With the Federal Reserve's wide-ranging efforts to address the ongoing Credit Crisis through unprecedented money-creation activities, we are now likely witnessing the final phases of the U.S. Dollar's 64-year reign as the primary global reserve currency. Few Americans understand the implications of this dramatically unfolding global sea-change.
The U.S. Dollar was installed as the lynchpin of the international monetary system in July 1944 by and among the 44 Allied nations, and just as the end of WWII was in sight. At that time, the U.S. owned or controlled well over half of the world's wealth, and the Bretton Woods Agreement (named after the small town in New Hampshire where over 700 representatives of the leading industrialized nations met that summer) created the financial architecture whereby the U.S. Dollar, as backed by and exchangeable into gold at the rate of $35/oz, would function as principal 'reserve currency' in the post-war global monetary system. The dollar debuted in its newly-expanded role via the Marshall Plan and the reconstruction of post-war Europe, when the U.S. paid dollars into the accounts of foreign banks, both to maintain our overseas military bases as well as to rebuild war-ravaged economies. Very importantly, all crude oil transactions throughout the world were also designated to be priced in dollars, regardless of which nations participated in the oil trades. In many ways, the Bretton Woods Agreement can be seen as one of the great 'spoils of war' for the U.S., and the dollar's acceptance and dominance was subtly reinforced throughout the subsequent Cold War and afterwards by America's enduring global military supremacy - the so-called 'Pax Americana.'
Bretton Woods thus represented an enormous post-War economic advantage for America ever since, yet in mirror fashion it emerged as a major problem for the other countries, primarily because it created the possibility that the dominant U.S. could simply print money, and do so essentially at the expense of diluting the other nations' savings. Gold convertibility was to provide the discipline whereby the U.S., as keeper of the 'reserve currency,' would keep its budget in balance and the dollar as a sound reserve currency. That is, if other nations were uncomfortable with the U.S. spending policies which might dilute the value of their reserve savings, they could convert their dollar savings into gold. But Bretton Woods allowed the U.S. some convenient 'wiggle room.' Over time, the U.S. chose a predictable political path in ignoring key parts of the Agreement, often reminding the less-powerful Europeans who had saved them from the Nazis, who had won WWII, and who was now protecting them from the rising Soviet menace. In due course of the post-World War II era, the U.S. began to spend far beyond its means both for defense and foreign aid purposes, as well as for expanding domestic social programs.
By the 1950's the U.S. undertook the expensive Korean War, and then in the 1960s the U.S. began to spend in earnest for both the Vietnam War as well as for President Lyndon Johnson's 'Great Society' welfare and entitlement programs. These activities were essentially financed by creating new debt and/or new inflated dollars, and these efforts served to plant the seeds for significant dilution and debasement of the other countries' U.S. Dollar reserve accounts.
The era of ballooning U.S. deficit spending and rising inflation was well underway by the late 1960s. Over time, the Bretton Woods participants became increasingly frustrated about the debasement of their dollar reserve savings, and French President Charles de Gaulle even announced his intention to send a ship to the U.S. to exchange France's accumulated U.S. Dollars for gold at the official rate of $35/oz. By 1971, the other European nations were also increasingly uncomfortable, yet the dominant U.S. first downplayed and then later summarily dismissed their concerns through President Richard M. Nixon, when the U.S. officially and unilaterally suspended the gold-convertibility 'promise' of Bretton Woods. In officially closing the so-called 'Gold Window' on August 15, 1971, Nixon's Treasury Secretary John B. Connally rebuffed the Europeans with his now-famous quote: "The dollar is our currency, but it is your problem." So foreign central banks took it badly on both ends - they were unable to keep Congress and the U.S. from spending programs which were diluting their 'dollar reserve currency' savings, and they were also unable to redeem their dollars for gold as promised.
With Nixon's official abandonment of the Bretton Woods gold-convertibility system, the global economy moved thereafter to a 'floating' exchange-rate system where currency rates were no longer fixed against each other and/or backed by gold. The currency world entered a new and more speculative 'Relativistic Age' where currency exchange rates instead varied constantly, depending on changing perceptions of the strength of one another's economies, and especially reflecting their comparative internal structures of interest rates. With the emerging need to 're-cycle' petrodollars following the Arab Oil Embargo of 1973, and with dollar fundamentals further weakened by continuing frequent U.S. trade and budget deficits since the Vietnam era, the global economy became increasingly awash in dollars by the late 1970s. With oil price shocks and deficit-spending combining to produce double-digit inflation by 1979, a 'dollar rescue' of sorts developed in 1980, when U.S. Fed Chairman Paul Volcker dramatically raised Fed Funds rates, eventually pushing the Prime Rate to 21 1/2% by late 1981. Volcker's Fed tenure represented a painful adjustment period for the U.S. economy, but it won the U.S. great praise around the world for bringing inflation under control. Unfortunately for dollar holders, the Volcker Era did not last.
Douglas E. Johnston, Jr., is a C-Level executive with national experience in the core development of five 'best in class' companies in five different industries including Mergers & Acquisitions, Commercial Banking, Nationwide Commercial Real Estate, Consumer Products Manufacturing, and Media / Entertainment.
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