Financial Cryptography

From Bretton Woods to GW-II

The great shifts in currency politics go on - this polemic "Bretton Woods and the Forgotten Concept of International Seigniorage" is on the background of the USD since Bretton Woods, leading up to the recent Iraq invasion. Evidence seems to be mounting that one of the major factors (of three or four) was the importance of the oil-dollar trading book as a mainstay for USD reserves at world central banks.

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Bretton Woods and the Forgotten Concept of International Seigniorage

Dix Sandbeck

In the summer of 1944, delegates from 44 allied nations met for the now famous economic conference at Bretton Woods, New Hampshire. Their mandate was to finalize plans for the post-war economic order and currency cooperation that had been circulating among the Allied nations.

Some of the results of this meeting are still familiar elements of the current structure for international economic co-operation: the International Monetary Fund - and the World Bank are cases in point.

Largely forgotten today is that the establishment of an international reserve currency had also been on the agenda at the time. Keynes, chairing the British delegation, proposed the establishment of a special reserve currency, provisionally named the "bancor." President Roosevelt had at first instructed the American delegation to support such an initiative.

Keynes envisaged the bancor as an international trade currency and unit of account. Its management and issue was to be in the hands of an another planned international organization, the International Clearing Union (ICU). The value of the bancor was to be determined by the value of the different national currencies in a trade weighted basket. Values of currencies would be fixed, but could be changed by mutual agreement.

A fundamental aim of Keynes' plan was to install a truly multilateral system. No nation would be allowed to dominate; nations in surplus or in deficit would be disciplined alike. Shortly before the conference however, the Americans rescinded their support for the bancor. Presumably, they felt that the bancor scheme, with its control in the hands of the ICU, was a shrewd strategy to rob the United States of its greatest spoil of victory: unfettered post-war dominance.

Instead, the Americans insisted on a system where the US dollar would be fixed to a gold value of $35 per ounce, though convertible only for central banks. All other currencies were to be aligned to this dollar-gold anchor. If adopted, this would confer on the US an unprecedented supremacy Even Britain, at the pinnacle of her power had not enjoyed such a position. But at Bretton Woods the exhausted European nations were eager for the continued flow of dollars to finance the war and the impending reconstruction. No nation was in a position to challenge the American volte-face.

In general, the dollar-gold link has been viewed as the key feature of the Bretton Woods system. In 1971, President Nixon "closed the gold window" by officially cancelling the right for all other central banks to convert any dollar holdings into gold. Many have considered this the year of Bretton Woods' demise. However, the dollar-gold link had always been an illusion elevating the dollar to the role of a global reserve currency. The true significance of Nixon?s decree in 1971 was simply to destroy that mirage.

The fixed exchange rates served a clear purpose in the immediate post-war period when stability was at a premium. After economic activity and trade had rebounded, the tendency of fixed exchange rates to magnify misalignments took over.

International Seigniorage

Seigniorage as a concept originated in medieval times. Monarchs used their monopoly in coining precious metals as a major source of revenue. Periodically an issue of gold or silver coins would be recalled, recoined with a lesser precious-metal content. The difference in value, between the face value and value of actual gold or silver content, was the seigniorage gain. When modern states expand their monetary base, they do so by sending more money into circulation, which pays for some of their expenditures. Since money is largely credit today, the seigniorage gain is almost equal to the face value.

Countries whose money functions as international reserve currencies, benefit from seigniorage, on an international scale. They can, as a nation, pay for imports with the seigniorage gain accruing from the expansion of international reserve holdings of their currency.

Ultimately, Bretton Woods allowed the US to reap international seigniorage by providing the world with much needed reserves. As a result, the US was able to impose many of its internal problems onto other nations. This key outcome of Bretton Woods continues to be an integral part of the global economic order.

By the late seventies, the oil crises had dramatically changed the terms of trade between the oil exporting nations and the rest of the world. Through forging a close political partnership with Saudi-Arabia, the leading oil exporter, the US ensured that oil would continue to be priced in dollars.

The oil exporting countries' collective surplus of petro-dollars was recycled back into the international financial system as liquidity, which was increasingly held in off-shore accounts as eurodollars. Although many of the developed nations experienced rising trade deficits, they had little problem in financing them by drawing on these pools of liquidity. The real losers were the developing nations that ran into exploding debt burdens.

Currently, international organizations with a role in providing development assistance to the Third World are almost entirely dependent upon contributions or paid-in quotas from richer nations. The bancor plan would have made the gain from international seigniorage partially or fully accessible for development assistance, instead of, as it is now, squandering it in support of the world richest nation and its over-consumption.

The Road to Baghdad

By the late nineties, US dollar holdings were estimated to account for approximately 65% of all held international reserves. The resultant dollar strength has allowed the US to sustain imbalances in the form of budget and trade deficits, that no other nations would be capable of (as was the case during the Reagan administration). The Clinton administration successfully turned the budget deficit around, but at the cost of a trade deficit that escalated uncontrollably.

The US economy has continuously reaped the benefits from the international economic system's inability to discipline it effectively. Because of this, American administrations have become accustomed to pandering to short term economic interests of key constituencies. Not surprisingly, these policies have resulted in such abysmal deficit levels, that had a developing nation applied for IMF support with such numbers, they would have been promptly rejected or at least placed under a harsh array of conditions. However, there is evidence that the days of smooth sailing are drawing to an end.

The first problem arises from the fact that dollars need to be invested in dollar denominated assets in order to earn a return. Consequently, when the world experiences a rising dollar overhang, it creates inflationary tendencies in the pricing of dollar assets. This was no doubt a major factor behind the stock market bubble of the '90s. The subsequent correction appears to have made international dollar holders wary of repeating the cycle.

Then there is the emergence of the euro as a full-fledged currency, presently used by 12 of the EU nations. This means that all trade and tourism spending between these nations has become internalized into euro transactions. Previously, the majority of these transactions were based on non-dollar pricing and reserve holdings.

As previously mentioned, a major component in maintaining the dollar's dominant position during the wake of the oil crises, was the Saudi's commitment to preserve the dollar as the currency in which oil was priced. This leads to the third, but potentially the most worrisome, cloud in the sky for the Americans. For a long time, the majority of nations seemed to have acquiesced to the oil-dollar relation, the linchpin of its dominance in recent decades. Nevertheless, signs have emerged during the last couple of years that this is no longer the case. A clear example can be observed in the actions of Chavez in Venezuela who started to counter-trade with some of his Latin American neighbors, thus cutting the dollar out of the loop.

But the real shocker for the Americans must have been when Saddam declared in November of 2000, that Iraq would commence pricing their export under the oil-for-food program in euros. American worries were compounded by subsequent rumours that both Libya and Iran were considering a similar currency shift.

This leads to the final question concerning the real reasons behind the American attack on Iraq. Did the Americans really have such faulty intelligence that they deemed Iraq to be an imminent threat to their security?

Of course not. However, by pricing Iraq's oil in euros, WMDs or not, Saddam engaged in an ultimate act of American defiance. What definitive role it played in galvanizing the American call to war, is hard to say. What is clear however, is that toppling Saddam's regime showed everybody the big stick, and more importantly took the impending euro pricing of oil off the table.

Dix Sandbeck

from Economic Reform, Sep. 2003

Posted by iang at February 23, 2004 09:16 AM | TrackBack