Dollars and pence


This paper from the Levy Economics Institute offers a simply explained account, from a Chartalist perspective, of the US dollar’s unique and historically unprecedented status, plus some its consequences for e.g. funding defence expenditure:

[Even] the hegemon suffered from one particular constraint during the Gold Standard period and in the previous international monetary systems. Even though the pound was the key reserve currency, it was fixed to gold. In other words, debt was ultimately redeemable in an asset that was not directly controlled by the monetary authority. Default was a possibility, even if a remote one…

In fact, since the closing of the gold window the dollar became the first world fiat money. For the first time the international currency is akin to the domestic currency for the hegemon, since its central bank can always buy assets denominated in the domestic currency and finance government debt. There is no balance-of-payments constraint for the hegemonic country and the principles of functional finance apply on a global basis. In this sense, it is possible for the hegemonic state, in this case, the United States, to be a global debtor (as national states are in their domestic economies) and to provide a default-risk-free asset to facilitate global accumulation…

The reason the dollar remains and will remain the key currency is not that its value is stable, as Metallists would argue is necessary for fiat money, but because the United States does not incur debt in other currencies and the institutions that manage macroeconomic policy guarantee that a default in dollars cannot take place. This creates the capacity for the United States to incur international debt without any reasonable limit.

Note that an important part of that privilege is associated with the fact that key commodities, like oil, are priced in dollars in international markets. Not only does that imply that there cannot be an insufficient source of dollars to import key commodities, but also a depreciation of the dollar does not have the impact of increasing the price of imports.

These circumstances did not come about merely because Nixon ended the dollar’s convertibility for gold in 1971. Protecting the dollar’s special status, and preserving the privileges Washington thereby accrues, has required statecraft using military, diplomatic and other blunt tools.

In 1974 OPEC countries held around 15% of their foreign-exchange reserves in sterling. Following the oil price spike, this became an enormous proportion of total sterling holdings. Saudi Arabia and Kuwait alone held £1.8 billion out of global holdings of £4.9 billion, i.e. more than one-third of all sterling reserves.

A previous post described how in July 1974 US Treasury Secretary William Simon, together with State and Commerce Department officials, pressured the central banks and finance ministries of OPEC states to convert revenue from oil exports into purchases of US Treasury securities outside the regular auction.

Through diplomatic, commercial and security arm-twisting, the Saudi Arabian Monetary Agency was dissuaded from what the CIA called a ‘modest diversification program’ of its foreign-reserve portfolio. Lack of cooperation, US officials reportedly told their Gulf allies, would be interpreted as an ‘act of war.’

Along with explicit commitment to its regional military umbrella, Washington agreed in June 1974 to ‘supply of the Kingdom’s requirements for defensive purposes.’ Washington agreed to provide over $2 billion of military hardware to Saudi Arabia and Kuwait (on top of $4 billion, including F-14s, to the Shah’s Iran). The Saudi National Guard Modernization Programme commenced in 1975 with the contract awarded to US firm Vinnell (now a subsidiary of Northrop Grumman).

Riyadh was thus convinced to invoice oil sales exclusively in dollars, rather than in a basket of currencies including the British pound. (Around 25% of oil sales had hitherto been conducted using sterling.) Along with regular purchases of US Treasury issues in competitive auctions, the SAMA agreed in December 1974 to confidentially buy a further $2.5 billion of T-bills.

These secret dealings secured Washington an immense strategic victory. Unlike its rivals, the United States could now finance its global military programme, and imports of oil and manufactured goods, without external funding constraints.

The switch of oil exporters to the dollar precipitated a run on the pound. Over the next two years OPEC central banks reduced their UK Treasury bill holdings by £2 billion. The UK Treasury and media began to speak of a balance-of-payments crisis.

By 1976, on the advice of Treasury and Chancellor Denis Healey, the Labour Government was conducting negotiations with the IMF for a loan.

