US domination of the world affairs is often attributed, among others, to its technological prowess; nuclear arsenal; fleet of aircraft carriers; satellite networks gathering intelligence round-the-clock. But its most potent weapon that has wrecked foreign economies; destroyed nations; and has been used to buy Prime Ministers, Presidents, Army Generals, Judges and Ministers is often ignored. That is the power of its currency. United States dollar (US$) was born when Continental Congress of the United States authorized the issuance of the US$ on 8 August 1785.
Post World War II (WWII) the creation of The International Monetary Fund (IMF) & The World Bank was the first step towards establishing a global US$ hegemony. The US sat back and watched the WWII unfolding, saying that this was not its war, until the attacks on Pearl Harbor. In response, after nuking Japan, the US-led allied forces claimed victory in this global mayhem. Nearly all the European and Asian countries were war-wrecked and started borrowing from the US to rebuild their infrastructure and economies. This gave the US an opportunity to develop institutions and make fiscal policies to enslave the world in the coming decades.
The centerpiece of this neo-imperialism was to turn a green piece of paper into the most lethal weapon the world has ever witnessed. Starting from Bretton Woods to the US$ hegemony and then to the modern day foreign exchange (currency) markets, understanding these three phases are essential to grasp the intricacies of the subject. BRETTON WOODS: The Bretton Woods Accords were entered into at the end of World War II, on 22 July 1944, “to regulate the international monetary system”. The chief features of the Bretton Woods system were an obligation for each country to adopt a monetary policy that maintained the exchange rate by tying its currency to the U.S. dollar and the ability of the IMF to bridge temporary imbalances of payments. Currencies were allowed to fluctuate from this “peg” only within a very narrow band of plus or minus one percent.
The principal architects of the Bretton Woods Accords were British economist John Maynard Keynes and Assistant U.S. Treasury Secretary Harry Dexter White. Keynes envisioned an international central bank but the United States had just become the world‟s only financial superpower and was not ready for that step in 1944. The IMF system was formulated by Dexter White, and it reflected the power of the American dollar.
Under the White Plan, the US$ would be backed by gold, which were considered “as good as gold” because the United States had agreed to maintain their convertibility into gold at US$35 per ounce. As long as people had faith in the US$, there was little fear of running out of gold, because gold would not actually be used.
The Bretton Woods worked for a while, but it was mainly because fewer countries actually converted their dollars into gold. Trade balances were usually cleared in US$, due to their convertibility into gold. US suffered a great blow in the Vietnam War. International confidence in the US economy declined. The French started converting their US$ reserves into gold. Other countries followed.
The US had lent more dollars than the gold it had in its vaults. A massive conversion would drive the US into bankruptcy. President Nixon issued Executive Order 11615 in August 1971 closing the “gold window” permanently. This meant the dollar would not be converted (a promise on which it was originally issued) into gold anymore. Since the US was a superpower no country would dare retaliate let alone go to war. This act was known as the Nixon Shock. The result of taking the dollar off the gold standard was to finally take the brakes off the printing press. Now Fiat dollars (or dollars backed by nothing) became the new global currency!
The cost of producing a US$ to the US is simply the cost of printing the note, whereas a foreign government must provide a US$‟s worth of goods for that US$. The difference between these two values is called “seigniorage” and its benefits go directly to the US government. Further, the US$’s position in the world allows the US government to borrow money at exceptionally low interests rates due to high demand for the US$. This phenomena is generally called “exorbitant privilege” and allows the US to run a balance of payments deficit “without tears,” as French economist Jacque Rueff said.
The above was an initial phase of the dollar hegemony. Another important development followed that allowed the dollar hegemony to grow further. Till 1970s, the world oil resources were owned by 7 private American and European oil companies popularly called “Seven Sisters”. Due to domestic pressure, oil producing nations began “nationalizing” their oil fields. This was achieved by buying the equity stakes of foreign oil companies. This “transfer of ownership” was allowed by the US on one condition: the oil will be priced (bought and sold) in US$ only ! As long as oil transactions were denominated in US$, the US essentially controlled all the oil in the world financially regardless of who owned the oil fields. This reduced all oil producing nations into mere commodity agents.
The U.S. dollar, which was originally backed by gold, was now “backed” by oil. Every country had to acquire US$ to purchase this essential commodity. Oil-importing countries around the world were left with two options: (a) borrow US$ from the IMF/World Bank by signing up to atrocious conditions or (b) earn US$ by producing exportable goods for paying expensive oil import bills. Even if it meant diverting productive capacity away from feeding and clothing their own people.
