decline. Declining prices would reduce the appetite for imports at home and make the nation's exports more affordable abroad. Eventually, balanced trade would be restored.9 By implicitly linking credit creation to gold supply, Bretton Woods also limited the ability of governments to issue debt. Sustained public deficits would reduce the amount of credit available for private enterprise, initiating the same cycle of recession, deflation and correction described above.10

The Bretton Woods agreement was intended to prevent the sorts of international trade imbalances that led to the disintegration of global commerce in the 1930s.11 But returning to the discipline of gold introduced new obstacles to post-war recovery. American industry metastasised during the war years, fueled by massive government spending. With European capital in ruins, the United States accumulated 59 percent of the world's metallic reserves by 1945.12 Under Bretton Woods, Europe would no longer be able to afford American imports, ensuring a return to pre-war double digit unemployment figures in the US. The gold standard would also restrict credit in Europe, impeding reconstruction there. To address these problems, Bretton Woods provided for the creation of two new institutions - the IMF and the World Bank - designed to facilitate lending abroad (under terms favourable to the US, of course).13

The American-led renaissance of global commerce envisioned by the architects of Bretton Woods failed to materialise after the war. Europe's trade deficit with the United States dwarfed loans from the IMF and World Bank. The International Trade Organization was scuttled, allowing the US to maintain tariffs on imports. Britain teetered on the brink of bankruptcy, unable to repay its colonies for raw materials imported during the war and unable to meet the costs of occupying defeated Germany. By 1949, the US had amassed three-quarters of the world's gold. Europe and Latin America were forced to consider a return to pre-war protectionism in order to avoid being stripped of their remaining reserves.14

To reverse this trend, the United States embarked on the most expensive international military expansion in history. Dollars spent on food, fuel and housing for US forces abroad allowed other nations to import American goods. But private trade never succeeded in balancing military expenditures. The Korean War marked the beginning of an ever-growing US balance-of-payments deficit that would continue, almost without interruption, up until the present.15 Under the ruse provided by the Cold War, the US was so successful in replenishing the world's reserves that within two decades it could no longer ensure the convertibility of its dollars.

By 1968, the United States's external obligations vastly exceeded the value of its diminishing gold stock. American officials pressured European central banks to exchange their dollar surpluses for treasury bonds rather than gold. This was presented as a temporary measure that would buy time while the US put its house in order. Not coincidentally, the additional demand for treasury bonds would also help finance the escalating war in Vietnam. Compliance meant allowing the US to pay for imports with I.O.U.s. Refusal opened the possibility of a run on the dollar, reducing the value of America's foreign-held debt, as well as the price of its exports. Only France refused.16

Bretton Woods ended with a whimper rather than a bang. In August of 1971, President Nixon conceded that dollar convertibility was a fiction and officially closed the gold window.17 The governors of the world's central banks convened in Washington later that year to establish a new system of fixed exchange rates. Under the resulting Smithsonian agreements, the dollar was devalued by 11 percent against most major currencies. But even this new system proved unsustainable. The mounting costs of the war in Vietnam dragged the US balance-of-payments further and further into deficit. European central banks were forced to purchase excess dollars on the open market in order to maintain the value of their currencies. One by one, the world's industrial nations abandoned the Smithsonian agreements, allowing their currencies to float. To stem the tide of speculative movement out of the dollar, it was devalued by an additional 10 percent in February of 1973.18

European nations closed their currency markets in early March to prevent the emergence of a full-blown crisis. After meeting in Paris, the nine members of the EEC agreed to a joint float of their currencies - dubbed ‘the Snake' by the financial press. The value of each currency would be maintained within 2.25 percent of the others (meaning that all nine could rise or fall together, but not individually). More importantly, the central banks of the EEC announced that they would no longer intervene in currency markets to purchase excess dollars.19

Image: 'Excess dollars'? $134 billion worth of fake U.S. Treasury bonds seized August, 2009

The collapse of Bretton Woods had several unintended consequences. Floating currencies in Europe sent the dollar into free fall. A weak dollar made American goods less expensive in Europe and European goods less affordable in America. The US balance of payments swung into surplus for the first time in over two decades. Under normal circumstances, nations strive to achieve balance of payments surpluses. But since 1968, the United States had enjoyed increased demand for treasury bonds produced by its foreign deficits (in the absence of convertible dollars). Between 1946 and 1969, publicly held US government debt grew by $14 billion - more than $9 billion of which was funded by foreigners. Between January of 1970 and March of 1973, foreign central banks purchased $52 billion in treasury securities.20 When the falling dollar caused the flow of trade across the Atlantic to reverse itself, European banks began selling off their stockpiles of treasury bonds to pay for American imports. The flood of government debt squeezed credit in the US, pushing interest rates to all time highs.21

Meanwhile, the overnight transformation of world trade caused by the falling dollar threatened the integrity of the nascent European Snake. As investors traded their dollars for more stable German marks and Swiss francs, the value of those currencies skyrocketed against their weaker European counterparts. As their currencies appreciated, exports from Switzerland and West Germany plummeted. Between 1970 and 1974, the value of the Deutsche Mark more than doubled against the dollar - eroding the value of West German dollar reserves by more than a third.22 In order to stabilise their currencies and restore trade, EEC nations had little choice but to buy back excess dollars once again. Central bank intervention in currency markets amounted to $52 billion between March of 1973 and December of 1974.23

