A Currency Of Exorbitant Privilege

A Currency Of Exorbitant Privilege Asia Subsidizes The United States' Debts Martine Bulard Le Monde diplomatique March 2005

Whether the dollar soars or crashes, other economies always pay for the damage. This is the consequence of the unique position that it enjoys internationally as the currency both of settlement and reserve. This exorbitant privilege has rarely been questioned since the end of the second world war. JULY 1944. It began at Bretton Woods, a small town in New Hampshire in the United States. The first United Nations monetary and financial conference established the International Monetary Fund (IMF)*, and the International Bank for Reconstruction and Development, which became the World Bank. The new monetary system obliged every state to guarantee the convertibility of its currency and a fixed parity with gold or the dollar (within a 1% band). But what it really did was to seal the dominance of the US and the dollar. Although the Soviet Union was to emerge from the war as the US's closest rival, it was not in an economic position to act as a counterbalance and decided not to participate in the system. The Marshall plan, with its financial subsidies for European reconstruction, strengthened the dollar's hold. The US increased foreign investment (from less than $10bn in 1946, to $19bn in 1950 and $40bn in 1959) and made up its balance of payments deficit by printing money. But the situation changed during the 1960s with the cost of the Vietnam war and the growing industrial power of Germany and Japan. In 1961, in an attempt to shore up the system, the leading central banks organised a gold pool. The rest of the world accepted responsibility for sustaining the dollar at its fixed parity of $35 per ounce of gold, buying the dollar when it fell and selling when it rose. (France withdrew from the pool in 1967.) A two-tier market was created in 1968, with a floating gold rate for private market trading and a fixed rate (held at $35 per ounce) for central banks. AUGUST 1971. After the failure of attempts to counter the weakness of the dollar, the US president, Richard Nixon, announced the end of its convertibility into gold. There would in future be more reserve banknotes than gold in the US central banking system. The immediate consequence of the non-convertibility of the dollar was the revaluation of the mark and yen. This destabilised the European monetary snake, created in 1972 to maintain narrow fluctuation margins between European currencies. By the end of 1973 it was common practice for currencies to float. JANUARY 1976. The Jamaica Agreement formalised the end of the fixed parity system and of the gold standard. The dollar fell from 5.5 French francs in 1971 to barely 4. Initially this slide benefited the US, boosting exports and market share; but this was no longer the case and the US deficit was soaring. The agreement failed to stabilise the situation. MARCH 1979. The European Monetary System was established to reduce fluctuation margins between Europe's currencies. There was no direct relation between this and the US Federal Reserve's choice of a strong dollar monetarist policy, forcing up interest rates (to more than 20% in 1980). Capital flooded into the US, where domestic investment soared. The dollar rose from just over 4 francs in 1979 to almost 10 in the first quarter of 1985. SEPTEMBER 1985. In response to the first debt crises (in Latin America) and to the Savings and Loan debacle in the US, the G5 finance ministers and central bank governors concluded the Plaza Agreement, named after a New York hotel. The idea was to devalue the overvalued dollar. US interest rates would be lowered and central banks would sell dollars - an expensive consequence of having bought dollars at their peak. The dollar duly fell in value. But financial deregulation was now in fashion. Capital flowed without restraint and catastrophes ensued: the US junk-bond crash (1989); the European monetary crisis; the devaluation of the franc and the Italian lire; sterling's dramatic exit from the ERM (1992); crises in Mexico and Argentina (1994), and in Asia (1997). A Japanese proposal to create an Asian monetary fund failed when China proved too weak and the US vetoed the idea through the IMF. JANUARY 1999. The euro was launched, replacing national currencies in most EU countries three years later. In line with the Maastricht treaty of 1992, the aim was to create a strong euro, like the strong dollar of the 1980s. As the dollar fell, the euro soared, weakening European growth already undermined by low salaries and social deregulation. 21 FEBRUARY 2005. The South Korean central bank announced that it intended to diversify its currency reserves, following China and Argentina, which have already moved some of their foreign exchange reserves from dollars into euros. The dollar fell in immediate response, forcing Korean officials to qualify the proposal. South Korea is the world's fourth-largest holder of dollars, after Japan, China and Taiwan. Translated by Donald Hounam

* In 2004 the US had 17% of voting rights at the IMF; the countries of the EU had 30%, more than a blocking minority if they chose to exercise it. ALL RIGHTS RESERVED © 1997-2005 Le Monde diplomatique http://MondeDiplo.com/2005/03/03privilege