Exorbitant Privilege
Exorbitant Privilege
The US’ exorbitant privilege has become a rich world privilege – New study calls for a reform of the international monetary system
The US’ exorbitant privilege has become a rich world privilege – New study calls for a reform of the international monetary system
By Gastón Nievas and Alice Sodano (Paris School of Economics, World Inequality Lab)
Over the past decades the world has experienced a process of financial integration and capital liberalisation that has permitted an increase in foreign capital accumulation, especially since the 1990s. Gross foreign assets and liabilities have become larger almost everywhere, but particularly in rich countries, and foreign wealth has reached around 2 times the size of the global GDP. The unequal distribution of this external wealth, with the top 20 % richest countries capturing more than 90% of total foreign wealth, poses constraints on the poorest countries.
Gastón Nievas and Alice Sodano investigate how rates of return on foreign assets and liabilities impacted different groups of countries across time. They put together a novel database encompassing the entire world (216 economies) for the period 1970-2022.
Key findings:
Returns on foreign assets have decreased for everyone. On the contrary, returns on foreign liabilities have only decreased for the top 20% richest countries. This differential between returns on assets and returns on liabilities has extended the United States’ exorbitant privilege (rooted in the early years of the Bretton Woods system) into a rich world privilege.
The richest countries have become the bankers of the world, attracting the excess savings by providing low-yield safe assets and investing these inflows in more profitable ventures. Such a privilege is translated in net income transfers from the poorest to the richest equivalent to 1% of the GDP of top 20% countries (and 2% of GDP for top 10% countries), alleviating the current account balance of the latter while deteriorating that of the bottom 80% by about 2-3% of their GDP.
Moreover, rich countries also experience positive capital gains during the period, which further improves their international investment position.
Contrary to prior beliefs, the positive return differential does not come from rich countries investing in riskier or more profitable assets. Instead, it is the result of rich countries accessing low interest debt, public and private, as a consequence of them being issuers of international reserve currencies.
The paper proposes a set of policies that would overthrow such a privilege, including tax reform, a global reserve currency and a redesign of the governance of the international financial institutions.
Gastón Nievas, co-author of the paper, said:
“The size of net transfers that stem from the differential rates of return are substantial and are the result of unequal access to global capital markets. The burden they represent for poor countries cannot be neglected, each year they send 2-3% of their GDP to the rich world while they could be investing that amount in education, health or climate related policies. If we are aiming for a more egalitarian global system, we need to construct a more stable international monetary and financial system based on true democratic global governance. It’s imperative that developing countries have a voice and vote extending beyond major powers. Redefining the IMF quota formula is a crucial step toward promoting a more equitable international monetary and financial system.”
“The increasing divergence in development paths between rich economies, who are the dominant shareholders, and poorer economies, who are the primary clients, has reached alarming proportions. To stop labelling countries as privileged, rich, developed, developing, poor and so on, the international monetary and financial system need to be reformed, as they are currently unsustainable. We can reform them now or wait for another crisis to do so.”
Read more here.
De Gaulle Did not Use the Expression "Exorbitant Privilege"
By Etienne Rolland-Piegue (repost December 29, 2018)
Head of Central Authority on Intercountry Adoption (Mission de l'adoption internationale) at French Ministry of Europe and Foreign Affairs
A review of Barry Eichengreen, Exorbitant Privilege: The Rise and Fall of the Dollar and the Future of the International Monetary System, Oxford University Press, 2011.
Most French people attribute the expression "America's exorbitant privilege" to de Gaulle. Those familiar with postwar economic history may associate it with the name of Jacques Rueff, the independent economist who advised de Gaulle on monetary matters. The "exorbitant privilege" of the dollar has been associated with America's ability to record a "deficit without tears" that gives people the impression "that they can give without taking, lend without borrowing, and purchase without paying", to borrow a quotation from Jacques Rueff. Or, as a Treasury Secretary once famously replied to Europeans worried by exchange rate fluctuations, the dollar "is our currency, but your problem."
