The rise of the Tea Party and the huge Republican victory in last year’s midterm elections affected more than just the political calculus in the United States. In the realm of economics, ideas that once were relegated to the minority, or consigned to the crackpot cellar, are suddenly getting full exposure in the bright of the day.
Ron Paul, devoted fan of the gold standard and sworn enemy of the Federal Reserve, is now the chairman of the House subcommittee on monetary policy. One presidential candidate, Tim Pawlenty, warns against the injection of “fiat money” into the economy, while another, Michele Bachmann, has introduced legislation intended to prevent any foreign currency from becoming “legal tender” in the United States. Legislators in a dozen or more states have introduced bills aiming to legalize payments of debts in gold or silver, and there’s even talk about purposefully refusing to raise the debt ceiling, a heretical and potentially disastrous notion that no previous generation of politicians has ever seriously considered.
A common thread ties together all these fiscal and monetary oddities — concern about the dollar, the currency that still reigns supreme on the international scene despite everything the U.S. government and Wall Street have managed to do to undermine it. But it is a concern wrapped in contradictions. We are warned that hyperinflation is supposed to be imminent while at the same time the rest of the world considers the dollar the safest place to put their money on the planet.
When looking for answers to these questions, it might be tough to find a more qualified expert than Barry Eichengreen, a professor of economics and political science at U.C. Berkeley. Eichengreen is the author of “Golden Fetters: The Gold Standard and the Great Depression,” an investigation into how reliance on the gold standard hampered the ability of governments to respond to the economic crisis. More recently, in January, the Oxford University Press published his newest book, “Exorbitant Privilege: The Rise and Fall of the Dollar and the Future of the International Monetary System.” Professor Eichengreen kindly agreed to help Salon gain some clarity on modern monetary mysteries.
Maybe the best place to start is with the title of your latest book. In the context of discussing the rise and potential fall of the dollar, what does the phrase “exorbitant privilege” mean?
The dollar’s “exorbitant privilege” is that it is not only America’s currency but the world’s. That it is the dominant unit used for international transactions of all kinds means that foreign central banks and governments and others have an appetite for dollars for use in their own international transactions as a form of insurance. But their own central banks cannot print them so they have to hoard them for use in a crisis. That means that we [the U.S.] can effectively export green pieces of paper in return for importing BMWs. In the 1960s French President Charles de Gaulle and his finance minister Valéry Giscard d’Estaing called this America’s “exorbitant privilege” — meaning that our currency unfairly monopolized the international sphere.
You write that foreign demand for the dollar allows the U.S. to borrow money at low interest rates. That sounds like a good thing. Is there a downside? Does it enable our profligacy?
There are a couple of downsides. There’s that one, certainly, that foreigners lend to us more freely than otherwise so when we put that borrowed money to poor use we get into more trouble than we would otherwise. When we climb out on a shaky financial limb, they allow us to climb out yet further. The other downside is that when a weaker exchange rate would be appropriate for our circumstances — because we want to double our exports in five years, or we want to rebalance away from producing for domestic consumption and produce more for foreign consumers — it’s hard for us to get that weaker exchange rate because foreign central banks peg their currencies to the dollar. China, for example, has been doing this for years to its own benefit but with adverse consequences for us and for the global system.
Does this mean that the so-called strong dollar is actually a source of vulnerability? I recall early in Treasury Secretary Timothy Geithner’s tenure he faced a House panel and got grilled by Michele Bachmann on whether he sufficiently supported a strong dollar. She seemed to think that he had a secret plan to undermine the dollar in favor of some other foreign currency. But if the foreign popularity of the dollar actually is an enabler for bad fiscal practices, would the rise of some other currency as a dominant international medium of exchange be such a bad thing?
It’s not the worst thing that could happen. I think one simple characterization of the recent financial crisis which doesn’t do too much violence to a complex reality is that there was an imbalance between our multi-polar global economy and our still dollar-dominated international monetary and financial system, and that the world will be a safer financial place when there is a better balance — when the dollar shares its exorbitant privilege with the euro and China’s renminbi. In the short run I think that will mean slightly lower living standards than otherwise. It won’t be possible for us to export green pieces of paper and import foreign automobiles and flat screen TVs to the same extent as before. But it will make for greater financial stability and it will be part of what will enable us to rebalance our economy toward manufacturing, exports and all those things that both of our political parties believe are important.
