Barry Eichengreen

In this useful book, Barry Eichengreen compares the "Great Depression" which started in 1929 with the "Great Recession" Sub-Prime Crisis which started in 2008.

He shows that the run up to the two had obvious similarities, with property speculation, easy credit and new technology, generating the same "This time is different" idea as in a "Permanently High Plateau", or the "Great Moderation" with its supposedly greater understanding and discounting of risk.

However, the core of the book is an show more evaluation of the big differences in government reactions to the two crises.

Each crisis had its own context. In 1929 there was an awareness of the hyperinflation that had hit Central Europe in the early 1920's leading to a hesitancy in providing liquidity, whereas in 2008 there was the example of 1929 itself (closely studied by Bernanke) perhaps leading to the FED going too much the other way and providing excessive liquidity.

In any event, the post 2008 flood of liquidity did protect the banks and helped the economy by turning a potential Depression into a longish Recession.

He sees this as good news and bad news.

The good news is that there wasn't an economic collapse. The bad news is that the government never faced the kind of true crisis that would have generated the political will for fundamental reform (of the type seen after 1929). Post 2008 America never saw a stimulative New Deal, or a Glass-Steagall Act separating commercial and investment banking and it retained banks that are still "too big to fail", excess leverage, vast quantities of opaque derivatives and minimal reserves (i.e.still an accident waiting to happen).

Basically Eichengreen is saying that everything would have been OK if the government had broken up the banks in 2008, separated commercial banking from investment banking, introduced transparency in derivative markets and reduced leverage, but above all, if they had instituted large scale Keynesian deficit spending (New Deal) type policies, and this seems to be his main proposal.

However, (in the opinion of this reviewer) there may be some problems with the idea.

He rejects Andrew Mellon type "liquidationist" arguments (with regard to the Great Crash), Mellon said, "..... It will purge the rottenness out of the system.... People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up the wrecks from less competent people." Eichengreen seems to propose more Keynesian spending, even while the rottenness stays in place. with his definition of "rottenness" restricted to banking and finance, when in reality it probably extends throughout U.S. society (e.g. the special interest capture of healthcare and military spending among much else).

More fundamentally, the author doesn't really differentiate between good investment and bad investment. For example, Michael Pettis in his worthwhile book, "The Great Rebalancing: Trade, Conflict, and the Perilous Road Ahead for the World Economy" defines good investment as spending that can generate enough wealth to repay capital with interest and he goes on to suggest that these situations are rather special and rare (e.g. European reconstruction after WW2, America opening up the West, or the first phases of development of new technologies).

Pettis sees Keynesianism taking credit for a post Great Depression recovery that really occurred due to plentiful good investment opportunities rather than any Special Theory, and he gives a whole list of bad (capital destroying) dead end investments such as new factories, real estate and inventories without demand, credit financed consumption or QE used to fuel speculative bubbles. On this reading, Keynesianism looks more like a leftist propaganda tool used to justify increased government spending rather than a genuine description of economic reality.

The author also approves of Japanese "Keynesian" government spending in the early 1930's. As he sayson P257, "Takahashi then submitted a supplementary budget providing for new spending on rural relief and on the army's military operations in Manchuria, where renegade officers, protecting Japan's colonial holdings there, had staged a terrorist incident they blamed on Chinese bandits, allowing them to launch a police action (actually the invasion of NE China). Takahashi himself was opposed to Japanese military intervention in Manchuria, but he could still use it to advance his economic strategy." - "Japan's experience thus illustrates what concerted monetary expansion, backed by fiscal stimulus could do."(i.e.good economic policy from the author's viewpoint).

This may be so, but a more traditional interpretation of the Mukden Incident would be that it marked the supremacy of militant Japanese imperialism and was thus the first step in the eventual complete destruction and nuclear bombing of Japan.

So, revisiting the Hall of Mirrors, one would assume that the author approves of the Keynesian stimulative effect of the large scale military spending resulting from the 9-11 attack on the U.S. (currently in the region of $ 3.8 trillion including Iraq, Afghanistan and Homeland Security and more counting future medical and disability claims) taking place against a background of strong monetary expansion. The author curiously doesn't even touch on the subject, but it would surely come under Pettis' heading of Bad Investment.

As with Japan, Eichengreen doesn't consider any political fallout from events and the economic consequences.

