The dollar wars return amid uncertainty

Harold James, Author, 'The End of Globalization: Lessons from the Great Depression' Project Syndicate

Faced by uncertain re-election prospects, and worried about job losses, U.S. President George W. Bush has begun to blame other countries, sending his Treasury Secretary to demand that they raise their exchange rates in order to make foreign goods more expensive for American consumers.

That was John Snow's mission on his recent trip to China, but his goal was nothing new. Two of Snow's predecessors, John Connally and James Baker, followed a similar quest for politically desirable exchange rates.

What Snow asked of China is an odd demand: We do not normally go into stores and ask the shopkeeper to raise his prices. But the emergence of powerful new currencies always provokes fresh attempts at the use of exchange rates for political purposes.

For 20 years after World War II, there were just two major international currencies, as there had been through the interwar period: The British pound and the American dollar. By the end of the 1960's, the pound had been so weakened that international markets lost interest. Instead, two new major currencies emerged, as the strength of the Japanese and (West) German economies produced big trade surpluses.

American producers and the U.S. government complained that American workers were being priced out of jobs because the Yen and D-mark were being held at artificially low levels. The U.S. government under President Richard Nixon pressed the Germans and Japanese to revalue their currencies.

The Germans did but the Japanese did not, infuriating the U.S. Treasury Secretary, who tried his best to bully Japan. John Connally complained that Japan had a "controlled economy" and did not play by the rules.

All sides engaged in mudslinging about who was doing the most damage to the world economy. The Americans accused the Europeans and especially the Japanese of growing too slowly, while the Europeans and the Japanese argued that the U.S. was exporting inflation to the rest of the world and abusing the international monetary system in order to sustain its military adventurism (at that time in Vietnam).

Indeed, U.S. monetary expansion had itself become a weapon in the war over exchange rates. High inflation in the U.S. highlighted the exchange-rate problem by showing the instability of the dollar standard. Indeed, Connally called the dollar "our currency but your problem."

In the end, the U.S. forced the Japanese to revalue their currency by destroying the international monetary order in August 1971. The Americans first unilaterally suspended the gold convertibility of the dollar -- the backbone of the fixed but adjustable exchange-rate regime created by the post-World War II Bretton Woods conference -- and then teamed up with the Europeans to force on Japan a 16.9 percent revaluation of the Yen against the dollar. (Japan's Finance Minister had threatened to commit hara-kiri if the revaluation rate was set at 17 percent.)

But the end of the fixed exchange-rate regime for industrial countries did not end activist management of currencies. The scenario of the early 1970's was replayed with floating rates in the mid-1980's, with the meetings of the major countries' finance ministers first forcing down the Yen and the D-mark against the dollar, and then trying in 1987 to hold rates stable.

Both of these historical episodes ended in chaos. The breakdown of Bretton Woods in 1971, far from stopping inflation, unleashed a synchronized monetary surge. A decade later, efforts to keep the Yen in line with American views produced the Japanese bubble economy, for which many Japanese blamed America after it burst.

Today, the U.S. dollar is also looking at a challenge from two new or newly important currencies, China's renmimbi and the euro. As in the 1970's and the 1980's, the rising Asian currency is seen as a much greater threat because that is where the biggest trade imbalances lie. Moreover, the U.S. still has a powerful weapon because other countries hold so many dollars: The current estimate is that 46 percent of U.S. Treasury bonds are held overseas.

This invites both sides to play a game of brinkmanship. America's leverage consists in the rest of the world's massive financial stake in the fate of the dollar. But the rest of the world can threaten a dollar sell-off.

China's government today might find some useful lessons in the apparently remote dramas of the 1970's. The most immediate and most obvious is that it is difficult to hold out long against the U.S., especially when the American government is under pressure from major domestic interest groups whose strong lobbying power might be used to lead a push for new trade protectionism.

But the world -- and the U.S. in particular -- might also learn some lessons. Previous episodes in the politically driven creation of new exchange-rate systems have been highly chaotic, and resulted in increased levels of international tension.

At an emotional level, debating exchange rates means blaming foreigners for whatever goes wrong in the domestic economy. This approach is both unhealthy and immature, yet not necessarily very damaging. What is worse is when the economic policy response becomes the equivalent of blaming foreigners: Imposing new forms of trade barriers. Doing so may feel good in the short term, but it merely destroys wealth and undermines job creation everywhere.

The writer is professor of history at Princeton University.