Understanding the Instabilities in the
Flexible-Dollar-Standard
European Network Academy of Social Movements
Miguel Otero-Iglesias, ATTAC Spain
Freiburg, 10 August 2011
(Working Slides)
The Era of Bretton Woods (1944-1971)
 The International Monetary System (IMS) is based on the
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dollar standard linked to gold
The dollar is fixed at $35 the ounce of gold
The rest of currencies are linked to the dollar
Trade is promoted – Free current account
Speculation and Exchange rate movements are hindered:
Capital Account controls
Since the 1960s the US is losing in competitiveness and
Europe and Japan start to catch up
Nonetheless, the US enjoys the ‘Exorbitant Privilege’
The Problem of the Triffin Dilemma
 The US needs to run current account deficits to provide the world
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with the necessary liquidity
The US is the demand pull in the IMS
This creates constant current account imbalances between the US
and its major creditor countries
This undermines the credibility of the dollar in the long run
In the 1970s it was mostly Europe (especially Germany)
In the 1980s it was Japan
In the 1990s, there is the emergence of the New Economy and the
US is able to regain competitiveness despite a strong dollar
In the 2000s the creditor is China
Monetary Power in Action
 Monetary Power is the capacity to delay and deflect the
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adjustment costs as much as possible
Delay means extending the time of adjustment
Deflecting means that when adjustment comes, the monetary
power is able to deflect some of the adjustment burden upon
others
This is known as the ‘Dollar Weapon’
You talk down the dollar, you introduce expansionary
monetary and fiscal policy, you ask others to appreciate and
to implement expansionary fiscal policy
With Germany and with Japan the US had the upper hand
because it provided the security umbrella
The Exorbitant Privilege since BW
The Dollar Index since BW
The Flexible-Dollar-System and the
Explosion of Liquidity
Exponential Growth in FX Reserves
GLOBAL FOREIGN EXCHANGE RESERVES ($m)
10,000,000
9,000,000
8,000,000
7,000,000
6,000,000
5,000,000
4,000,000
3,000,000
2,000,000
1,000,000
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Other developing
Mexico
Brazil
Algeria
Saudi Arabia
Russia
Other industrial
Australia
UK
Eurozone
US
Other Asia
Malaysia
Thailand
Hong Kong
Singapore
India
Korea
Taiwan
Japan
China
Consequence of this liquidity: Constant
Financial Crises
Situation since the tech bubble burst in
2000
Who carries the adjustment cost?
 The US applies a policy of “benign neglect” in relation to the
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dollar
The US tries to convince China to revalue its currency as it
did before with Germany and Japan
China does not give in and maintains a peg to the dollar until
2005, and reintroduces it in 2008
The hawkish attitude of the European Central Bank brings an
appreciation bias to the euro
Europe is the only major trade player that has not an active
policy in relation to its FX rate
Euro-dollar Exchange rate
Dollar-Chinese Yuan Exchange Rate
Currency Wars Arrive to Brazil
POST-CRISIS REAL EXCHANGE RATES
(JP Morgan)
150.0
140.0
130.0
120.0
110.0
100.0
90.0
Russia
India
Turkey
Indonesia
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China
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Brazil
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80.0
Mexico
Current situation:
“To put it crudely, the US wants to inflate the rest
of the world, while the latter is trying to deflate
the US. The US must win, since it has infinite
ammunition: there is no limit to the dollars the
Federal Reserve can create. What needs to be
discussed is the terms of the world’s surrender:
the needed changes in nominal exchange rates
and domestic policies around the world.” Martin
Wolf, Financial Times, 12 October 2010
The main features of the FDS
 The US is the main provider of liquidity and demand pull of
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the system (first Bretton Woods, and then Bretton Woods II)
The system is inflationary in the good times and deflationary
in recessions
In the FDS adjustment falls mainly on deficit countries, but
the US who enjoys the exorbitant privilege
This asymmetry can be seen in the eurozone crisis
The rest is exposed, therefore there is the incentive to be a
surplus country (Germany, Japan, South East Asia, China)
Can we have a more stable IMS?
The Chinese Proposals to deal with the
dollar overhang
 More use of the IMF SDRs
 Inclusion of the Yuan/RMB in the SDR basket
 Creation of a Substitution Account in the IMF
 China has proposed to create a managed floating exchange
rate regime
Problems:
 US unwilling to let its exorbitant privilege go
 US demands flexible yuan, independent central bank and
opening of capital account (China will not accept)
 Can the SDR without a political authority behind?
 Do we need a world government?
Possible Future Scenarios?
 1) Increased competition between the Dollar, the Euro and
the Yuan (this can lead to major disruptions if transition not
managed).
 2) The US will press ahead with its exorbitant privilege,
more quantitative easing (QE), more liquidity, more tensions
and perhaps a return to a gold link or similar (uncertainty is
widespread in the IMS)
 3) The international community can move towards
cooperation. SDRs as harbinger for a global currency a la
Bancor. (The euro might provide useful lessons)
Conclusion
 The FDS is structurally flawed
 The Triffin Dilemma is the main cause of the instability
 The US is the main source of demand but also the main
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source of destabilising liquidity
The growth in FX reserves is clear proof of this situation
The EZ has played by the rules (flexible exchange rate and
open capital account) and has carried most of the adjustment
cost
A unipolar monetary system induces the hegemon to exploit
it
A more coordinated and multilateral IMS could potentially
be more stable