It's becoming increasingly clear for example, that the complex 9-11 "Operation" was a terrorist incident staged by militant Israeli and U.S. Zionists and blamed on Arabs, allowing them to launch the "War on Terror" in the Middle East and the Patriot Act and "Homeland Security" in the United States, and marking the supremacy of militant Zionism in both Israel and the U.S. (Google "World Trade Centre building 7" and keep reading).

How a rising awareness of this reality plays out economically is anyone's guess, but it's odd that Japanese Imperialist military spending from the 1930's is evaluated but American 9-11 related military spending in the new millennium doesn't get a mention in an otherwise useful book. show less

China's favourite business book of 2011

Since the Second World War the U.S. dollar has dominated international business despite the fact that the American slice of foreign direct investment has fallen from 85 to 20 percent. This creates an uneasy tension with the dominance of the dollar in international trade and as a reserve currency, which is in itself peculiar: in earlier times there have always been multiple reserve currencies.

The dominance of the dollar brings various advantages to show more American businesses: they operate free of foreign exchange costs and currency risk. Foreigners have had to provide the US with 500 billion worth of goods and services for the US currency circulating overseas. Additionally, foreigners hold 5 trillion in bonds of the US Treasury and government agencies. Consequently the US pays 2 to 3 percentage points less to borrow than the return on its foreign investments. Giscard d'Estaing called it an "exorbitant privilege".

A currency is attractive as a reserve currency if it is large, rich, growing and if it is backed by a country that is powerful and secure.

By the 19th century Britain had become the premier financial centre. Britain was the leading international investor, had the most important commodity exchanges an was an efficient provider of trade-related services like shipping and insurance. Here the members of the British empire serviced their debts and foreign countries could use its efficient clearing mechanisms. 60 percent of world trade was settled in sterling. The liquidity of the London market allowed large business volumes without moving prices. Britain's "first mover advantage" remained long after the country's relative decline. At the start of World War I, foreign reserves were 60% in sterling, 30% percent in French franc and 15% in Deutschmarks. There were none in US dollars, given the lack of a central bank in the States that foreign countries could deal with.

American banks were restricted by regulations even after America had become a greater exporter than Britain. This changed with the disruption to Europe from the First World War and the emergence of the Federal Reserve that bought trade acceptances from banks to stabilise markets. By the mid-20's the interest costs of US trade acceptances was 1% below London. The US had half the market and would soon overtake London (causing the author to warn against putting faith in incumbency). Sterling rebounded somewhat, because it went off the gold standard before others and thus supported economic resilience before other countries (mandatory use of Empire entities also helped, p.37).

Devastated Europe required US loans and investments to rebuild its economy. It is also a necessary element of being a reserve currency. With trade re-established other nations had enough dollars again and the Triffin problem of Bretton Woods emerged: with one element (gold) inelastic and the other (dollars) elastic, confidence would be eroded as the amount of dollars (necessary for trade) increased. The US had to leave the gold standard and devalue the dollar, but the dollar remained the reserve currency.

The euro emerged out of a political project in the 1990's. It was realised before all the economic prerequisites were in place. The euro could however also protect European economies from dollar disruptions (p.70), that each time caused the mark to rise and the franc to fall. Earlier Bretton Woods had helped European integration by supporting standard prices for the Common Agricultural Policy (p.72). The creation of the euro was a slow process described in some detail by Mr. Eichengreen. Many of the current (2011) setbacks are nothing new. The current standpoints of the Bundesbank are equivalent to the days of Helmut Schmidt. With the knowledge of hindsight, Mr. Eichengreen's summary is quite an embarassment to read. France devalued many times against the Deutschmark. In 1997, one year before the euro currencies and conversion rates were set, France was saved by a tightening Clinton administration (p.94). And then came the dotcom-boom and the Great Moderation.

Stability is the sine que non of a reserve currency. Nothing is more damaging than a full-blown financial crisis. And that is what happened to the dollar in 2008. Beyond reasons related to the FED, the banking sector and regulation, overseas central bank purchases of dollars in 2008-2009 to meet short-term liabilities in case of a crisis that added to low American interest rates. In a crisis capital flows become volatile. Additionally there were excess savings abroad (mainly from emerging Asia) that found there way to America. Higher US savings (that had fallen to near zero) would have stopped that inflow). On top of this emerging-market central banks bought foreign currencies to prevent their currencies from rising. Because lots of trade was done in dollars and because of the liquidity of the dollar market, it was sensible to buy mostly dollars. Foreign purchases of U.S. debt securities were responsible for Greenspan's conundrum. All this overinvestment reduced trust in the dollar. America is no longer seen as a supplier of high-quality financial assets. As long as a majority is owned by foreigners, America will be tempting to inflate the debt away.

