Disorder, page 14
In practice, Bretton Woods proved both inadequate to the problems of recovery in a world short of dollars and unpalatable to the Roosevelt administration’s successor. During the 1947–48 European economic crisis, Harry Truman eschewed the Bretton Woods institutions in providing dollars to the West European states; instead, he initiated the Marshall Plan. He also made little effort to stop the New York banks receiving illegal capital outflows from Europe, although he accepted that Europe’s currencies would for trading purposes remain non-convertible for some time.
The 1947–48 European economic crisis also revealed a fundamental fault line around the dollar–gold relationship that would persist until Bretton Woods ended. In his search for a solution that would give the dollar primacy and yet still rely on gold, Harry Dexter White—the chief American negotiator at Bretton Woods—had created a system where a national currency served as a physically bound international reserve asset. The result was a system that had to function with either too few dollars, as it did between 1947 and 1948, or too little gold, as would be the case in the 1960s.8
The second of these problems was hugely intensified by the rise of Eurodollars as an offshore currency. They ensured that by the late 1960s there were many more dollars in the world economy that were not backed by gold than those issued by the Federal Reserve.9 Eurodollars began in the early post-war years as dollar deposits held in banks outside the United States that were not subject to American banking controls.10 By the end of the 1950s, banks were trading and lending these offshore dollars in London.11 In these London markets, capital moved free from the post-war capital controls deployed by the European governments, or the controls on interest rates operated by the US Treasury. By the mid-1960s, a significant Eurodollar credit market had emerged. It was increasingly dominated by American banks that established London branches to participate, and it allowed European firms to borrow in offshore dollars. Quite how these Eurodollar credit markets worked to generate an accelerating quantity of dollars was far from transparent. In a seminal article about the Eurodollar system, the monetarist economist Milton Friedman commented upon ‘the mystifying quality of money creation’ and suggested that Eurodollars were ‘mostly the product of the bookkeeper’s pen’.12 In December 1968, the Fed discussed the risk that it might come to be seen as the lender of last resort to these credit markets.13 But what happened in the Eurodollar system was ultimately beyond any central bank’s control or authority. As the American political economist Jeffry Frieden has neatly expressed the point: ‘who was going to supervise the dollar deposits in a German bank’s branches on British soil? The answer came quickly: nobody.’14
With the Eurodollar markets rendering even the principle of dollar–gold convertibility incoherent, American decision-makers could not make Bretton Woods work as it was designed. From 1965, their geopolitical priorities worsened the dilemma. In deciding to send American combat troops to Vietnam, President Johnson increased American borrowing and, abetted by the Federal Reserve, allowed inflation to rise. This overt disregard for the dollar’s external value infuriated the French president, Charles de Gaulle. From 1965, de Gaulle demanded gold for France’s dollar reserves, and charged that the system allowed the United States to run up ‘enormous debts’ to finance its wars for which others had to ‘suffer’.15 His anti-dollar stance and Johnson’s de facto anti-gold stance created an unresolvable structural conflict.16 Johnson’s decision in March 1968 to change course in Vietnam during a gold crisis—discussed in chapter two—demonstrated just how constraining dollar–gold convertibility had become.
From the 1970s, oil made these American choices harder. Since domestic pre-shale oil production peaked in 1970, the United States imported growing quantities of oil through the decade.17 Rising oil imports structurally widened the trade deficit. Bretton Woods was designed for a world where the dominant economy with a strong domestic oil supply had a large trade surplus, not one in which the world’s largest oil consumer was on a path to becoming the world’s largest oil importer.
This pressure oil placed on the American trade deficit amplified a problem that predated it. Dexter White was wrong to assume that the system necessarily protected American export competitiveness. By the late 1960s, it did not require currency devaluation for West Germany and Japan to benefit from the exchange rate parities in operation; they only had to resist significant revaluation. In response, American politicians could only threaten trade tariffs to protect those sectors, starting with textiles, most imperilled by international competition. This dynamic created a choice between maintaining the international monetary system and maintaining the international trading order.18 In one way, it was the same choice that American politicians in the early 1930s had confronted, albeit without the added complications around German reparations. Then, Hoover and Congress had supported tariffs while Roosevelt had preferred to remove the dollar from gold.19 This time, the politically tumultuous year of 1968 ensured that the burden of decision fell upon Richard Nixon, a man who took office convinced that the Fed’s monetary caution at the decade’s start had lost him the 1960 election to John Kennedy.
