An Article Review on: the Borrower of Last Resort: International Adjustment and Liquidity in Historical Perspective* Ramaa Vasudevan

China has become a perceived threat to the U.S. economy because of the increasing trade deficit between the two countries, their ability to undercut production costs of similar products produced in the United States, and the amount of leverage that China has over the United States due to amount of money that has been lent by China. Although the United States has taken steps to close the trade deficit, such as convincing China to raise prices on their exports, there is still a considerable gap (Prasad). The United States government continues to print money that they simply can’t afford, therefore, relying even more heavily on China sustaining the value of their currency. Unless the United States is able to close the trade deficit and regain control of our economic flexibility, the problems caused by foreign countries owning our debt will remain eminent.

After rapid growth in the international debt of developing countries in the 1970s – and the increasing incidence of scheduling back debt in the early 1980s, the risk of countries reflecting the ability and willingness of a country to financial services has been a topic of concern for the international world (Cosset and Roy, 1991).

With the onset of the war, the stability of the relationship between Britain, France, and Germany – which the Gold Standard was dependent on – crippled (lecture, 10/13). During the interwar period, 1914-1945, the lack of coordination between economies led to a liquidity shortage while the nations held a floating exchange rate. The interwar period saw a breakdown in international monetary coordination – proving that a floating economy was doomed for failure (FLB 264). Outside of the lack of international coordination, the Gold Standard had other downfalls leading to its demise. For example, national governments had no authority to stimulate their country’s economies in times of need. Moreover, the fixed economy limits foreign trade, hurting the country’s industries (lecture,

After World War II, the Bretton Woods Agreement established the gold standard and two support institutions called the International Monetary Fund (IMF) and the World Bank. This would lead to a shift, away from the gold standard, to more relaxed systems. The idea of currency purely backed by gold was slowly being shifted to a trust based currency. These institutions purpose was to regulate the economies by injecting or taking money in a process called sterilization. Sterilization is to protect certain countries from a going bankrupt. If a country goes bankrupt, it chain a chain reaction of bankruptcies. So, in order to maintain balance, currencies need to be stable enough, so that it can be in debt without having to declare bankruptcy. The idea is

“A weak currency is the sign of a weak economy, and a weak economy leads to a weak nation.” – Ross Perot. The words of the 1992 Presidential candidate still ring true today, and in fact they have since the abolition of the gold standard in 1971 by President Nixon. Ever since that warm August day the United States has been on a death plunge into immaculate amounts of debt. However, by the establishment of the silver standard in the way I will explain to you today, makes it clear that action on such a policy must be taken.

Throughout the 20th century, the United States has slowly constructed a global system of control. Its superior military, weaponry and intelligence apparatus have been crucial in this system, but an equally important factor has been its control of the global economy, and its primary weapon, the U.S. Dollar. The dollar’s world reserve status alone does not make it unique, but its deeply rooted role in American and global geo-politics certainly does. As Vassili Fouskas and Bülent Gökay point out in their book The New American Imperialism, “Dollar hegemony has always been strategic to the future of American global dominance, in many respects more important than America’s overwhelming military power. While military power is more visible and useful as a display, it is the dollar’s role as reserve currency that secures the domination of the U.S. in the global economic market place”. [1] This system is built on serious fault lines and its future is the most important issue for international relations today.

Nations trade with one another because it is mutually advantageous for both parties when one is more efficient at producing a certain good and at a lower cost, and the other is proficient at producing a different good or service more efficiently. This is based on Ricaro’s theory of comparative advantage.

One of the characteristics of gold standard defined by Temin is that the adjustment mechanism for a trade deficit country was deflation rather than devaluation, that is, a change in domestic prices instead of a change in the exchange rate. In the event of a balance-of-payment deficit, countries on the gold standard could not devalue their currencies or expand the money supply to stimulate domestic demand, because by doing so would push up good prices, encourage more gold exports, and weaken the currency. Instead, they could only tighten monetary conditions with the goal of reducing domestic prices and costs until international balance was restored. “Critical to this process was the effort to reduce wages, the largest element in costs.” That is to say, the gold standard system must be maintained at the expense of the welfare of ordinary people, which they must either experienced wages fall or unemployment. This mechanism worked well to facilitate trade and exchange before the First World War, the reason,