For the IMF read US Treasury – which at this time held 20% of voting rights and a veto. The conditions on Britain’s loan were thus drafted with the advice of Treasury Secretary Simon and Undersecretary Edwin Yeo, together with other officials from that department, the Federal Reserve (including Fed Chairman Arthur Burns) and Commerce Department:

In the last days of the IMF negotiations, Simon flew to London to meet secretly with Bank of England and UK Treasury officials and get their appraisal of where the Labour Cabinet stood. To maintain clandestinity, the meeting took place at an exclusive London tailor’s and cost Simon the price of three suits — well worth it, he said.

Simon had made his first million as a bond trader before he was thirty; Undersecretary Yeo was a former Pittsburgh banker. The connexions between Wall Street and the City of London undoubtedly smoothed their path. But it was only in their capacity as American state officials that Simon and Yeo could play the role they did.

It was not easy. Edwin Yeo later described how the Treasury had ‘sweated blood’ to get its way, not least against Henry Kissinger and the State Department who favoured gentler handling of such a key Cold War ally. As William Rodgers, Simon’s successor at the Treasury, later put it: ‘We all had a feeling it could come apart in a quite serious way . . . it was a choice between Britain remaining in the liberal financial system of the West as opposed to a radical change of course. I think if that had happened the whole system would have begun to fall apart. So we tended to see it in cosmic terms.’

This was a period of intense struggle between US federal departments of Treasury and State for primacy in international financial policymaking. By 1977 Treasury came out on top due its control over the institutional lever of the IMF. This body – and thus the US Treasury and its Wall Street constituency – would gain in resources and global influence in subsequent decades.

The loan conditions the IMF outlined to Downing Street involved a £2.5 billion reduction in public expenditure over the next two years, targeting of monetary aggregates, etc.

Members of Prime Minister Callaghan’s ministry blanched at these terms. They sought, instead, support for the pound from West German Chancellor Helmut Schmidt and his Bundesbank. Meanwhile Brent Snowcroft, then National Security Advisor, described a possible British turn towards trade protection and capital controls as ‘the single greatest threat to the Western world.’

As it turned out, the loan was never taken up, though the would-be creditor’s conditions were imposed: Healey had sent a letter of intent accepting borrowers’ terms.

And this too produced another stunning strategic victory for Washington in the mid-1970s. Austerity terms brought about the destruction of the British Labour Party’s Bevanite wing, the ascent of Margaret Thatcher, the Conservative victory of 1979, and the destruction of the UK’s manufacturing base, just as North Sea oil was about to come online and Britain became the world’s fourth-largest oil exporter.

In several ways, too, this was a triumph for the US Security State in particular.

Various intelligence figures (including CIA counterespionage chief James Jesus Angleton, who apparently thought Prime Minister Harold Wilson a Soviet mole) did not consider high-ranking Labour figures sufficiently trustworthy or committed to Atlanticist goals.

For decades the CIA had cultivated right-wing trade-union bureaucrats and MPs (the ‘Gaitskellite wing’ of Labour) via the International Confederation of Free Trade Unions, and these were the preferred satraps. Throughout the mid-1970s MI5 played a substantial role in destabilizing Harold Wilson’s Labour government (and Ted Heath’s Conservative leadership), with disinformation and smears leaked to the press in Northern Ireland.

Amid a growing sense of unease in elite circles following the 1974 miner’s strike and several years of high inflation, dubious figures like Airey Neave and George Kennedy Young helped to parachute Thatcher into the Conservative leadership. The disorder brought about by structural adjustment – freeze on public-sector pay leading to the Winter of Discontent, etc. – then brought Thatcher to power.

The split of the Gaitskellites from the Labour Party, and the final defeat of the figures around Tony Benn, led ultimately to the ascendancy of New Labour and the impeccably Atlanticist Tony Blair. (Meanwhile the ‘Europeanist’ wing of the Conservatives, their avatar in Cabinet being Michael Heseltine, was held at bay.)

Not coincidently, around the same time Australia saw the rise of a new cohort of Washington-inclined, staunchly pro-Zionist ALP leaders – Hawke, Keating, Beazley, Gillard – as well as the likes of Paul Howes, Mark Arbib and Michael Cooney.