Would we be able to run $1.6 trillion deficits if we were no longer the international currency of choice?
We would not be able to finance either our budget deficit or our external deficit as freely as we have in the past. And that’s not a bad thing. I think that in a world where there are other places to turn for international liquidity besides the dollar and the United States we will end getting exposed to the kind of healthy market discipline that we need more regularly.
So here’s the contradiction I don’t understand. If deficits are such a high concern for conservatives, why don’t they see that the strong dollar is really working at cross purposes to what they want. If you really want to discipline the U.S. government, wouldn’t a good way to go about it be to have a weaker dollar, and a more multi-polar world with a stronger renminbi and a stronger euro? Or is this just a case of nationalist fervor trumping policy?
There is a tendency for American politicians to assert that we are the greatest country in the world and therefore we must have the greatest currency. But the fears about debasement of the dollar, or the nostalgia for the gold standard also go back further — I think they all emanate from a deep and abiding suspicion of government. Americans have been suspicious of powerful central governments since at least the day of Thomas Jefferson.
In your book you write about the French economist Jacques Rueff, an influential de Gaulle advisor who advocated the gold standard because he believed it acted as a restraint on government action. We’ve been hearing a lot about the gold standard lately from Tea Party-influenced politicians, for exactly the same reason. They believe that the gold standard would prevent the U.S. government from running up deficits and inflating its way out of debt. Is that valid?
Any kind of rigid monetary rule would limit what the government could do. But if you are serious about this, why peg the dollar to gold? Why not peg it to a basket of commodities? There’s nothing intrinsically different about gold from silver, copper, platinum, wheat, tobacco, automobiles, et cetera. You could also just target the consumer price index. There are central banks that do that. It’s called inflation targeting. Targeting rules are a way to be sure that you get price stability and you can write them into the Constitution or the central bank statute.
But what they eliminate, of course, is flexibility and the ability to respond to unanticipated events. With a monetary rule, the mint’s printing presses would click on or click off in response to the latest information on gold prices or consumer prices or whatever you are targeting. But what happens when there is a problem in financial markets — for example, a Lehman Brothers bankruptcy — and you have to flood the markets with liquidity? That’s what a central bank sometimes has to do, to act like a lender of last resort, and that’s what’s wrong with the gold standard or any other simple monetary rule. There is no flexibility for doing that.
I suspect that Ron Paul would say that we wouldn’t have Lehman Brothers type of problems, we wouldn’t have financial instability requiring lender of last resort intervention, if we had a gold standard. And to that I would say, go back and study the 19th century gold standard — when financial crises occurred in the United States about every 10 years. When because of the difficulty of managing the 1907 financial crisis under the gold standard the decision was taken to create a central bank in 1914.
So if we go back to the gold standard we would be returning to a period where we were at the mercy of a financial crisis every 10 years?
It would only make sense to return to a simple monetary rule like the gold standard or hard and fast inflation targeting if you also regulated the banking system with a vengeance. So that’s the irony here, that if you are a gold bug and a true believer in the gold standard you have to have public utility banking and nothing more, because the banks have to be conservative, limited in what kind of operations they are permitted to do, so they can’t get into the kind of trouble that requires the central bank to step in with emergency liquidity provision. That I think is an implication that is not widely appreciated in certain circles.
Ron Paul has repeatedly introduced legislation that would deregulate control over the actual creation of money. His argument is that a proliferation of domestic currencies — presumably tied to gold or other commodities — would put welcome pressure on the dollar by providing safer alternatives than a so-called fiat currency. I look at that and I can’t help thinking back to a time where you had to bite your coins to see if they were real. It sounds like chaos!
Or it sounds like wildcat banking in the U.S. before the Civil War. In the era of free banking every bank could issue its own bank notes — engraved dollar bank notes — and they had to be backed by an equivalent amount of gold. And it was chaos.
What provided the impetus to centralize that?
