2. Please read the following excerpt from James Galbraith’s
The Predator State
(Free Press, 2008: pp. 197-200).
QUOTE
Is the United States a fully open economy? Well, of course it
is: it is certainly
fully open to trade and capital, it certainly trades in a
highly unbalanced way, and it
certainly borrows on a phenomenal scale. And yet precisely
because the United States
operates in global capital markets in a way open to no other
country, the rules as they
apply to the United States are different from what they are
for anyone else. To put it
crudely, the United States is not subject to the normal rules
of the world system. It
does not have to accept the terms and discipline of the
capital markets. Rather, it is in
a position, up to a point, to make the rules, impose them on
others, and exempt itself
from their harshest implementation. This is hardly fair, to be
sure. But it is the way the
system has worked.
How did the United States get into this position?
The answer goes back to the dominant fnancial role the United
States played in both world wars and in the construction of the
postwar fnancial order and the cold
war. In World Wars I and II, the United States was far more
than a military ally: it was
also the “arsenal of democracy,” and in addition to that,
democracy’s banker. Both wars
strengthened America’s fnancial position, moving the world’s
stock of gold to our
shores and ultimately permitting us to dictate the terms of
the postwar monetary
order. As agreed at Bretton Woods in 1944, that order would be
centered on the
dollar as the anchor currency, to which the value of all the
others would be pegged.
Underlying that agreement, there was an implicit bargain
between the United
States and the anticommunist, democratic governments of Europe
and (eventually)
Japan. We provided and would continue to provide military
security, including the
nuclear umbrella represented by U.S. strategic forces. (At the
beginning, we would also
supply steel, machinery, and credit to get European and
Japanese recovery under way.)
Those countries in turn accepted a subordinate diplomatic and
fnancial role, and
continued to accept it long after their own economies had
fully recovered from the
war. Indeed, they continued to accept it long after they had
gone on to create new
areas of industrial and technological advantage, even
dominance on world markets, and
despite the fact that in the 1970s, their currencies,
especially the yen and the mark,
were in increasing demand on world markets. In much of the
developing world as well,
particularly through Latin America, Africa, and Southeast
Asia, friendly governments –
anticommunist but not always democratic – put themselves under
American
protection. And the United States assisted them in repressing
both external subversion
and internal dissent, whether real or imagined, legitimate or
otherwise. This bargain –
security for seigniorage, defense for dollars, in effect –
defned the global economics of
the cold war.
Thus for a half-century the United States led a world
community centered on
a common defense of managed capitalism…The American trade
defcit is nothing
more, or less, than the normal consequence of that system, and
particularly what
emerged after the formal mechanisms of international fnancial
management and
exchange rate stabilization were abandoned between 1971 and
1973.
Bretton Woods still partook of the idea, rooted in ancient
practice and folk
wisdom, that every country in the world had to run a balanced
current account – a
rough parity of imports and exports – over time. Under the
discipline of the gold standard, foreign accounts before 1913 had
to be settled in precious metal. If you ran a
defcit for too long, gold would drain away. Eventually your
domestic prices would fall
(because there was not enough gold in the system to support
the economy at current
prices) or your domestic output would collapse (because credit
could not be had at
any cost), or you would fnd that you could not pay your import
bills on your
contractual debts (often, if you were a small country in debt
to a larger one, a cause for
war). Bretton Woods created a peaceful and orderly means for
easing those trade
adjustments that might be necessary from time to time, but it
did not obviate the need
to adjust. Faced with a defcit, a country could in the frst
instance borrow from the
IMF. If the defcit proved intractable, it could devalue –
adjusting the parities of the
world currency system. Eventually, the theory had it, a
general pattern of trade balance
would return.
By putting the dollar at the center of the system, Bretton
Woods had
removed the possibility that the dollar could devalue, and at
the same time insulated
the United States alone from the need to adjust to a defcit in
our trade. But not
entirely. As noted, central banks retained the option of
demanding trade settlement in
gold. And as tensions within the system built in the 1960s,
notably over Vietnam, they
increasingly did so.
The contradiction in the system for the United States was that
unlike other
countries, it could not adjust its trade defcit using
devaluation; devaluation by the
currency to which other currencies were tied was a
system-breaking move. Thus if
other countries were not prepared to tolerate U.S. defcits at
high employment, the
United States could either retreat from full employment at
home or break the system.
In 1969-1970, Richard Nixon had tried the frst course of
action, to near political
disaster. In 1971-1972, he took the second course, ensuring
his own reelection at the
expense of plunging the world economy into turmoil. For a
time, in consequence, the
future of the world fnancial system was very uncertain; many
thought that the dollar
might fail and be replaced by some combination of currencies,
including the German
deutsche mark, the Japanese yen, the British pound and the
Swiss franc. The entire
decade from that point forward was fnancially unstable, and
the United States itself
paid part of the price in the form of infation and periodic
recessions.
Reagan’s macroeconomics ended the uncertainty – and resolved
the contradiction. And although monetarism and supply-side
economics wrecked major
sectors of American industry, drove up the rate of
unemployment, and made the nation
far more unequal, they also fundamentally reestablished
American fnancial power. The
same high interest rates that did so much damage to Ohio and
Michigan were even
more devastating outside the country than within. And, in the
relations between the
United States and the rest of the world, they turned the
fnancial tide, creating a new
dollar-based system that became the foundation of the world
economy. From a purely
national perspective, this would lead to huge benefts to the
United States, at everyone
else’s expense. For now, most countries came to protect
themselves against the
worldwide fnancial instability, itself often generated from
within the United States, by
holding fnancial reserves, which consisted mainly of U.S.
Treasury bonds.
Now the Prometheus was truly unbound; even the largely
self-imposed
macroeconomic and trade discipline of the Bretton Woods period
became a thing of
the past. The post-1981 position of the dollar meant not only
that Americans could
import much more than we export; actually, it meant that we
must import more than
we export. We routinely cover the difference with nothing more
than a note and a
promise to pay interest down the road. The extent to which we
can do this – the
extent to which we must do this --- is determined, entirely
and exactly, by the
willingness and desire of other countries to hold the bonds.
As the world economy
grew, and particularly as China emerged as a global fnancial
player with reasons of its
own for holding dollar bonds, that extent appeared to have few
practical limits.
As a result, the United States has been running trade defcits
continuously.
And every year as the world economy grows, they grow larger.
At this writing, they are
greater than 6 percent of annual GDP, more than $800 billion.
To repeat, the main
reason for this is that other countries, for reasons of their
own, have wanted to anchor
their fnancial portfolios in U. S. Treasury bonds. We could
not do it otherwise, and we cannot avoid doing it, given those
desires.
Why does Galbraith write that “the rules as they apply to the
United States are
different from what they are for anyone else?”
Galbraith describes the classical gold standard and the
workings of the price-specie
flow model. Where does he do that?
According to Galbraith, what replaced the gold standard as
the international
monetary system?
What historical factors led to the current system? How does
it
operate?
Galbraith writes in the last paragraph quoted that “other
countries, for reasons of
their own, have wanted to anchor their financial portfolios in
U. S. Treasury bonds.”
What countries do you think he has in mind? What do you
suppose are some of the
reasons of their own? Why does this choice by other countries
mean that the U.S.
“cannot avoid” running a trade deficit?