The geostrategic consequences were many, but within Britain these measures also involved reasserting the privileges of the propertied classes against those of the employed population and related social layers. For this see Prime Minister Callaghan’s extraordinary speech, in September 1976, to the Labour Party Conference:

When I say there is no other way, that does not mean that it is going to be quick or easy. That has been promised before. It is neither. Britain has lived for too long on borrowed time, borrowed money, borrowed ideas…

For too long, perhaps ever since the war, we postponed facing up to fundamental choices and fundamental changes in our society and in our economy. That is what I mean when I say we have been living on borrowed time. For too long this country – all of us, yes, this Conference too – has been ready to settle for borrowing money abroad to maintain our standards of life, instead of grappling with the fundamental problems of British industry…

The cosy world we were told would go on for ever, where full employment would be guaran­teed by a stroke of the Chancellor’s pen, cutting taxes, deficit spending, that cosy world is gone. Yesterday delegates pointed to the first sorry fruits: a high rate of unemployment. The rate of unemployment today – there is no need for me to say this to you – cannot be justified on any grounds, least of all the human dignity of those involved. But Mr. Chairman and comrades, I did not become a member of our Party, still less did I become the Leader of our Party, to pro­pound shallow analyses and false remedies for fundamental economic and social problems.

When we reject unemployment as an economic instrument – as we do – and when we reject also superficial remedies, as socialists must, then we must ask ourselves unflinchingly what is the cause of high unemployment. Quite simply and unequivocally, it is caused by paying ourselves more than the value of what we produce. There are no scapegoats. This is as true in a mixed economy under a Labour Government as it is under capitalism or under communism. It is an absolute fact of life which no Government, be it left or right, can alter. Of course in Eastern Europe you cannot price yourself out of your job, because you cannot withdraw your labour. So those Governments can at least guarantee the appearance of full employment. But that is not the democratic way.

We used to think that you could spend your way out of a recession, and increase employ­ment by cutting taxes and boosting Government spending. I tell you in all candour that that option no longer exists, and that in so far as it ever did exist, it only worked on each occasion since the war by injecting a bigger dose of infla­tion into the economy, followed by a higher level of unemployment as the next step. Higher inflation followed by higher unemployment. We have just escaped from the highest rate of inflation this country has known; we have not yet escaped from the consequences: high unemployment…

Now we must get back to fundamentals. First, overcoming unemployment now unambiguously depends on our labour costs being at least com­parable with those of our major competitors. Second, we can only become competitive by having the right kind of investment at the right kind of level, and by significantly improving the productivity of both labour and capital. Third, we will fail – and I say this to those who have been pressing about public expenditure, to which I will come back – if we think we can buy our way out by printing what Denis Healey calls ‘confetti money’ to pay ourselves more than we produce. I do not care what economic system we live in – at least, I do care very much – but the moral I want to draw is this that whatever system we live under these fundamentals are at the heart of the standard of life of the people of the country concerned, and we ignore them at our peril. They are also at the heart of the Social Contract and of our industrial strategy.

Britain is now at a watershed. We have the chance to make real and fundamental choices about priorities which are absolutely necessary to achieve a growing and prosperous manufac­turing industry, with all the advantages and easements that can follow…

[The] first priority of the Labour Government must be a determined attack on inflation. That remains; we have halved it in the last twelve months but we must do more yet. The Government’s objec­tive must be to reach inflation rates comparable with those of our major competitors by the end of next year. We are already getting there….

Let me add one more thing about how to get a strong manufacturing sector of industry. Hold on to your seats. The willingness of industry to invest in new plant and machinery requires, of course, that we overcome inflation, but also that industry is left with sufficient funds and has suf­ficient confidence to make the new investments. When I say they must have sufficient funds, I mean they must he able to earn a surplus and that is a euphemism for saying they must be able to make a profit.

Whether you call it a surplus or a profit, it is necessary for a healthy industrial system, whether it operates in a socialist economy, a mixed economy or a capitalist economy. If industry cannot retain and generate sufficient funds as a result of its operations, and replace old plant and machinery, then you will whistle in vain for the investment and we shall continue to slide downhill. These are elementary facts of life. They are known to every trade unionist. Who would they sooner go and negotiate with when they want an increase in pay: a firm that is bankrupt or a firm that is doing well and generat­ing a good surplus?