I think there was a sense that the situation was chaotic and that in a limited number of cases people would set up banks out where the wildcats roamed and just issue bank notes unbacked without limit. You’d have to have a pretty good government regulator to be sure that all these mints were doing what they were supposed to. The other thing that led to the National Banking Act in the Civil War was that the Union government needed to place all its bonds with the banks to fight the war. But it was ultimately just seen as a better system.
Just a few weeks ago we had a Republican presidential candidate, Tim Pawlenty, criticize Obama for injecting “fiat money” into the economy. “Fiat” has always been a popular word in gold standard fandom, but to hear a modern presidential candidate say it was a bit of a shock — since that’s basically how the entire world’s monetary system works today. This idea that our currency is make-believe — is there anything to that?
In the history of North America, many things have been used as money. Tobacco has been used as money, even warehouse receipts where you’ve deposited your tobacco. These things all have an intrinsic value — with a warehouse receipt you can convert that into a certain amount of tobacco. With fiat money, it is true, you have only the “full faith and credit” of the government, the word of the government, standing behind it. But my conception of countries like the United States is that we have a system of checks and balances, and an independent judiciary and a healthy public debate that encourages the government to stand behind its commitment to be sure that this paper can be converted to a certain quantity of goods and services. My view of fiat money is like Winston Churchill’s view of democracy — the worst possible system except for all the others.
What’s so amazing to me about our make-believe currency is that even after the incredibly destructive financial crisis that the U.S. unleashed on the world, the dollar is still considered a safe haven for investors all over the world. How is that possible?
There aren’t a whole lot of alternatives to it at the moment. The euro has its problems right now, to put it mildly. You can only get your hands on limited numbers of Chinese renminbi. When people wanted liquidity in the financial crisis, they were reminded that the single most liquid financial market in the world is the U.S. Treasury market. So even though the United States hasn’t addressed its medium-term fiscal problem, the market in U.S. Treasuries is more liquid than any other market right now. So where do you want to be?
I think that’s one thing that will change over time. Europeans, now that they have their backs to the wall, will get their act together. They will complete their monetary union and the Chinese will internationalize their currency. So eventually there will be two other liquid markets as alternatives to the U.S. Treasury market.
If we believe that a multi-polar world would be better for everyone than a dollar-dominated world, are there steps that could be taken to accelerate that process from the U.S. end?
I don’t think it’s a challenge for us, frankly. We are the incumbent. And the dollar has enjoyed its exorbitant privilege for so long because there haven’t been alternatives. So the policy agenda is for the issuers of the alternatives. I do think it will make the world a safer financial place if Euroland gets its act together and if the Chinese continue to move over the next 10 years to internationalize their currency. But the task is mainly theirs, and not ours.
In your book you write that the dollar overtook the pound sterling in a relatively short period of time. What could facilitate the same kind of quick transition today, between the dollar, and, say, the renminbi?
You can have a rapid transition if the issuer of the incumbent international currency screws up badly. Part of the explanation for how the dollar overtook the pound sterling was that Britain was the sick man of Europe for a long time in the mid-20th century. If the U.S. didn’t get its fiscal house in order, and if our economic growth suffered as a result and as a result, people, both private and official foreign holders of dollars, started looking much more actively for alternatives, there could be a rapid transition.
There’s been talk from some conservatives about not raising the debt ceiling — there’s even been suggestions in some quarters that a debt default by the U.S. government would be the first step in getting our financial house in order. What kind of impact would that have on the dollar?
History shows that debt default has very serious reputational costs. It would then be much more expensive for American companies to borrow for investment purposes, not only for the U.S. government. Because there would be a shadow of suspicion over American debts more broadly — the same people who voted for the politicians that opted for default would be the people borrowing for investment projects and homes and automobiles. There would be serious costs in terms of our access to financial markets, the willingness of foreigners to hold dollars and for our living standards.
So, what the financial crisis did not manage to do in terms of unseating the dollar, something like that could?
That’s what I talk about in the final chapter of my book. There are different scenarios in which one can imagine that the dollar would be unseated — would lose its exorbitant privilege entirely. The only plausible one, to my mind, is this one, where we do it to ourselves, through reckless fiscal policy or reckless financial policy that destroys the dollar’s reputation in the eyes of foreign investors.