Copyright © 2008 by Craig Karmin All rights reserved. Published in the United States by Crown Business, an imprint of the Crown Publishing Group, a division of Random House, Inc., New York. www.crownpublishing.com Crown Business is a trademark and the Rising Sun colophon is a registered trademark of Random House, Inc. Library of Congress Cataloging-in-Publication Data Karmin, Craig. Biography of the dollar: how the mighty buck conquered the world and why it’s under siege / Craig Karmin. 1. Dollar, American. 2. Foreign exchange. 3. International ﬁnance. I. Title. HG540.K37 2008 332.4'973—dc22 2007035501 eISBN: 978-0-307-40981-2 Design by Lenny Henderson v1.0 .
cc oo nn tt ee nn tt ss Introduction 1 c h a p t e r 1 Fishing in the Three-Trillion-Dollar Pond 17 c h a p t e r 2 Blowing Up the Money Factory 57 c h a p t e r 3 More Sound Than the Pound, and Good as Gold 97 c h a p t e r 4 The Triumphs and Travails of a Dollar Colony 149 c h a p t e r 5 The Dollar’s Buyers of Last Resort 193 c h a p t e r 6 An End to America’s Exorbitant Privilege? 221 Bibliography 249 Acknowledgments 252 Index 254.
Introduction OO ne dark November day, people in the Nether- lands turned on their TVs to watch something few thought they’d ever see: The mighty dollar was col- lapsing before their eyes. The currency’s sudden demise begins at 1:00 A.M. Greenwich mean time (GMT), when a trader at a large Singapore bank receives a big order to sell dollars. Ru- mors spread quickly that the request came from a giant hedge fund that needs to unload its dollar-denominated assets at any cost. Central banks in Japan, South Korea, and China—all big-dollar holders—start buying more dollars to steady the greenback’s decline. But by now panic has set in, and the central banks’ dollar purchases are overwhelmed by private investors, traders, and specula- tors who are scrambling to sell dollars as fast as they can. The dollar is sinking rapidly when trading opens in Europe. The region’s bond markets have frozen up and its stock markets all plunge more than 10 percent in a few scary minutes. Even before the European Central Bank (ECB) announces that it will provide emergency loans to commercial banks, the ECB’s phone lines are jammed with desperate calls. Traders report that the .
2 BIOGRAPHY OF THE DOLLAR dollar’s unforeseen collapse has put countless hedge funds out of business. A Dutch news anchor reports winding lines at ATMs in Amsterdam, where crowds turn hostile after ﬁnding the machines empty. The city’s foreign exchange kiosks shut their doors. At 1:00 P.M. GMT, a mere twelve hours after the crisis started with that big trade in Singapore, Banca di Torino becomes the ﬁrst European bank to go under. Then trading begins in the United States. The dollar keeps falling. A dispute breaks out between America’s Federal Reserve and the European Central Bank over how best to respond. The ECB wants to enforce a new ﬁxed exchange rate between the euro and the dollar, but the Fed balks. It decides instead to freeze all trans- Atlantic ﬁnancial transactions. The United Kingdom sides with Washington, threatening to quit the European Union unless the ECB backs down. But the oil produc- ing nations of OPEC ally with Europe, announcing that crude oil prices will now be priced in euros instead of dollars. Back in Amsterdam, at the end of this dizzying day, a man calls for a taxi to take him to a train station. With both the dollar and the euro in ﬂux, he pays the driver with three packs of Marlboro cigarettes. This scenario, of course, did not happen in the real world. But it did play out on a Dutch television network in 2005. Reminiscent of Orson Welles’s famous War of the Worlds radio hoax, many viewers who tuned in mid- program and saw real-life news anchors reporting the dollar’s meltdown believed the ﬁctional account to be terrifyingly real. Some even raced to withdraw cash from their ATMs before it was too late. “We wanted to show that the world is a more dangerous place ﬁnancially .
INTRODUCTION 3 than most people realize,” Maarten Schinkel, a Dutch economics newspaper reporter who wrote the script for this ﬁlm, told me. “What people don’t understand is how much the world is still dependent on the dollar.” Financial Armageddon, if it ever comes, probably won’t unfold as quickly or dramatically as Schinkel de- picts. But he’s right that the dollar’s presence has become so ubiquitous in our world that it is like water to a ﬁsh. It’s around us every day, and we take for granted that it always will be. Few of us ever pause to consider how powerful a force the dollar is in the world today and the degree to which it drives both America’s and the globe’s prosperity. Likewise, few reﬂect on the possibility that the dollar’s privileged status might one day end. And what that would mean for us all. This book aims to shed a bit of light on these issues with a scenic tour of the dollar through the global econ- omy. It examines the greenback’s allure, its history, its many functions, and its role as a catalyst for globaliza- tion. These pages also assert that the dollar’s emergence as the world’s main currency is driving two of the deﬁn- ing trends in the world economy today. The ﬁrst development is unambiguously positive: The dollar’s universal acceptance has been an essential force behind the world’s powerful economic expansion. This has swollen the ranks of the middle class and lifted many others from poverty. But the ﬂipside has been cause for concern: Enduring demand for the dollar has also encouraged the United States to run up enormous— some would say unsustainable—foreign debts and record trade deﬁcits. The United States now pays out the equiv- alent of $1 million each day for every man, woman, and .