Further assumed that the export and import of goods and services between country A and country B perfectly offset one another. The balance of payments accounts of country A and B in theory would be zero. Otherwise, when exports are greater than imports, balance of payments would be in a deficit. In contrast, when exports are less than imports, balance of payments would be in a surplus. As more countries entered global commerce, determining the balance of payments required, netting of all the transactions of goods and services in respective currencies involved. Consequently, a fluctuation in relative currency strength could alter a country’s the balance of payments. Conversely, a country’s balance of payments surplus or deficit could strengthen or weaken its currency relative to others. Hence, stable global monetary system was essential for a stable global commerce. Accordingly many countries adopted the gold standard. Under the gold standard, a currency derived its value from gold. The gold standard provided an automatic rebalancing mechanism for trade imbalances. For instance, when gold reserve is used to settle a deficit balance of payment, it triggered a reduction in money supply, causing interest rate to rise, shrinking the economy and ultimately reducing consumption. The reduced consumption eventually returned the balance of payment to equilibrium. In contrast to a deficit, a surplus balance of payment led to the price inflation, making export less competitive, thereby correcting the surplus and returned the balance of payment to equilibrium. The gold standard, thus was an efficient system to manage the balance of payment accounts. Nevertheless, the one drawback of the gold standard was the scarcity of gold itself. Thus, consequence of limited gold supply was limited money supply which can lead to high interest rates impeding economic growth, a deflationary

At the end of an economic depression, the year 1898 proved to show that better times were coming. The money supply of the country was showing an increase once again. During 1898, the money supply of the United States has been increased by at least $500,000,000 (“Abundant Money” 1). Gold production and gold importation have added at least $200,000,000 to the stock. The net balance in the foreign trade account accounted for another $300,000,000 (“Abundant Money” 1). This increase in the money supply makes money cheap and easy. Its abundance was verified by the large holdings of the New York banks and of the National Treasury. Investment activity was very active and the purchase of bonds resulted in a steady rise in the prices of all first-class

This paper will discuss the implications of the Fed’s monetary policy on the globe because of the gold standard, the problems caused by a decentralized Fed, and the Fed’s failure of a lender of last

How did this historical evolution unfold? In the late 1960’s, capital movements began to undermine the Bretton Woods preoccupation with capital controls, as US officials began actively encouraging the growth of the Euromarket— the pool of unregulated dollar reserves concentrated in the City of London. Speculative capital flows, however, began to undermine the capacity for the US to guarantee the convertibility of dollars into gold at fixed parity (Triffin, 1960). In 1974, Nixon closed the gold window and loosened capital controls. The deregulation of financial markets established a global market of mobile financial capital, yet Keynesian inspired institutional arrangements remained intact, especially the maintenance of cheap money policy for

There are countries which have greater economic power through increased exports and those which have limited economic power caused by increased imports resulting in a trade deficit. Trade discrepancy between nations made the gold standard difficult to implement since it failed to take into consideration two fundamental pillars of monetarism. Say’s law and quantity theory are the key components of monetarism, they highlight that excess money is spent and not hoarded. However, this was not the case with the gold standard which saw many countries bleed out their gold reserves. Sequentially, economic policies which supported the rigidity of the gold standard had to be done away with, since it brought the world financial market to the brink of collapse (Paul, Robert and Llewellyn

Deutsche Bank (Karczmar, 2004) suggests that the euro could eventually challenge the dollar as a reserve currency, but the euro is still far behind the U.S. dollar as a reserve currency, representing just 24.2 percent of the world banking reserves in the 2013 third quarter (International Monetary Fund, 2013). Numerous economists endorse the United States’ ability to safely continue its external deficits. Cooper (2001) poses the argument in its simplest form:

Between 1870 and 1900, most developed countries throughout the world used the gold standard. Countries used the gold standard mainly because of Britain’s steadfast of gold and that they had the most commercial and financial significance at the time (Meissner, 2005). The gold standard also allowed for an easier, more stable, secure way to trade with one another. Countries who adopted the Gold Standard saw greater symmetry, and lower costs of trade (Alesina and Barro, 2002). The Gold Standard was like a “Good Housekeeping Seal of Approval”, which was a system of adherence between countries to have cheaper trading. The more a country adhered to the gold standard, the less they were charged during trade. Countries, who did not adhere or only moderately adhered, were charged a considerably higher rate during trade at this time (Bordo, 1995). This fostered an environment of a desire to adhere and participate in having your countries currency backed by gold. However, there were times when the Gold Standard was not adhered to at all. These exceptions to the gold standard were allowed only during times of war, a financial crisis or shocks to terms of trade. The Unites States, Britain and France were the benefits of this exception, saving them financially during World War I and various financial panics they had domestically (Bordo, 1995). Furthermore, the gold standard was predominately beneficial by linking together fixed exchange rates between countries and circumventing