None of these conditions hold in our dollar-based global trading system because of the transformational role played by the US economy. While traders chose which currency it was most convenient in which to trade, shifting from the use of one currency to another had barely any impact on the underlying structure of trade. Under the gold- and silver-standards, in other words, trade imbalances did not put downward pressure on global demand, and so global trade expansion typically led to global demand expansion.Īnd third, under gold and silver standards it was trade that drove the capital account, not vice versa as it is today. That is because while monetary outflows in deficit countries force them to curtail domestic demand to stem the outflows, the corresponding inflows into the surplus countries cause an automatic expansion of domestic money and credit that, in turn, boosts domestic demand. Second, and much more importantly, as trade imbalances reverse, the contraction in demand required in deficit countries is matched by an expansion in demand in surplus countries. This means that while small imbalances were possible to the extent that they allowed wealthier economies to fund productive investment in developing economies, this was not the case for large, persistent trade imbalances - except under extraordinary circumstances.² First, trade imbalances in the former must be consistent with the ability of economies to absorb gold and silver inflows and outflows. Trade conditions under gold or silver standards are dramatically different from those in a dollar world in at least three important ways. In that case foreigners tended to reverse their use of sterling, forcing the Bank of England to raise interest rates and adjust demand to regain gold reserves.¹ While sterling was indeed used more than other currencies in Europe to settle trade, and the credibility of its conversion into gold was hard-earned by the Bank of England after the Napoleonic wars, whenever sterling claims rose relative to the amount of gold held by the Bank of England, its credibility was undermined. Consider the widely-held belief that sterling once ruled the world in much the same way the dollar does today. A world in which trade is denominated in gold or silver, or in claims that are easily and quickly convertible into gold and silver, creates very different conditions from those today. A country’s currency could only be a “major” trade currency to the extent that its gold and silver coins were widely accepted as unadulterated or, by the 19th century, if the convertibility of its paper claims into gold or silver was highly credible. Trade before the days of dollar dominance was ultimately settled in gold or silver. The history of the world is replete with famous currencies, but these played a very different role in the flow of capital and goods across international borders. It’s not that there haven’t been other important currencies before the dollar. The fact that so many analysts base their claims on this putative history only shows just how confused the discussion has been. The role of the US dollar in the global system of trade and capital flows is unprecedented, mainly because of the unprecedented role the US economy plays in global trade and capital imbalances. The problem with this argument, however, is that there is no such history.
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