After falling off with his US masters, Saddam tried to sell Iraqi oil in non-US$ currencies. Thus the wars in Iraq were less about physically controlling oil and more about keeping oil denominated in the US$ and protecting US$ hegemony. The difference is subtle but important. This is why central banks around the world have been forced to hold more US$ reserves than they need.
While the trade-surplus nations are forced to lend their export earnings back to the US, these same nations are starved for capital as export earnings in US$ are only invested in their export sectors to earn more US$. The domestic sector with local currency earnings remain of little interest to global corporations. As a result, domestic development stagnates for lack of capital.
The foreign exchange currency transactions mean that one party purchases a quantity of one currency in exchange for paying a quantity of another. As per the Bretton Woods system the exchange rate of nearly all countries (currencies) were fixed. But when Nixon broke the “gold window” and refused to convert the US$s into gold, the system of floating exchange rates came into existence. Since no viable alternative existed after the US$ went off the gold standard, so most countries agreed to it. They had no choice other than fixing or „pegging‟ their currency with the US$ or leaving their currency on a floating exchange rate wherein its value is determined by its demand and supply in the market.
It is intriguing how Wikipedia introduces the „foreign exchange market‟. Rather than admitting that US broke the Bretton Wood agreement and as a direct consequence the foreign exchange market came into existence, and that the modern day market is not a thoroughly planned and organized market, it states that the market “we see today started evolving during the 1970s when world over countries gradually switched to floating exchange rate from their erstwhile exchange rate regime, which remained fixed as per the Bretton Woods system till 1971”. Readers are conveniently deceived by the use of words “evolving” and “gradually switched” leaving an impression that the system was developed periodically and systematically.
After the Bretton Woods was abandoned, currencies were (and still are) valued merely by their relative exchange rates in the so-called “free” market. Foreign exchange markets became giant casinos, in which large US institutional investors (now dominated by Hedge Funds) are betting on the relative positions of different currencies. The daily estimated foreign exchange trades are over US$ 4 trillion . Of this, over 45% are “swaps”; 35% “spot transactions”; and approximately 12% “outright forwards”. Similarly, an estimated US$370 trillion are now riding on complex high-risk bets known as derivatives. This is 28 times the US$13 trillion annual output of the entire U.S. economy. But only smaller countries are vulnerable and left at the mercy of these investors who can radically devalue national currencies just by selling them short on the international market in large quantities. These currency manipulations could be devastating and bring countries down on their knees.
The alternative to letting the currency float is for governments to keep their currency tightly pegged to the US$. But governments that have taken this course have faced other hazards. The currency becomes vulnerable to the US monetary policies; and if the country does not set its peg right, it can still be the target of currency raids. In the interests of “free trade,” most governments agree to keep their currency freely convertible into US$. This means governments should be ready to absorb any surpluses or replenish deficits in the exchange market. For this, they must have enough US$ reserves to buy back their own currency. Recent depreciation of Indian and Turkish currencies is being attributed to these countries‟ current account deficits (higher imports and lower exports). But this is not the only reason!
If governments set the peg too high (so that their currencies do not buy as much as the equivalent in dollars), there will be “capital flight” out of the local economy. Capital flights then force governments to spend their US$ reserves to “defend” their currencies; and when the reserves are exhausted, the governments either default on their US$ obligations or let their currencies devalue to earn more US$s. When the value of a currency drops, so does everything priced in it. Through enforced privatization programs, national assets are then snapped by circling “foreign vulture capitalists” for pennies on the dollar. But what goes around, comes around. The same sort of speculative devaluation could happen to the US$ if international investors were to abandon it as a global “reserve” currency, something they are now threatening to do in retaliation for what they perceive to be the US economic imperialism.
There is no really safe course at present for most nations. Whether their currencies are left to float or are kept tightly pegged to the dollar, they can still be attacked by speculators or strong nations. Professor Henry C. K. Liu is a Harvard educated economist. He chaired a department at UCLA before becoming an investment adviser for developing countries. He calls the current monetary scheme, upon which the economic infrastructure is built, a ”cruel hoax”. “When we wake up to that fact”, he says, “our entire economic world view will need to be reordered, just as physics was subject to reordering when man‟s world view changed with the realization that the earth is not stationary nor is it the centre of the universe”. Till then, uncle Sam will continue to rule the roost!