In August 1971, President Nixon dramatically ended dollar–gold convertibility and imposed tariffs on imports that would stay in place until other states agreed to a dollar devaluation. Four months later, Nixon secured that devaluation as part of the Smithsonian agreement. This agreement could have reset Bretton Woods. But while some in the Nixon administration did want to reform the international monetary system, Nixon wanted to end it. Indeed, in 1972, his Treasury indicated it wished to liberalize capital from laws that restricted its movement in and out of the United States. With oil imports widening the American trade deficit, the American economy now needed an overseas supply of dollars to finance that deficit. Without even the appearance of American restraint, the exchange rate parities became ever more strained. In March 1973, all attempts to maintain fixed exchange rates were abandoned. Thereafter, currencies would float, their value being determined by daily transactions in the foreign exchange markets. At the beginning of the next year, the Nixon administration removed all American capital controls. What could have been a trade war became instead a several-decades-long competition about exchange rates and who should bear the monetary burden of what Washington and the Fed wished to do with the dollar.20
In the post–Bretton Woods monetary world, the Eurodollar markets and oil became the basis of American financial power. Preserving the dollar’s international position at as little domestic cost as possible was made much easier by the Eurodollar system: these offshore markets made the dollar the premier currency for banking and credit. Then the 1973 oil price shock—as the next chapter will discuss—boosted Eurodollar activity.21 It also engineered a flow of the dollar earnings of the Arab oil-producing states in OPEC back into the United States.22 To reduce any temptation Saudi Arabia might have had to lend those dollar revenues to European countries, Nixon’s treasury secretary in 1974 procured an agreement that Riyadh would buy US Treasury bonds outside the normal auctions where government debt was sold and without any requirement that the volume of purchases be publicly released by the Treasury. In exchange, Saudi Arabia received increased military aid and access to new arms purchases.23 Nixon’s successors maintained this petrodollar recycling. In the second half of the 1970s, the dollar’s weakness incentivized Saudi Arabia and other OPEC states to peg oil prices to a basket of the world’s major currencies. But the Carter administration brokered an increase in the Saudi quotas and voting rights in the IMF to bind OPEC to dollar pricing, a deal probably sweetened by more military aid.24 In this sense, Saudi Arabia’s emerging utility to American energy security in the Persian Gulf in the 1970s was paralleled by the part Riyadh played in allowing the United States to import oil denominated in its own currency at a moment when OPEC state-run companies were taking over from the big American and European companies in the Middle East.
* * *
This post–Bretton Woods world in which no currency was convertible into a metal—the world of fiat money—was an unprecedented monetary phenomenon in human history. Allied to the oil shocks, these hitherto untried monetary conditions produced profound economic changes. Public and private debt exploded, with total world debt more than doubling as a proportion of world GDP between 1974 and 2016.25 Inflation, in the past associated with war, accelerated. Unemployment, which Keynesian economists were convinced should fall when inflation rose, increased across virtually all Western economies.
The political implications of this new inflationary and debt-shaped world were complex. Indeed, who politically benefited and who lost, and why they did became bitterly contested. One familiar narrative makes the 1970s the beginnings of the political rise of an anti-state approach to the organization of economies and economic policy.26 This telling renders Paul Volcker’s appointment as president of the Federal Reserve Board in 1978 followed by Margaret Thatcher’s arrival in power in Britain a year later and Ronald Reagan’s 1980 election win watershed moments. Each—and in Thatcher’s and Reagan’s cases their advisers—is then cast as attracted to the arguments of the Austrian economist Friedrich Hayek and the American monetarist Milton Friedman that the state’s post-war interventions were responsible for the surging inflation and weak growth that marked the 1970s. The unemployment that arose from their policies in the late 1970s and 1980s led critics to charge that the American and British economies were sacrificed to ideological dogma. Much later the ideology was given the name neoliberalism, even though the origins of ideas that can coherently be labelled neoliberalism are to be found in the Habsburg Empire’s demise and what its defenders saw as the post-inflationary onslaught of a destructive nationalism tied to democracy replacing constitutional monarchy.27
But making the economic story of the 1970s one of any ideological ascendancy necessarily downplays the structural material causes of the decade’s crises that played out regardless of the prior dispositions of politicians and central banks.28 In particular, energy casts a huge shadow over the apparently ideological debate in the 1970s about what the state could and should do.29 Politicians on both sides of the Atlantic had an acute incentive to retreat from regulating capital flows because they needed easy access to dollars to pay for larger oil import bills. In the United States, those who advocated economic deregulation in the 1970s were first and foremost arguing for an end to federal government agencies regulating energy prices and allocating oil to individual states for specific uses—as will be discussed in chapter eight.30 The first executive order Ronald Reagan issued as president lifted all remaining federal controls on oil prices and allocations, pronouncing that ‘the 1970s were the Dark Ages of America’s energy history31.’ Milton Friedman, frequently taken to be a leading proponent of neoliberalism, was obsessed with the energy question, charging that governmental controls on prices and effective federal oil rationing were entirely responsible for the energy shortages.32 Indeed, Friedman’s intellectual insistence that inflation was always a monetary phenomenon, and hence unaffected by energy shocks, might politically be seen as the corollary of his belief that oil prices needed to increase to end the supply shortages. Quite simply, without taking energy seriously there is no persuasive story that can be told about the trajectories of economies from the 1970s through to the 1980s, or their political consequences, including those that led to the euro’s creation.