As European central banks struggled to absorb the glut of dollars on world currency markets, Third World countries experienced unprecedented inflation. After World War II, the World Bank discouraged developing nations from undertaking the land reform necessary to achieve agricultural self-sufficiency.24 As a result, most of the proceeds from raw materials exports were used to pay for grain and industrial imports from the US and Europe. But since raw materials are typically priced in dollars, the value of Third World exports fell dramatically in early 1973. In order to pay for food and manufactures, developing nations were forced to increase output and sell off mining rights to the West. OPEC announced that it would quadruple oil prices in December of 1973 to help defray the loss of purchasing power caused by the weak dollar. This announcement came on the heels of the embargo of Arab oil exports to the US following the outbreak of the Yom Kippur war in October.25

The collapse of Bretton Woods and the Oil War of late 1973 had a chilling effect on US-European relations. The United States enjoyed access to significant mineral resources and could presumably ride out any Arab embargo for months if not years. Europe's access to oil was both more limited and more costly. European nations were therefore motivated to reach some sort of accommodation with their Arab counterparts. Europe refused to follow the US in backing Israel against Syria and Egypt. American troops and munitions bound for the region were not allowed to land at European bases or pass through European air space.26

The alliance between Europe and the Middle East posed a threat to the emerging Dollar Standard. European nations were forced to continue selling off their stockpiles of treasury bonds in order to meet rising energy prices. The central banks of the EEC argued for the creation of a new fund, managed by the IMF, to help balance mounting deficits with oil exporters. Arab nations would invest the receipts from their energy sales in the fund, financing further oil purchases by their Western counterparts. The United States adamantly opposed this plan since it would allow OPEC to recycle its excess petrodollars into IMF credit rather than treasury bonds.27 Meanwhile, Arab nations wanted to use their new found wealth to purchase capital goods and build infrastructure. Sheik Yamani of Saudi Arabia announced in January of 1974:‘In the future we won't sell our oil for dollars. We will sell only to those who will give us technology and industrialization.'28

The Nixon administration attempted to counter these disturbing trends by calling for total US energy independence by 1980. The development of viable energy alternatives would exert downward pressure on oil prices. Secretary Kissinger issued the following ultimatum: ‘[OPEC] can accept a significant price reduction now ... for stability over a longer period, or they can run the risk of a dramatic break in prices.'29 American officials also pushed ahead with plans to form a cartel of oil-importing nations, euphemistically referred to as the International Energy Agency (IEA). The IEA would serve as a hedge in the unlikely event that energy independence could not be achieved by 1980.

European leaders responded on February 5, 1974 (just one week before the first IEA conference in Washington) by announcing their intention to establish a New International Economic Order (NIEO).30 The NIEO consisted of a broad set of proposals aimed at securing economic independence for the Third World and creating an alternative to the emerging Dollar Standard. For developing nations, these proposals promised debt relief, improved terms of trade and greater control over multinationals. Commodity prices would rise and fall with the price of industrial goods and technology manufactured in Europe and the US (rather than simply falling with the dollar). Raw materials exporters would be free to form cartels, like OPEC. Trade surpluses from commodity exports would be used to develop industry and infrastructure in the Third World, rather than financing government deficits and military spending in the United States. The proposals also included a return to the gold standard - and with it, a return to balanced international trade. The basic objectives of the NIEO were adopted by the U.N. general assembly on May 1, 1974.31

While the rest of the world was banding together to prevent the emergence of the Dollar Standard, the United States set out to purge gold from the world monetary system - thereby eliminating the most likely alternative. US diplomats had already secured agreements from foreign central banks to stop selling gold to one another during the crisis of 1968. This effectively froze the amount of gold in world reserves (since it could no longer be used to settle deficits). As a result, America possessed more gold than any other single nation - even after its massive foreign spending spree during the '50s and '60s. The US announced plans to sell a portion of its reserves to private citizens in December of 1974. In September of 1975, the IMF agreed to auction off one third of its gold reserves. As a concession, central banks were allowed to resume gold sales between themselves. But the aggregate amount of gold held by the IMF and its members was capped at 1975 levels.32


Image: Time Magazine cover, 21 January, 1974.  In the US, Treasury Secretaries are revered as gods.

