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The Pitfalls of Dollar Hegemony

Although Keynesian economics has withstood repeated challenges and updated itself over the decades, it would be a mistake to conclude that it is sufficient for making sense of contemporary economic change. For that, we need to resurrect an alternative perspective on what money does and how it works.

CHICAGO – In Money and Empire, Perry Mehrling of Boston University recounts the remarkable moment, in 1965, when Congress summoned international monetary economist and historian Charles P. Kindleberger from MIT to testify on the troubling US balance-of-payments deficit. After World War II, the United States had persistently exported more than it imported. But by 1965, the reverse was true: West German goods were flooding the US domestic market, and Japanese imports were soon to follow. With dollars flowing overseas as payment for these imports, many had begun to ask if it was time to reform the post-war Bretton Woods international monetary system, which had pegged the US dollar directly to gold and tied other currencies more flexibly to the dollar.

Kindleberger’s answer was no: US trade could be financed, and the dominant international status of the US dollar secured, he argued, by an alliance of central banks led by the US Federal Reserve. “Many of my colleagues are terrified at the thought of collaboration of central bankers superseding [national] economic sovereignty and so on,” he observed. But central bankers “are technicians,” he said, “and this is the kind of problem they can handle easily.”

In hindsight, Kindleberger’s comment is uncanny, considering that central banks have since become economic policymaking’s “only game in town.” Fed Chair Paul Volcker’s 1979-82 interest-rate shock, which halted the high inflation of the 1970s, was followed a decade later by the ideological and policy triumph of “central bank independence,” with Fed Chair Alan Greenspan becoming something of a financial industry folk legend.