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Given the preponderance of "hit and run" articles on foreign central bank reserves at most financial sites, it was interesting to me to read a more detailed piece with significant historical background. (vBulletin altered the formatting in this quote.)
Given the preponderance of "hit and run" articles on foreign central bank reserves at most financial sites, it was interesting to me to read a more detailed piece with significant historical background. (vBulletin altered the formatting in this quote.)
The Bretton Woods system conceived by Keynes and Harry Dexter White in 1944 was more than a simple recognition of the reality that the United States would emerge from the Second World War in a position of overwhelming economic strength and that any workable global financial regime had to start from that premise. It mandated specific institutional action and imf approval to reset the exchange value of any currency in the system vis-à-vis the dollar. Most importantly, it required that the us maintain both the will and the ability to sell gold at $35 an ounce to foreign central banks on request, which meant that Washington had to take action whenever trade deficits threatened a precipitous loss of gold. When in 1971 the Nixon administration suspended the gold sales, did not use economic tightening to reverse the structural trade deficits, and could neither persuade nor browbeat its trading partners—notably Japan—to undertake compensating adjustments, the system collapsed. But despite a decade that saw the exchange value of the dollar plummet, the financial world continued to revolve around the dollar and does so to this day.
There is every reason for the us to be happy with Bretton Woods ii since Americans reap vast benefits from the arrangement, most importantly in the ability to finance trade deficits with impunity—what French economist Jacques Rueff famously labelled ‘deficits without tears’. Among other things, that allows Washington to project military power around the world at little real financial cost, since the necessary money is first created by the Federal Reserve, then exchanged for goods and services from foreigners, and borrowed back by the us Treasury. [4] (Technically, it does not matter in what form foreigners hold dollars, whether us government debt, corporate debt, equities or anything else with a $ sign. As long as the securities are denominated in dollars they remain within the American banking system, where they serve to create credit in the us.)
But if the benefits to the us in Bretton Woods ii may be obvious, the benefits to those who prop it up are much less so. Indeed, the system is curious in at least two ways: unlike Bretton Woods i, there is no formal institutional requirement on anyone to support it; and adjustment burdens have generally been shouldered not by the system’s primary beneficiary—the us—but by its creditors. To be sure, Volcker put the American economy through a recessionary wringer in 1979, bringing inflation down and thereby slowing the precipitous decline in the purchasing power of the dollar that had set in after the collapse of Bretton Woods i. The first Bush administration raised taxes, while the Clinton administration succeeded in producing a balanced Federal budget. But the us would have needed to take these sorts of measures anyway. Washington was not acting disinterestedly to save a global system, but rather to head off runaway inflation and economy-crushing interest rates. On the other hand, Japan’s support for the dollar was a major cause of the 15 years of deflation and low growth it endured after 1990, while lower-income China used savings extracted from its impoverished citizens to finance American consumption.
Initially it was the opec nations, led by Saudi Arabia, that did most to prop up a dollar-centred international order after the collapse of Bretton Woods i. Their swollen revenues were put on deposit in London; where they were recycled by leading commercial banks in the form of loans to non-petroleum developing countries, financing the latter’s import bills. True, several opec nations briefly flirted with the idea of charging their customers in a currency other than dollars, but for a mixture of practical and geopolitical reasons (at the time, no other currency circulated in sufficient quantities and the Saudi regime depended on us military protection), they stuck with dollars.
But since 1977, when Japan became the first developed nation to recover from the worldwide mid-70s recession, it has played the starring role in dollar support operations. It was Japan that unleashed the floodgates of its burgeoning financial wealth in the early 1980s to finance the so-called Reagan Revolution—America’s first experiment in steep tax cuts without concomitant spending reductions. It was Japan that pumped credit into the international system in the weeks after Black Monday—19 October 1987—when the us stock market lost one quarter of its value in a few hours. It was Japan that largely financed the first Gulf War, sold billions of yen for dollars in the wake of the Mexican peso crisis of 1995, and kept buying dollar securities right through the Asian financial crisis, 9-11 and the invasions of Afghanistan and Iraq. In the last ten years China has joined Japan as a primary supporter of Bretton Woods ii; its official dollar reserves may even exceed the $880 billion Japan reported in May 2005. But when the vast dollar holdings of Japan’s private sector banks and companies are added to that official figure, it becomes clear that Japan continues to play the central role it has for 25 years now in supporting the global value of the dollar—and by extension, us hegemony.
There is every reason for the us to be happy with Bretton Woods ii since Americans reap vast benefits from the arrangement, most importantly in the ability to finance trade deficits with impunity—what French economist Jacques Rueff famously labelled ‘deficits without tears’. Among other things, that allows Washington to project military power around the world at little real financial cost, since the necessary money is first created by the Federal Reserve, then exchanged for goods and services from foreigners, and borrowed back by the us Treasury. [4] (Technically, it does not matter in what form foreigners hold dollars, whether us government debt, corporate debt, equities or anything else with a $ sign. As long as the securities are denominated in dollars they remain within the American banking system, where they serve to create credit in the us.)
But if the benefits to the us in Bretton Woods ii may be obvious, the benefits to those who prop it up are much less so. Indeed, the system is curious in at least two ways: unlike Bretton Woods i, there is no formal institutional requirement on anyone to support it; and adjustment burdens have generally been shouldered not by the system’s primary beneficiary—the us—but by its creditors. To be sure, Volcker put the American economy through a recessionary wringer in 1979, bringing inflation down and thereby slowing the precipitous decline in the purchasing power of the dollar that had set in after the collapse of Bretton Woods i. The first Bush administration raised taxes, while the Clinton administration succeeded in producing a balanced Federal budget. But the us would have needed to take these sorts of measures anyway. Washington was not acting disinterestedly to save a global system, but rather to head off runaway inflation and economy-crushing interest rates. On the other hand, Japan’s support for the dollar was a major cause of the 15 years of deflation and low growth it endured after 1990, while lower-income China used savings extracted from its impoverished citizens to finance American consumption.
Initially it was the opec nations, led by Saudi Arabia, that did most to prop up a dollar-centred international order after the collapse of Bretton Woods i. Their swollen revenues were put on deposit in London; where they were recycled by leading commercial banks in the form of loans to non-petroleum developing countries, financing the latter’s import bills. True, several opec nations briefly flirted with the idea of charging their customers in a currency other than dollars, but for a mixture of practical and geopolitical reasons (at the time, no other currency circulated in sufficient quantities and the Saudi regime depended on us military protection), they stuck with dollars.
But since 1977, when Japan became the first developed nation to recover from the worldwide mid-70s recession, it has played the starring role in dollar support operations. It was Japan that unleashed the floodgates of its burgeoning financial wealth in the early 1980s to finance the so-called Reagan Revolution—America’s first experiment in steep tax cuts without concomitant spending reductions. It was Japan that pumped credit into the international system in the weeks after Black Monday—19 October 1987—when the us stock market lost one quarter of its value in a few hours. It was Japan that largely financed the first Gulf War, sold billions of yen for dollars in the wake of the Mexican peso crisis of 1995, and kept buying dollar securities right through the Asian financial crisis, 9-11 and the invasions of Afghanistan and Iraq. In the last ten years China has joined Japan as a primary supporter of Bretton Woods ii; its official dollar reserves may even exceed the $880 billion Japan reported in May 2005. But when the vast dollar holdings of Japan’s private sector banks and companies are added to that official figure, it becomes clear that Japan continues to play the central role it has for 25 years now in supporting the global value of the dollar—and by extension, us hegemony.
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