The dollar is our currency, but your problem
But in fact it was not de Gaulle nor Jacques Rueff who used this expression first, and the "exorbitant privilege" is nowhere to be found in their speeches or writings. It was Raymond Aron, the public intellectual otherwise sympathetic to American power, who wrote it for the first time in his column published by Le Figaro in February 1965. The line was a quote from a declaration by Valéry Giscard d'Estaing, finance minister to de Gaulle, and also much less inclined to denounce American hegemony.
Barry Eichengreen, who rightly attributes the quote to whom it is due, is the don of international monetary history. He has published scores of books and papers on the international monetary system, from the gold standard to Bretton Woods and beyond. No one is therefore more qualified to write an essay about the challenges facing the dollar as an international currency. His book covers a lot of material presented in a concise and non-academic way. Readers who need a one-stop shop for the history of international currencies should look no further.
The history of money
The story starts with the clam shells, furs and tobacco leaf bundles used by the Pilgrim Fathers in their trade with Native Americans and between themselves (need a wampum, anyone?). The book then covers the successive attempts to create a central bank in the US. The third trial was the right one: the Fed was born as the creature from Jekyll Island, the remote resort off the Georgia coast where six influential financiers retreated in 1910 to discuss their plot while avoiding publicity. The First World War transformed the US from debtor to creditor nation, and gave a fatal blow to Britain's power. For Eichengreen, from as early as 1914, and even more so in the interwar period, the fat lady had sung its song, and the dollar had dethroned the sterling as the premier international currency. The sterling was however able to cling as an important reserve currency until the Suez Crisis in 1956, when US opposition to UK imperialist policy brought the sterling crashing down (the expression "gnomes from Zürich" used to disparage currency speculators dates from then, and was coined by a British politician, not by the French or de Gaulle, to which it is sometimes attributed. The reasons so many quotes are wrongly attributed to de Gaulle is because he was a master of words, using such rare expressions as "volapük" "tracassin", "cabri" or "tous azimuts" that are a strain to students of French as a foreign language.)
The book also provides a well-rounded chapter on monetary integration in Europe. Eichengreen argues that the eurozone was built with initial flaws that later came to haunt it in the aftermath of the late-2000 Great Recession. To summarize, it all happened because of Luxembourg. This tiny country with impeccable European credentials could only be admitted in the eurozone's inner circle when the European monetary union was created in 1999. But it was already in a monetary union with Belgium, which had a large public debt and more fragile economic governance. Admitting Belgium in turn meant that it would be impossible to invoke the Maastricht Treaty's public debt ceiling to keep other countries from joining in. Hence entered Italy, Ireland, Spain, Portugal, and even Greece, although the admission of the later came back with a vengeance in 2010. Nonetheless, the author is moderately optimistic about the prospects for the euro. Although it was created before all the economic prerequisites were in place, the member states now feel compelled to complete them, and this is why "the euro will likely emerge from its crisis stronger than it was before", Eichengreen writes.
Dollar crush
The subprime crisis and the 2008-2009 financial meltdown are covered in some detail, with the author still brimming with anger at the follies of financiers stretching for yield and the sloth of regulators asleep at the switch. In the last chapter ("Dollar Crush"), Eichengreen gives us a glimpse of what the world would look like after the dollar comes tumbling down and loses its international status. It is not a comforting sight. The United States are downgraded to emerging economy status, and have to rely on the generosity of others in the event of a crisis. Losing their exorbitant privilege means Americans will have to consume less, export more, and pay higher interest rates on a debt that will be partly denominated in foreign currencies. The Fed will no longer be able to cut interest rates in recessions without paying due consideration for the external value of the dollar, and it will have to raise rates in case of dollar depreciation. The author deems this scenario moderately plausible. As he notes, "people have been wrong before when betting against the U.S. economy. They have been wrong before when betting against the dollar. They could be wrong again. Or they could be right, in which case the dollar's exorbitant privilege will be no more."
