The Dollar Might Be Having Problems, But Here's Why We Really Don't Want to Go Back to Gold

For more than half a century, the dollar was both a symbol and an instrument of U.S. economic and military power. At the height of the financial crisis in the fall of 2008, the dollar served as a safe haven for investors, and demand for U.S. Treasury bonds (“Treasuries”) spiked. More recently, the United States has faced a vacillating dollar, calls to replace the greenback as the global reserve currency, and an international consensus that it should save more and spend less.

At first glance, circumstances seem to give reason for concern. The U.S. budget deficit is over 10% of GDP. China has begun a long-anticipated move away from Treasuries, threatening to make U.S. government borrowing more expensive. And the adoption of austerity measures in Greece—with a budget deficit barely 3% higher than the United States—hovers as a reminder that the bond market can enforce wage cuts and pension freezes on developed as well as developing countries.

These pressures on the dollar and for fiscal cut-backs and austerity come at an awkward time given the level of public outlays required to deal with the crisis and the need to attract international capital to pay for them. But the pressures also highlight the central role of the dollar in the crisis. Understanding that role is critical to grasping the link between the financial recklessness we’ve been told is to blame for the crisis and the deeper causes of the crisis in the real economy: that link is the outsize U.S. trade deficit.

Trade deficits are a form of debt. For mainstream economists, the cure for the U.S. deficit is thus increased “savings”: spend less and the bottom line will improve. But the U.S. trade deficit didn’t balloon because U.S. households or the government went on a spending spree. It ballooned because, from the 1980s on, successive U.S. administrations pursued a high-dollar policy that sacrificed U.S. manufacturing for finance, and that combined low-wage, export-led growth in the Global South with low-wage, debt-driven consumption at home. From the late nineties, U.S. dollars that went out to pay for imports increasingly came back not as demand for U.S. goods, but as demand for investments that fueled U.S. housing and stock market bubbles. Understanding the history of how the dollar helped create these imbalances, and how these imbalances in turn led to the housing bubble and sub-prime crash, sheds important light on how labor and the left should respond to pressures for austerity and “saving” as the solution to the crisis.

Gold, Deficits and Austerity

A good place to start is with the charge that the Federal Reserve triggered the housing bubble by lowering interest rates after the dot-com bubble burst and plunged the country into recession in 2001.

In 2001, manufacturing was too weak to lead a recovery, and the Bush administration was ideologically opposed to fiscal stimulus other than tax cuts for the wealthy. So the real question isn’t why the Fed lowered rates; it’s why it was able to. In 2000, the U.S. trade deficit stood at 3.7% of GDP. Any other country with this size deficit would have had to tighten its belt and jump-start exports, not embark on stimulating domestic demand that could deepen the deficit even more.

The Fed’s ability to lower interest rates despite the U.S. trade deficit stemmed from the dollar’s role as the world’s currency, which was established during the Bretton Woods negotiations for a new international monetary system at the end of World War II. A key purpose of an international monetary system—Bretton Woods or any other—is to keep international trade and debt in balance. Trade has to be mutual. One country can’t do all the selling while other does all the buying; both must be able to buy and sell. If one or more countries develop trade deficits that persist, they won’t be able to continue to import without borrowing and going into debt. At the same time, some other country or countries will have corresponding trade surpluses. The result is a global trade imbalance. To get back “in balance,” the deficit country has to import less, export more, or both. The surplus country has to do the reverse.