What is America’s ‘unique advantage’?
The US consistently imports more goods and services than it exports. Indeed, it has not run a trade surplus since 1974. For most countries, such a situation would be impossible to sustain, since over the long run they need income from exports to pay for imports. For America, however, with the world’s only reserve currency – used to settle most international trade – it is possible to fund the gap by creating new dollars to buy things with. This is in one sense a unique advantage – dubbed America’s “exorbitant privilege” by Valery Giscard d’Estaing, then France’s finance minister under de Gaulle in the mid-1960s.
What’s wrong with this ‘privilege’?
As Ben Traynor, economist and editor of Gold News explains in a recent piece, when gold was still convertible into dollar bills, this so-called privilege could have emptied “the United States’ huge stockpile of monetary metal”. The problem for the US throughout the Bretton Woods era – a fixed dollar exchange-rate system in a world of increasing dollar liquidity – is summed up by what became known as the Triffin Dilemma, after Belgian economist Robert Triffin. On the one hand, America was all but forced to run a trade deficit since the world economy – recovering from World War II and expanding – needed more dollars. But at the same time, as more dollars entered the system, it inevitably put upward pressure on the dollar gold price, encouraging arbitrageurs and speculators to take advantage. From 1961, the advanced economies made an effort (in the form of the London Gold Pool) to keep gold prices down by co-ordinating central bank sales. But it was a losing battle, and collapsed after France pulled out as it increasingly (and understandably) wanted to hold more gold and less US currency than allowed under the system.
What could Nixon do?
In effect there were three choices. First, “close the gold window” – that is, end the dollar’s fixed convertibility to gold at $35/ounce – to force other countries to revalue their currencies against the dollar. Second, sell off America’s remaining stocks of gold. Or, alternatively, he could continue to try to keep the price of gold from rising, requiring a massive decline in the prices of everything else, and almost certainly triggering a great deflationary spiral on the scale of the Great Depression. He chose the first option – as a “temporary” measure that turned out to be permanent. To sugar the pill, he removed the 10% surcharge on all imports imposed several months earlier.
What happened next?
Initially, it worked. In Japan, where the yen soared in value, the events of August 1971 became known as “the Nixon shock”. This ‘shock’ (together with the oil price surge of 1973) forced Japan to move its economy upmarket towards higher technology and greater energy efficiency. This is where d’Estaing’s “privilege” raises its head again. Since 1971, as the post-Bretton Woods age of free-floating currencies developed, the dollar has remained the world’s reserve currency, unbacked by anything other than faith in the US government to settle its debts. So America has been free to exploit its double-edged ‘privilege’ with gusto.
In what ways has America exploited its position?
By spending. From 1940 to 1971, when foreign holders of dollars were in a position to exert some monetary influence and discipline on US finances, federal debt in the hands of the public grew at a compound annual rate of 6.5%. But since 1972 – following the “activation of our paper-dollar credit card”, as James Grant put it recently in the Washington Post – that rate has jumped to 9.2%. America runs up such titanic debts because it can. But “sooner or later, someone will take steps to ensure it can’t”. Many commentators (for example, Roger Lowenstein in a recent long piece in BusinessWeek) also argue that the ‘Nixon Shock’ unleashed a new world of risk and instability. Central bankers were able to give in to political pressure for limitless monetary expansion everywhere from the US to Greece.
So closing the window was a mistake?
America’s ability to print unlimited quantities of money is now under intense scrutiny. There have always been rises and falls in the gold price, nor is it (yet) at an all-time high in inflation-adjusted dollar terms. However, what is different this time round is a growing fear that gold’s ascent does not signal a temporary depreciation in one or other major currency. Rather, the depreciation of gold signals a slump in confidence in “fiat” currencies in general and the entire global monetary system per se. This state of affairs has lead to fresh calls for a return to some form of gold standard.
The back-to-gold debate
The debate on reverting to some form of gold standard or anchor for monetary systems is strongest within America itself. Proponents include Tea Party types, such the right-wing governor of Utah, Gary Herbert. Herbert recently signed the Utah Sound Money Act, declaring gold and silver legal tender and scrapping taxes on both. But more authoritative figures have also voiced qualified support, including World Bank president Robert Zoellick, Nobel laureate Robert Mundell, and even ex-Fed chairman Alan Greenspan. This means that the debate is now becoming more mainstream. On the other hand, the last apex of the back-to-gold movement was around 1980 – a sign (some have argued) that the price of gold was about to peak.