The primary concern of our industrial strategy and our economic policy for the next three years is quite simple. The strategy and the priority is to create more wealth, and to do it with the agree­ment and the support of the trade union move­ment.

Soon after this speech, however, it became clear that the British Treasury forecasts of public-sector borrowing requirements and the current-account deficit, used by Chancellor Denis Healey to persuade Cabinet of the looming emergency, had been overblown.

The balance-of-payments constraint rapidly receded. Production from Britain’s North Sea oilfields had begun in 1975, and within three years the largest field, Forties, had reached peak daily output.

With export receipts flowing, the new Conservative government allowed the pound to appreciate, deliberately wiping out much manufacturing industry.

From late 1979 sectoral output fell off a cliff; by 1982 the number of workers employed in manufacturing had dropped by 1.5 million.

During the 1980s the trade surplus and the removal of regulatory controls allowed the export of capital: firms and institutional investors buying up overseas assets, both equity and bonds, and the City of London increasing its social influence and control over policy making.

The return to dominance of the financial sector had several implications.

The first was that the earnings of industrial and commercial firms retained after interest and dividends had been paid out was reduced. This meant less was available for productive investment.

The following two charts show (1) the reduced share of profits that went towards productive expenditure; (2) the effect this had on growth in the fixed capital stock. For several years gross investment in buildings, machinery and equipment was insufficient even to cover depreciation and the total real-asset base contracted.

Slow growth in the stock of accumulated capital raised the output/capital ratio, increasing the rate of profit from its mid-1970s nadir.

Over time, the high proportion of the surplus drained by unproductive expenditure, and the consequent slow productivity growth, has made British industry high-cost and uncompetitive, leading to persistent trade deficits over the past two decades as domestic energy production has begun to decline.

This has helped British integration into the European continental economy. The highly unproductive offshore island, in which the financial sector has a disproportionately large weight, neatly complements the export-oriented Mitteleuropa centred on Germany and incorporating Sweden, the Netherlands, Austria and the Czech Republic.

Mohun and Veneziani

This closer integration of Britain with mainland Europe has not threatened the Atlantic alliance or damaged Washington’s overriding objective, pursued via the NATO umbrella, of preventing the European superstate from developing the military capacity to independently pursue its own strategic or ‘security’ interests. Quite the opposite.

Washington has since the 1970s encouraged Britain’s economic and diplomatic incorporation into Europe, where it functions as a beachhead and Trojan horse. With the opportunity (and risk) presented by North Sea oil, from the mid-1970s this project took the form of tempting a wing of the British ruling elite to weaken the labour movement by destroying domestic industry and running down the capital stock.

This task achieved, the inveterately pro-US Thatcher was subsequently despatched when her Europhobia became an obstacle to further progress, and she was eventually replaced by the Europhiles of New Labour, foremost among them Blair, Peter Mandelson, and George Robertson, among whom the latter two were notable members of the British-American Project.

Thus, notwithstanding its current pose in the forefront of the “international community”, Britain is a third-rate power. Not only is it dependent on the US in military, intelligence and strategic matters, but its chronic current-account deficits now reflect Britain’s subordination to the leading EU economies.

Harold Wilson, Labour PM during the 1967 and 1976 balance-of-payments crises, traced the UK’s problems back to Lend-Lease and the end of Imperial Preference. We could go further back.

The disproportionate weight of the rentier class arose in the Edwardian era, during which period Britain’s capitalist class first abjured productive investment, retiring to coupon-clipping in stately homes.


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10 Responses to “Dollars and pence”

  1. Max Says:

    Dear Nick
    I’m very interested in using the picture of Wilson, Healey and Foot for my history research dissertation. Do you happen to know the original source?

    Best wishes and many thanks

  2. Nick Says:

    Hi Max. Sorry, it’s the result of a Google search a long time ago. Can’t remember where I found it. Good luck with your dissertation!

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