A guest review of Exorbitant
Privilege: the rise and fall of the dollar, by Barry Eichengreen

Philip Thornton, Clarity Economics

From a
standing start in 1914, the US dollar overtook sterling as an international
currency within the space of less than a decade. When sterling finally fell off
its pedestal as the world’s reserve currency in the wake of the Suez crisis, it
was America that gave it the final shove.

Could
history be about to repeat itself? The dollar is going through a crisis of
confidence, weighed down by historically high deficits. Since its entry into
WTO in 2001, China has leapt to become the world’s second-largest economy. Meanwhile
the Chinese authorities have publicly raised the idea of alternatives to the
dollar and taken preliminary steps towards making the renminbi a more
international currency.

Anything is
possible and, as Barry Eichengreen points out, if history is any guide then a
collapse of the dollar would develop not gradually but abruptly. History
plays a significant role in this short but detailed and fast-moving analysis of
the rise of the greenback as an international currency. Readers eager for
Eichengreen’s forecast of how the tensions between China and the US over
currencies will pan out need to wait 150 pages for that action to begin.

Their
patience is rewarded, as Exorbitant Privilege is almost five books in
one. A history of the dawn of the dollar provides a long historical context;
the post-war battle of supremacy takes us to Bretton Woods; then the creation
of the euro; the 2008/09 financial crisis; and finally the denouement of the
dollar. Eichengreen,
a professor of economics and political science at the University of California,
Berkeley, mixes those two disciplines effortlessly to show how it is long term
shifts in economic and political power that determine the fate of currencies. Thus it
took a quarter of a century and a devastating world war before sterling’s
demise as a global reserve currency was clear. Incumbency gives currencies
significant advantages, as the author frequently points out.

The dollar
has had a remarkable run as sole reserve currency over the last half century.
This enabled the US to run deficits “without tears” as French economist Jacques
Rueff put it, by printing money and requiring its trading partners to buy its
currency in order to transact.

This is
what Valery Giscard d’Estaing, then France’s finance minister, bitterly
described as the dollar’s “exorbitant privilege”, the elegant phrase that gives
the book its title.

But despite
the sub-title of the book, Eichengreen does not believe that history will
repeat itself in the way that sterling really did experience a rise and fall. The author
carefully points out the weakness in what he described as ”sensationalist”
reporting of the dollar’s imminent decline. The first is that unlike the 1950s
when the US held relatively few pounds, the Chinese hold some $2 trillion in
their reserves. A decision
to engineer a crash in the dollar would leave Beijing nursing staggering paper
losses on its holdings. Secondly China’s export-driven economy depends on US
consumers continuing to “buy Chinese”. Massive dollar depreciation would send
import prices sky high and trigger painful retrenchment among Chinese
companies. Third,
other countries – users of the euro in particular – would suffer too as their
currencies appreciated and would be more than willing to work with the Federal
Reserve to stabilise the dollar. Finally
China would have to allow the renminbi to fluctuate within the liquid and open
financial markets that Beijing has to date resisted while it seeks to engineer
high levels of export-driven economic growth to fund its infrastructure needs.

For
Eichengreen, the threat to the dollar comes not from the Chinese but from
America itself, and particular “eye popping” US deficits. He blames the
ballooning of the deficit during the good times of the Bush era, the cost of
tackling the financial crisis and the ticking time-bomb as the baby boomers
reach retirement. He pins his
hopes on a bipartisan initiative by Congress to rebalance the nation’s finances
but is not optimistic, a view supported by the recent failure of the National
Commission on Fiscal responsibility to strike a deal. The best
outcome would be a gentle decline in the dollar combined with tough action to
reduce the fiscal deficit while investing in infrastructure to help deliver a more
balanced economic recovery based on high-skilled industrial activity.

The point
is that whatever action is taken – Eichengreen suggests tax reform, caps on
bankers’ bonuses and investment – the dollar’s fate still rests with America,
something he sees as “good news”.

While the
Sino-American aspect of the book will grab headlines in the US, European
readers should not skip over the sections on the euro. In fact the
book is as much about the euro and the dollar. The dollar’s turmoils could have
opened the way for the single currency but political compromises towards
national sovereignty that prevented fiscal union and a genuine eurobond market
hampered the euro’s emergence as a truly global currency. As Eichengreen
puts it, the euro is a “currency with no state” while the renminbi is a
“currency with too much state”. The lack of rivals means that reports of the
dollar’s demise as an international currency appear to be greatly exaggerated.