As Eichengreen states in the introduction, much of what passes as conventional wisdom on international currency is wrong. It is thought that widespread international rule of a currency confers on its issuer geopolitical and strategic leverage. In fact, it is the other way around: people choose the dollar because the U.S. remains the largest economy in the world, able to back its stakes with military power and geopolitical influence. Likewise, it is wrongly assumed that there is place for only one international currency on the roost bar, whereas experience suggests several international currencies may coexist, as was the case in the interwar period and indeed in much of history apart from the second half of the twentieth century, when American power was undisputed. For the author, "a world of multiple international currencies is coming because the world economy is growing more multipolar, eroding the traditional basis for the dollar's monopoly." And we should not be particularly worried by this prospect, provided the transition is managed smoothly and the United States do not botch it.
Three reservations
This book was a stimulating reading, but I have several reservations with it. It is too much centered on the US. It is sometimes dogmatic. It only considers history in the light of the present. It lacks a theory of international currencies. And it largely ignores finance. Let me take these criticisms in turn.
Since the dollar has been the anchor of the international monetary system, it is understandable that the author gives it prominent place in his narrative. The history of European monetary integration is also well covered. But what about other countries? How do they manage their exchange rate regimes, and how do they cope with the dominance of the dollar? There is no discussion on dollarization, currency boards, crawling pegs, and other currency regimes. Japan is only mentioned as a side story, a reminder of how some countries can spectacularly mismanage their economy and lose their rank in the international order. As for China, the author is reduced to wild guesses and conjectures as to what the real intentions of its leaders are. Brazil, India, Russia and the other emerging countries are left out of the picture. If this book is to be used as a reference for government officials and academic experts engaged in G20 discussions (and I think it should), then it should broaden its scope and consider a wider range of policy challenges.
It should also be less dogmatic. Having researched the subject for years, Eichengreen rests on firm academic ground, and presents compelling evidence to back his claims. But he tends to be excessively confident and cock-sure, especially when he discusses other people's plans and ideas. He tends to close the debate before it has even started, and without giving other parties a chance to present their argument. The chapter on SDR illustrates this point: for him, this composite reserve asset is only funny money, period. There is no consideration to the role SDR could play to manage an orderly transition to a multipolar world, except to reject the idea of a substitution account as a non-starter. Likewise, people who wish to revive the role of gold or to think about an internationally-managed world currency are dismissed as cranks. He may be right, but on that account people gathered at Bretton Woods in 1944 could never have led the foundations to a new international monetary system. You need to inject some creative energy in the debate, even if some ideas seem crazy at first.
Eichengreen describes the past with an eye to the present. This can become annoying for some readers, who wish a clearer distinction was made between history and contemporary issues, and between fact and commentary. Lessons about how to manage the rise of China and to accommodate a multipolar world will certainly increase the policy relevance of the book, but at the cost of academic accuracy and durability. Twenty years after its publication, Eichengreen's thesis about The Gold Standard and the Great Depression is still widely read; this book will have a much shorter shelf life.
What is an international currency? Eichengreen repeats the textbook definition familiar to every student in economics: it should serve the three functions of money as means of payment, unit of account, and store of value. But a definition doeth not a theory make. Exorbitant Privilege doesn't make any reference to theory, neither to the hegemonic regime approach proposed by Charles P. Kindleberger that Eichengreen spent so much energy criticizing in his former essays, nor to the recent conceptualization proposed by Pierre-Olivier Gourinchas and Hélène Rey, who offer a novel theory of the exorbitant privilege of the dollar based on the consideration of U.S. assets and liabilities. As already stressed out, this is not an academic book, but a dose of academic theory would have helped.
The rules of global finance
As a last point, it seems to me that a theory of international currencies cannot abstract from the rules of global finance, including the considerations on a country's assets and liabilities that recent research has brought to the picture. Money is a financial asset, and portfolio theory may be useful to explain the motives and mechanisms by which people choose to acquire, retain, or sell an international currency. But Eichengreen does not refer to financial theory in this book. Indeed, he shows very little interest for financial market transactions, except to disparage the excesses and follies that have brought to us the greatest recession since the 1930s. By clinging to the classic view of international currency as fulfilling the three functions of money, Eichengreen turns his back on financial theory, and can only offer diatribes and invectives against the easy targets of bankers and speculators.
Read more here.