4 BIOGRAPHY OF THE DOLLAR child in the country—just in interest payments on that foreign debt. Washington’s ability to assuage interna- tional borrowers, who are becoming increasingly fearful these debts and deﬁcits are running out of control, may well determine how long the dollar can continue to enjoy its special status. And as we will see, loss of that sta- tus would have serious consequences for Americans and the rest of the world alike. To understand why any change in the dollar’s global role would have such a far-reaching effect, it helps to ap- preciate how almighty the buck really is. Even by the standards of a military and economic superpower, the dollar’s supremacy has been remarkable. While the U.S. economy accounts for about 30 percent of global gross domestic product and American companies compose nearly 50 percent of the world stock market capitalization, the dollar’s dominance is greater still. It ﬁgures in nearly 90 percent of all trades in the more than $3.2-trillion- a-day foreign exchange market. Nearly two-thirds of the world’s central bank reserves are held in dollars. In the post World War II era, the dollar has become the primary unit of international trade and ﬁnance. Emerging market nations borrow in it. China pegs its currency to it to ensure stability. All major commodities, from oil to soybeans, are priced in dollars. The dollar is truly the world’s currency in that of the $760 billion in circulation, about two-thirds are held abroad. Foreigners collect and spend these dollars even though, since the United States abandoned the gold standard in 1971, they are now backed by nothing more than faith in America. “The dollar is the greatest monetary achievement in the history of the world,” says James Grant, a ﬁnancial .
INTRODUCTION 5 historian and publisher of Grant’s Interest Rate Observer. “It is a paper claim of no inherent value that is accepted on its face in every corner of the earth. There is nothing behind it but the idea of America.” So inescapable is the dollar’s reach that even the na- tion’s historic adversaries have embraced it. Julia Kiraly, an economic consultant I met at Café Gerbeaud in Bu- dapest, recalls that during the Cold War, Hungarians were allowed a trip abroad every three years. Her prior- ity during each visit to western Europe in the 1970s and 1980s was to bring back as many dollars as she could hide in her apartment. Even when the Cold War ended and she was living in Belgium in the mid-1990s, Kiraly would continue to convert her Belgian franc paychecks into dollars. “I knew it didn’t make any sense,” she said, explaining that all her expenses were in the Belgian cur- rency. “But I am from the generation where we weren’t comfortable unless we had a big deposit in U.S. dollars.” In the other capitals of the Eastern bloc, a sort of “dollar apartheid” ﬂourished in the early 1990s, as de- mand for the currency pushed it out from the shadows of the black markets. A visitor to Moscow in the middle of that decade would ﬁnd that rubles were ﬁne for buy- ing toilet paper at the corner store or purchasing a ticket for the metro. But the prices at the city’s nouvelle French restaurants and the cover charge at trendy nightspots were settled in dollars. And while Saddam Hussein, in an act of rebellion against the United States, used to insist on being paid in euros for Iraqi oil, his captors found in his possession $750,000, all in neat stacks of one hundred dollar bills. There was not a euro among them. Anti-American protesters might torch the Stars and .
6 BIOGRAPHY OF THE DOLLAR Stripes or throw a brick through the window of a local McDonald’s, but when was the last time you saw footage of anyone burning that cotton-and-linen rectangle bear- ing the visage of Benjamin Franklin? Forget Coca-Cola, Microsoft, Toyota, Manchester United, the Christian cross, or the Islamic scimitar—the most powerful, most well-recognized, and most widely used and distributed symbol on earth is arguably $. Yet, at the start of the new millennium, it is hard to mistake signs that the dollar’s unrivaled supremacy is in the early stages of inevitable decline. The ﬁrst sign is the birth of the euro in 1999, now the currency of thirteen European nations—more than 317 million people—and soon perhaps several more. “For the ﬁrst time there is the prospect of another currency to rival the dollar,” says Barry Eichengreen, an international economist at the University of California, Berkeley, who has written extensively on currencies. “The euro has permanently changed the international ﬁnancial landscape. The ques- tion is how quickly the transition will go.” By most accounts, any transition will be gradual. Global markets and central banks don’t readily switch re- serve currencies. The pound sterling remained the world standard for some forty years after the United States had eclipsed Britain as the world’s economic superpower. Moreover, few see the dollar being completely knocked off the mountaintop—at least by the euro, and not for a while. Rather, economists see the euro, and eventually the Chinese yuan, playing increasingly important roles in the global economy, chipping away at the dollar’s dominance. Some of this is already under way. Central banks from Moscow to Riyadh have diversiﬁed their reserves .
INTRODUCTION 7 to include more euros. While this shift in part may reﬂect concern over a dollar bear market that started around 2002 and has wiped away more than half of the dollar’s value against the euro, the rise of a viable alternative cur- rency suggests central banks will store a portion of their reserves in euros on a permanent basis. Washington can slow this transition by cutting deﬁcits and enacting mea- sures to encourage private savings, steps that would likely help the dollar rally and raise its value. But U.S. policymakers cannot change the broader dynamics that lead central banks to diversify their holdings. The ﬁnancial crisis of 1997 and 1998 also marked a shift. Following a depletion of their dollar reserves, most Asian and Latin American countries stopped pegging their currencies to the dollar, allowing their currencies in- stead to ﬂoat more freely. As governments also whipped their economies into shape, paying down their debt and building up their reserves, they found that they could borrow money through the international markets in their own currencies. Global investors no longer insist that these bond transactions be sold in dollars. The growing sophistication of ﬁnancial systems could diminish the dollar’s central role in foreign ex- change trading, too. One reason the dollar ﬁgures in 90 percent of all activity is because it serves as a go-between when transactions are made between more thinly traded currencies, say the Colombian peso for the Thai baht. But superior technology is expected one day to allow these currencies to swap directly, rather than into dollars ﬁrst, thus further eroding at the margins the dollar’s cen- tral role in global ﬁnance. For now, however, the dollar remains the name of .