The world is becoming multi-polar and the monetary system should follow. During the Cold War support for the dollar was a quid pro quo expense by America's allies. This does not apply to China. But the dollar is still used in 85% of foreign exchange transactions. Incumbency is a factor: America remains the greatest debt market, and allows for easy price comparison for goods and services.

Notwithstanding current problems, the euro has some of the characteristics to become a serious challenger: scale, international trade, a first-class central bank that takes its price-stability mandate seriously and is willing to give emergency loans if necessary, as well as plenty of debt securities (p.128). On the other hand slow economic growth and demographics are not in Europe's favour. The absence of a euro-government is the main obstacle to further growth as reserve currency.

China holds extensive amounts of US Treasuries. If it would sell, their prices would tank. The dollar would fall and harm China's exports. After a flirt with SDR's it now focuses on promoting the renminbi for international transactions, a currency as yet inconvertible to protect it from capital flow volatility (p.144). China concludes swap agreements with some countries to do payments in either renminbi. By limiting the bond market China can channel more money to industrial development than under competition. Even at a 7% growth rate, China's economy will still be only half of America's by 2020. Even with all the trappings in place, the renminbi will be a regional reserve currency at best. Brazil and India are as yet even smaller.

China could cause the dollar to crash, albeit also at its own expense. Investors or a panic could also cause a dollar crash. America would rely on its allies, because of limited foreign currency reserves. America's budget deficits are the greatest danger. These could lead to an equivalent situation as in Greece, Portugal, or Spain. America's tax base is too small to support its deficits in the longer run. A dollar crisis will develop abruptly, but will not happen tomorrow. The consequence would be a need to export one trillion dollars more each year. This would require higher efficiency in production than its competitors. America has some catching up to do with countries like Germany here before it can accomplish that. Alternatively, the dollar could need to decline some 30% of its 2008 rate (p.172), which is bearable. Reigning in the budget deficit will not be detrimental to American interests in the world, as long as the underlying health of the economy is good.

Exorbitant Privilege is concise on technical details. Occasionally I had trouble catching some in the earlier chapters. The life stories of the various actors could have been somewhat reduced for such details. On the other hand, for an American book about economics, it is delightfully free of ideology. show less

For nearly a century the American dollar has enjoyed a position as the world's dominant currency. As Barry Eichengreen notes, Americans benefit considerably from the dollar's international status, both financially and economically. Yet the recent economic crisis has fueled growing concerns that the dollar's days of dominance are numbered. Eichengreen seeks to address this question in this short study, which looks both at the position of the dollar as an international currency and its show more prospects for retaining its unique status in the world.

Eichengreen begins with a short history of the dollar, one focused on its rise to global prominence. Though born with the republic in the late 18th century, the dollar did not become the dominant currency until the early twentieth century, when the combination of the establishment of the Federal Reserve Board and the First World War allowed the dollar to displace the pound sterling from that role. The dollar's dominance, Eichengreen notes, was enhanced by the absence of any credible competitors; it was not until the end of the twentieth century when the euro emerged as a possible alternative. He then shifts his focus to the financial crisis of the past few years, one not originating in fiscal policy but, as he demonstrates, was enhanced by it. Though he describes the problems faced in maintaining confidence in the dollar, he concludes that the dollar will retain its role for the foreseeable future, albeit in a world of multiple international currencies.

Insightful and informative, Eichengreen's book is a good concise study of the international role of the dollar. Though he assumes his reader to be informed about the basis of economics, for the most part he writes in a clear and intelligible manner that disentangles many of the complexities of international finance. The book's main weakness is in its peripheries; outside of his specialty, Eichengreen's command of the broader context, such as American history, is less sure. Yet his missteps are few and do not detract from the overall value of his work. This is a useful book that will be valued reading for anyone seeking to better understand a vital component of America's presence in the world and its future prospects. show less

The Dollar's position in the international currency market maybe in jeopardy sooner than we care to think. The Author's arguments are very persuasive. Need to read his earlier works.