With the path to a new gold standard effectively blocked, foreign creditors renewed their demands that the United States settle its mounting debts and return to balanced trade with the rest of the world. In some ways, the energy crisis simplified this problem for the US. Most of the dollars and treasury bonds accumulated by Europe and Japan were being funneled to the Middle East in exchange for oil. If it could convince OPEC nations to ‘recycle' their petrodollars into US assets, America would at once neutralise its deficits with Europe, Japan and the Arab world. In 1974 US Treasury Secretary William Simon traveled to the Middle East in an attempt to persuade OPEC members to invest their oil surpluses in treasury bonds and other government securities. On 8 June, Saudi Arabia agreed to purchase between $8 and $10 billion in treasury securities that year in exchange for military and economic cooperation.33

Since the mid-1970s, similar pilgrimages to America's foreign creditors have become routine for US Treasury Secretaries. Less than five months after assuming the office (and almost 25 years to the day after Secretary Simon's trip to the Middle East), Timothy Geithner traveled to Beijing as the United States' treasury bond salesman-in-chief. On the day of Geithner's arrival, China Construction Bank chairman Guo Shuqing told The Financial Times:

In the short term I don't think we can find another currency to replace the US dollar... People worry about US dollars very much because of the imbalances in the current account, but that has been the case for many years - they have had a deficit in the current account since the very beginning of the 1970s.34

For those who are not persuaded by this bit of kōan-like logic, there are other reasons to believe in the continuing dominance of the dollar. Since they were introduced in 1969, several nations (including the United States) have proposed that SDRs should function as the world's key reserve currency. Because of the unequal allocation of voting rights within the organisation, and because the US retains exclusive veto power, it is doubtful that such a sweeping reform will ever be pushed through the IMF. The Chinese renminbi remains the most significant threat to the dollar. But it is unlikely that the renminbi will replace the dollar any time soon. Many of the world's major currencies still cannot be converted into renminbi - the flow of funds into and out of China is tightly regulated.35 More importantly, China does not have open bond market which limits its ability to lend money overseas in its own currency.36 We have already seen that the resiliency of the Dollar Standard rests on foreign appetite for treasury bonds. China has yet to create a similar instrument for its government debt.

Unlike Bretton Woods, the Dollar Standard was not designed by famous diplomats and Nobel laureates. In the absence of a gold standard, central banks began investing their surpluses in treasury bonds almost as a matter of course. Nations like China that are willing to maintain easy credit and low export prices by recycling their excess dollars into treasury bonds are given full access to the US market. But with $13 trillion in external obligations, it has become increasingly clear that America will never repay its foreign-held debt. As one Nixon administration official is reputed to have said: ‘The dollar is our currency, but its your problem.

Daniel Berchenko <dberchenko AT> is a writer living in Brooklyn, NY


1 Krishna Guha, Tom Braithwaite and Peter Garnham, ‘Geithner gaffe on China plan drags on dollar', The Financial Times, March 26, 2009.

2 Geoff Dyer, ‘China has long way to go to dislodge dollar', The Financial Times, May 21, 2009.

3 Jamil Anderlini, ‘China stuck in dollar trap', The Financial Times, May 24, 2009.

4 Peter Garnham, ‘Dollar wrong side of economic revival', The Financial Times, May 24, 2009.

5 Jamil Anderlini, ‘China lost billions in diversification drive', The Financial Times, March 15, 2009.

6 Quoted in Jamil Anderlini, ‘China urges switch from dollar as reserve currency', The Financial Times, March 24, 2009.

7 Ibid.

8 Michael Hudson, Super Imperialism: The Origin and Fundamentals of U.S. World Dominance, London: Pluto Press, 2003, pp. 137-161 passim.

9 At least in principle. As we will see below, high prices do not always reduce demand for certain imports (such as oil). Similarly, declining prices cannot make exports competitive if they are restricted or tariffed abroad.

10 For an excellent comparison of the Bretton Woods system to the Dollar Standard, see Richard Duncan, The Dollar Crisis, Causes, Consequences, Cures, John Singapore: Wiley & Sons, 2005, pp. 5-13. See also, Michael Hudson, Global Fracture, the New International Economic Order, Pluto Press, London: 2005, pp. 17-33.

11 Most of my account of the period between 1945 and 1975 follows Michael Hudson's excellent book, Super Imperialism (cited above, see note eight) and its sequel, Global Fracture (see note ten).

12 Michael Hudson, Global Fracture, p. 12.

13 Ibid., p. 11.

14 Ibid., pp. 12-13.

15 Ibid., pp. 14.

16 Ibid., pp. 22-33.

17 Ibid., p. 25.

18 Ibid., pp. 59-60.

19 Ibid.

20 Ibid., pp.25-26.

21 Ibid., p. 95.

22 Ibid., p. 30.

23 Ibid., p. 96.

24 Ibid., pp. 34-37, passim.

25 Ibid., pp. 64-65.

26 Ibid.

27 Ibid., pp. 98-99.

28 Ibid, p. 111.

29 Ibid., pp. 88-89.

30 Ibid., p. 83.

31 In spite of the symbolic date, Michael Hudson is quick to point out that the NIEO was ‘A program more of nationalist regimes than of the political left ... a non-Communist New Deal.' Ibid., p. ix.

32 Ibid., pp. 103-106.

33 Ibid., pp. 108-110.

34 Lionel Barber, Martin Wolf, Jamil Anderlini, and Kathrin Hille, ‘China rules out dollar challenge', The Financial Times, June 2, 2009.

35 Although the People's Bank of China recently set up swap agreements with its counterparts in Argentina, South Korea, Indonesia, Malaysia, Belarus, and is in talks to do so with Brazil. See Dyer, op. cit..

36 Ibid.