This is a brisk and invigorating account of a century of international monetary developments by one of America’s foremost economic historians.footnote1 As would be expected, Exorbitant Privilege is extremely well informed, cogently argued and broadly persuasive. Events and policies, such as the Suez war, the ems breakdown or the current financial crisis—together with sharp criticism of the excessive deregulation favoured by both Alan Greenspan and Larry Summers—are splendidly documented. Conflicting views of what might happen in future are clearly put forward and analysed. Unexpectedly, perhaps, the book also displays fairly frequent touches of humour. In other words, it is both erudite and readable.
The main story begins in 1913, the year in which the us Federal Reserve system was created. At the time, America was already the world’s largest economy and largest exporter. Yet the dollar was hardly used in international exchanges. Semi-obscure currencies such as the Belgian franc or Italian lira were apparently more important. By 1924, just over a decade later, the dollar had dethroned sterling as the world’s main reserve currency and unit of account. Thus, already during the Weimar hyperinflation, prices in shops across German cities were only decided upon late each morning once a phone call from Berlin had provided the day’s exchange rate between the Reichsmark and the dollar. In part, the currency’s rise reflected America’s growing importance as a world power. But it was also strongly aided by the conscious efforts the newly founded Federal Reserve made to help its internationalization. After World War Two, of course, the dollar’s dominant role in international exchanges was institutionalized in the Bretton Woods agreement, enshrining what, at the time of the Vietnam War, de Gaulle’s finance minister Giscard d’Estaing would dub America’s ‘exorbitant privilege’. In some respects this would increase when Nixon abandoned convertibility with gold in the 1970s.
Yet in recent years, voices have increasingly been heard challenging this dominant role. Today, ‘in the wake of the most serious financial crisis in eighty years, a crisis born and bred in the United States’, Eichengreen writes:
There is again widespread criticism of America’s exorbitant privilege. Other countries question whether the United States should have been permitted to run current-account deficits approaching 6 per cent of gdp in the run-up to the crisis. Emerging markets complain that as their economies expanded, and their central banks felt compelled to augment their dollar reserves, they were obliged to provide cheap finance for the us external deficit, like it or not. With cheap foreign finance keeping us interest rates low and enabling American households to live beyond their means, poor households in the developing world ended up subsidizing rich ones in the United States. The cheap finance that other countries provided the us in order to obtain the dollars needed . . . underwrote the practices that culminated in the crisis.
More than this, some have argued that, ‘as a result of the financial mismanagement that spawned the crisis and growing dissatisfaction with the operation of the international monetary system’, the dollar’s singular status is now in doubt:
The us government has not been a worthy steward of an international currency, its critics complain. It looked the other way while the private sector produced the mother of all financial crises. It ran enormous budget deficits and incurred a gigantic debt . . . The dollar is at risk of losing its exorbitant privilege to the euro, the renminbi, or the book-keeping claims issued by the imf known as Special Drawing Rights.
The usual counter-argument has been that incumbent status should protect the dollar for many years or even decades to come. Interestingly, however, one lesson that Eichengreen draws from the inter-war experience is that reserve-currency status can quickly change hands if a new dominant power arrives on the scene. In the early years of its existence, it was thought that the euro might dispute the dollar’s hegemonic role. That never quite happened, and attention has now turned to the rise of China. The country is already a larger exporter than the United States, holds massive foreign reserves (mainly, of course, in the form of dollars), and its gdp, converted at current exchange rates, could match America’s by the middle of the next decade; in purchasing power parity terms, it should be larger well before. China is also beginning to flex its muscle in the international monetary arena. First came suggestions by Chinese officials in March 2009 that Special Drawing Rights should play a larger role. Then came lectures from the official state-run news agency, Xinhua, when Standard & Poor lowered America’s sovereign debt rating in August 2011: Washington was urged to cut its ‘gigantic military expenditure and bloated social welfare costs’—the latter, a nice ‘socialist’ touch. Might China wish gradually to raise the importance of its currency in international exchanges? Recent moves by the country’s monetary authorities suggest that this could well be the case; Eichengreen reports a Shanghai banking official mooting the possibility of a convertible renminbi by as early as 2020. Even if the ccp were to harbour doubts, an America enfeebled by continuing balance of payments and budget deficits, as well as by mounting external and domestic debt, could see importance slipping from the dollar. After all, sterling lost its international role in part because of the gradual weakening of the British economy. The dollar could follow a similar fate.