The Unloved Dollar Standard: From Bretton Woods to the Rise of China

The Unloved Dollar Standard: From Bretton Woods to the Rise of China

Ronald I. McKinnon

Language: English

Pages: 240

ISBN: 0199937001

Format: PDF / Kindle (mobi) / ePub


The world dollar standard is an accident of history that greatly facilitates international trade and exchange-even trade not directly involving the United States. Since 1945, the dollar has been the key currency for clearing international payments among banks including interventions by governments to set exchange rates, the dominant currency for invoicing trade in primary commodities, and the principal currency in official exchange reserves.

Although the strong network effects of the dollar standard greatly increases the financial efficiency of multilateral trade, nobody loves it. Erratic U.S. monetary and exchange rate policies have continually made foreigners unhappy. A weak and falling dollar led to the worldwide price inflations of the 1970s and contributed to the disastrous asset bubbles and global credit crisis of the noughties -- including the global credit crunch of 2008-09. Dollar weakness aggravated the postwar world's three great oil shocks in 1973, 1979, and 2007-08. After 2008, the U.S. Federal Reserve Bank's policy of keeping short-term interest rates near zero and out of alignment with emerging markets on the dollar standard's periphery, makes the international monetary system vulnerable to 'carry' trades: hot money inflows into the periphery that cause a loss of monetary control, commodity bubbles, and worldwide inflation . When these carry-trade bubbles suddenly unwind, they can result in huge swings in exchange rates and credit crunches.

The asymmetrical nature of the dollar standard also makes many Americans unhappy because they cannot control their own exchange rate. Under the rules of the dollar standard game as explained in chapters 2 and 3 of this book, foreign governments may opt to set their exchange rates against the dollar while, to prevent conflict, the U.S. government typically does not intervene. Nevertheless, Americans often complain about how foreigners set their dollar exchange rates unfairly. Japan bashing in the late 1970s to the mid-1990s over the alleged under valuation of the yen, and China bashing in the new millennium over the alleged undervaluation of the renminbi, are two cases in point.

Thus, while nobody loves the dollar standard, the revealed preference of both governments and private participants in the foreign exchange markets since 1945 is to continue to use it. As the principal monetary mechanism ensuring that international trade remains robustly multilateral rather than narrowly bilateral, it is a remarkable survivor that is too valuable to lose and too difficult to replace. This book provides historical and analytical perspectives on the different phases of the postwar dollar standard in order to better understand its resilience in spite of the great volatility in today's global monetary system.

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stability in the American and world economies. How can this be measured? First consider the long-term purchasing power of the dollar in a comparative international context. Figure 4.1 plots the path of the U.S. and German CPIs since 1957, when comparable data first became available, and then splices the CPI for the euro area in 2010 onto the German series through 2010. When the euro area is spliced in, its inflation rate is very similar to that of Germany’s—past and present. Since 1957 inflation

a carry trade is the uncertainty of exchange rates. The carry trader would run the risk of losing money if the investment currency suddenly depreciates but would gain further if it appreciates. Also, these transactions are generally done with a lot of leverage, so a small movement in exchange rates can result in huge losses unless the position is hedged appropriately. ( 62 ) The Unloved Dollar Standard This Wikipedia description is useful but not complete. A key feature of a carry trade is

his profit because f = i – i*. To get back into the funding currency, the cost of forward cover, that is, the forward premium f, is equal to the interest differential. Carry trading is a risky business where hedging is virtually useless! CARRY TRADING FROM THE FED’S ZERO-INTEREST-RATE POLICY From 2009 into mid-2011, almost all emerging markets (EMs) complained about ultralow interest rates at the “center” inducing hot money flows to the “periphery.” With the two-speed world recovery, the slowly

by noting that as absorption falls in the transferor, and the relative price of its nontradables begin to decline, then its exports will increase and imports decline as resources move into its tradables sector. If, myopically, one stopped at this point with adjustment only in the transferor, it then seems as if the orthodox presumption holds: the price of its exports would be bid down relative to the price of imports. However, absorption adjustment must be two-sided. As the transferee’s

1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 0 US Japan (in Yen) Figure 10.1. Percentage differences in Manufacturing Wage Growth for the United States and Japan, 1952–2010 (1952 = 100) Source: Japan Statistics Bureau and Bureau of Labor Statistics But what happens to wage growth when the national currency is expected to appreciate against that of the center country? After the Nixon shock of 1971, and then continual American pressure to have

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