Donald Trump has spent the last two years targeting the US trade deficit and what he sees as the disadvantages of a strong dollar. However, as the world’s reserve currency, would the dollar – and thereby the American economy – be better served by a return to the gold standard?
Writing in The Wall Street Journal last month Sean Rushton, director of the Project on Exchange Rates and the Dollar at the Jack Kemp Foundation, claimed that the breakdown of the Bretton Woods System and eventual unpegging of the dollar from gold by Richard Nixon in 1971, has jeopardised the US current account.
Following the Second World War and the Bretton Woods conference in 1944, the US dollar was established as the world’s reserve currency, backed in itself by gold. However, Rushton argues “this ‘gold exchange standard’ was fatally flawed: The world’s need for dollar reserves soon outstripped America’s gold supply.” Subsequently the rush of dollars to indebted countries rebuilding after the war put pressure on monetary policy makers in the US to keep their currency pegged to gold. This became increasingly difficult and in 1971 Richard Nixon, now needing to pay for the Vietnam war, took the dollar off the gold standard, allowing it to “float” freely like any other currency.
The hope was that the dollar would depreciate and “smoothly” reduce the trade deficit. However, writes Rushton, the opposite happened: “No longer bound by fixed exchange rates and dollar convertibility, the US government’s fiscal discipline broke down.” As they were no longer tied to the dollar, the American central bank, the Federal Reserve, was able to increase the money supply, thereby meaning that debt as a percentage of gross domestic product, which had been falling since the end of World War II, began rising steadily.
Additionally, says Rushton, foreign governments began to stockpile dollars, as they became more abundant. Between 1973 and 2017 there was a 22-fold increase in the amounts held in foreign reserves, moving from $500 billion, to $11 trillion, representing two-thirds of global currency reserves. “Because of high global demand, the dollar’s international position is always stronger and US interest rates are lower than they would be otherwise. This, in turn, means that America’s budget and trade deficits swell in tandem, while US exports are costlier and imports are cheaper, regardless of trade practices.”
Rushton is not alone in his assertions. Michael Howell, director of Cross Border Capital and Glint contributor, noted in a recent article published on Smartkarma that “we should not rush to the conclusion that China is necessarily the culprit behind these [recent] lop-sided patterns of trade: the international role of the dollar is arguably far more important.”
Mentioning the clandestine advent of the “oil exchange standard” which affirmed the dollar as the global currency by facilitating it as the money which paid for OPEC oil in 1974, Howell says the dollar, and the US economy, is now pressured by the mitigation of the traditional US-Arabia oil hegemony by shale extraction, renewables and Chinese demand. China’s rise has put it in a position to supplant the dollar, says Howell, pointing to the behemoth Belt & Road Initiative: “Taking prevailing World Bank estimates of the income elasticity of infrastructure spending, this programme could easily expand regional GDP by 35-40%. Taken over a quarter century it would add 1-1½% annually to pan-Asian growth.”
Howell points to Robert Mundell, Nobel laureate and “architect of the euro”, and his alleged claim that “every great country has a great currency”. China is no exception says Howell, it is the largest trader, dominates commodities, has a credit system as big as American’s and a central bank (The People’s Bank) 20% bigger. “Too many in the West underestimate China’s potential.”
The possibility of the yuan as the new leading fiat currency is becoming practice. Howell mentions the recent inauguration of the yuan-denominated oil contract on the Shanghai futures exchange. “This may prove hugely more important than the on-going scuffles in a tariff war. Its success needs to be closely watched, because it may prove the turning point in the global dominance of the US dollar and ultimately in America power. President Trump may be rightly concerned.”
So, according to Rushton, the US economy has lost out because the dollar has been inflated as the world’s reserve currency and according to Howell, it is set to lose out because the dollar is about to lose its spot as the trade currency of choice. The dollar looks like it might be about to bear the worst of both worlds. However, perhaps there is a route out from this awkward axiom of monetary decline.
To reduce the current dependence on the dollar as a reserve and the bind it puts the US economy in, Rushton advocates the creation of a new global reserve currency made up of suite of fiat (government issued) currencies such as the euro, yen and pound as well as the dollar and gold. Like Howell he mentions economist Robert Mundell, pointing to his suggestion of an international currency backed half by gold and half by the five leading fiats. He also mentions US policymaker Jack Kemp’s proposal of a full return to the gold standard.
“If the US has reached the end of its rope and is unwilling to feed the world’s demand for dollars through its trade deficit, then international monetary reform is the answer,” says Rushton. “It would put US trade on a more level playing field, enforce fiscal discipline in Washington, and help millions of American workers.” It’s not entirely a forlorn request: last month Congressman Alex X Mooney submitted a Bill calling for a return to the gold standard in order to help the American workforce.
To take this a step further, a gold backed dollar could also give the US a significant edge in any trade war. If Howell predicts Trump will be worried by states and corporations seeking payment in yuan, a gold backed dollar is the perfect answer as it offers security and puts the currency (almost) beyond the reach of political manipulation.
But it is by no means a magic pill, a gold standard makes it difficult for governments to create money in times of crisis and is subject to gold’s own supply issues. However, there are advantages: Although the age of the oil exchange standard might be over, a gold-based currency could maintain dollar prevalence in the Middle East, and the invaluable diplomatic capital that provides. In additional, the technological advances the world is seeing in money, poorly advertised by cryptocurrency, are creating a premium on valid, non-corruptible currency. Whether that is e-money or paper, if it is pegged to gold, it will be a transcendent store of value.
Finally, there is one other point worth considering in this context. The dollar might not be the only currency looking for the power and security endowed by gold: in the last ten years China has more than trebled its gold reserves, as has Russia.