Dwelling on neoliberalism as a principally Anglo-American phenomenon also obscures the fact that the strongest and most powerful proponents of anti-inflationary discipline in the 1980s were to be found not in Washington, New York, or London but in Frankfurt and Bonn. Nor, as will be shown, are these separate matters: it was precisely because the West German central bank did not treat the 1986 oil price slump as an end to the inflationary era that the French government began to turn back to the idea of European monetary union that had flickered and fallen during the last years of Bretton Woods.
The Twin European Monetary Burden
The West European governments were, to use Paul Volcker’s word, ‘stunned’ at Nixon’s actions in August 1971.33 Afterwards, they expected Bretton Woods to be repaired, not put on a path to destruction. But their common adversity could not disguise crucial differences in their perceptions of the crisis, their capacities to respond to it, and the prospects for their currencies in a new floating world.
German politicians and officials framed the Bretton Woods crisis around the Eurodollar markets. If higher interest rates could be avoided by banks and companies borrowing dollars in London, the Bundesbank could not in practice tighten credit conditions. For the West German chancellor, Willy Brandt, the Eurodollar markets compromised European monetary autonomy, by which he meant German autonomy. His solution was a European central bank. For French policymakers, Bretton Woods’ problems primarily arose from the cavalier American attitude towards gold. Indeed, just days before Nixon’s decision, French president Georges Pompidou had ordered a French warship to cross the Atlantic to retrieve France’s gold in New York.34
These different political judgements were compounded by material differences. The West German Deutsche Mark had an anti-inflationary credibility that the franc lacked. The German monetary advantage in part arose from the West German trade surplus and in part from the Bundesbank’s independence from democratic control at a time when in most of Western Europe governments, not central banks, decided interest rates. Over time, these two phenomena reinforced each other: the German central bank prioritized domestic price stability, making the West German economy export oriented.
Notwithstanding the divergence, the European Community (EC) began in 1969 discussing monetary cooperation. The 1970 Werner report proposed a three-stage transition to monetary union, while avoiding the question on which the French and Germans probably most disagreed, namely who would decide European monetary policy.35 By early 1971, there was massive upwards pressure on the Deutsche Mark’s parity against the dollar, with German firms borrowing dollars at high volumes in the Eurodollar markets, where interest rates were lower than those prevailing in the domestic economy, and then selling them for Deutschmarks.36 In May 1971, just two months after the EC states formally adopted the Werner Plan, West Germany and the Netherlands unilaterally floated their currencies. Pompidou denounced this currency appreciation tactic as a violation of ‘Community morality’ since by default it also changed the German and Dutch currencies’ value against those of other EC currencies.37 As one German official commented, unilaterally floating the Deutsche Mark had ‘brought the Community near to breaking point’.38 Although there was simply no policy available to deal with the Eurodollar and intra-European exchange rate instability problems simultaneously, French fury over the unilateral floating episode pushed Brandt to try to find a European solution anyway. In 1972, the EC adopted a collective exchange rate arrangement known as the Snake in the Tunnel. This pegged EC currencies against each other within margins narrower than their Bretton Woods parities. Consequently, their fluctuations against each other would be less than their individual movements against the dollar. Its participants were the six original Community states together with the three states—Britain, Denmark, and Ireland—that would join the EC in January 1973 plus Norway.
But the Snake in the Tunnel soon graphically demonstrated a slightly different version of the twin exchange rate dilemma at work around the dollar and the Deutsche Mark. After Nixon ended dollar–gold convertibility, most EC currencies faced upward pressure against the dollar, which affected export competitiveness against dollar-based producers, and downward pressure against the Deutsche Mark, which drove up inflation. This dynamic then left the West German government facing Deutsche Mark appreciation against both other European currencies and the dollar as well as demands from their EC partners for the Bundesbank to cut interest rates. When, in March 1973, fixed exchange rates ended, these conflicting tensions came to a head. After Nixon once again devalued the dollar and Japan floated the yen, the EC states suspended foreign exchange markets to deliberate as to what to do. Still scarred by the European divisions in May 1971, the West German government wanted commonality. Indeed, Brandt saw an opportunity to move towards monetary union. But the Snake in the Tunnel had already shown that stabilizing the EC currencies against each other required the weaker currency states to make policy changes that their governments could not politically contemplate. Consequently, any nominally collective approach could not include all nine EC currencies. The temporary solution divided the EC into two monetary groups. One, led by West Germany, reformed the Snake, pegging its members’ currencies against each other. The other, which included Britain, Ireland, and Italy, had currencies that floated against both the dollar and the Deutsche Mark.
This division left France in the West German monetary bloc. But it was an outcome driven by the necessity of Franco-German political agreement, not, as was soon evident, macro-economic compatibility. Unable to follow the Bundesbank’s monetary policy, the French government removed the franc from the Snake in January 1974, returned it in May 1975, demanding reforms from the Bundesbank, and quit again in March 1976 when none was forthcoming. As early as 1974, the French finance minister, Valéry Giscard d’Estaing, told President Pompidou that ‘ultimately we will not be able to prevent the franc and the DM from drifting away from each other’. By 1976, Brandt’s successor as chancellor, Helmut Schmidt, saw in the divide between the Snake around Germany and the larger group outside a ‘two-tier Community’.39
