Money, Markets & Sovereignty

Benn Steil and Manuel Hinds

Read this article in its Magazine format

Article Endnotes  

A central theme of this book is that such a dramatic expansion of trade could not have occurred without an international currency with which to pay for it. The gold standard – national currencies convertible into gold at fixed prices – provided such a world currency and other virtues as well.

During World War I the US and most other gold standard countries suspended the convertibility of their currencies into gold temporarily in order to expand their money supplies more than convertibility would have permitted to finance the war. With a number of executive orders in 1933 and the Gold Reserve Act of 1934 F.D. Roosevelt ended gold’s use as legal tender in the United States, restricted private holding of gold and re-established limited convertibility in foreign exchange markets in 1933 at the higher price of $35 per Troy ounce from the earlier $20.67 per Troy ounce.

Following the end of World War II and the establishment of the International Monetary Fund and other Bretton Woods institutions, most countries in the world formally adopted the Gold Exchange Standard in which most currency exchange rates were fixed in terms of the US dollar and only the dollar itself was convertible into gold and then only by other central banks.

Benn Steil, director of international economics at the Council on Foreign Relations, and Manuel Hinds, for many years a senior official of the World Bank and twice the Minister of Finance of El Salvador, present an interesting and insightful history of these developments and of the gradual slide and eventual collapse of the system in 1971 and more formally in 1973 into national monetary sovereignty – what Friedrich Hayek called “monetary nationalism”.

By monetary sovereignty the authors mean more than national currencies not convertible into anything and not exchangeable for other currencies at fixed exchange rates. They mean national monetary policies that are free to thwart the natural market forces of the gold standard to adjust the quantity of money in each country to the requirements of payment balances between them. Under the gold standard when one country sells more to another than it buys, it collects the difference in gold from the deficit country.

This reduces the money supply of the deficit country and its price level, making purchases from the surplus country more expensive and its own exports more attractive, thus restoring the external balance of trade. Under the Gold Exchange Standard and even more so under the current non-standard of fiat currencies with floating exchange rates, the surplus country (China) accepts dollars that it reinvests in the US. This has no impact on the US money supply and thus no corrective adjustment in prices is produced.

The resulting international trading and payments system is thus ultimately unstable. This was articulated with regard to the Gold Exchange System by Robert Triffin in the 1960’s when he observed that the use of a national currency (the US dollar) as an international reserve currency allowed the world’s holding of the reserve currency (US dollars) to increase faster or independently from the US increase in its gold reserves.

At some point, holders of dollars may come to doubt the United States’ ability to redeem them for gold. Since 1971/73 when the dollar is no longer redeemable for gold, this same tipping point reflects the credibility of the United States’ ability to service and honour its debts, public and private.

The authors bolster their argument that, “National monies and global markets simple do not mix,”with several interesting and worth reading side stories:
They celebrate globalisation (free trade in goods, services, labour and capital). “Writers of the most prominent pro-globalisation screeds do not simply applaud commerce. Rather, they celebrate technological and political forces advancing and deepening interaction among people across national boundaries3. “Gold had done what no conqueror or religion had managed to do: it had brought virtually all people on earth into one social system.”

They document the development of international law required for international commerce as a natural, non-sovereign process. “In the Western tradition, ‘good law’ – law worthy of the name, worthy of obedience – has always been law that was eternal, in the sense that it was rooted in human nature5…

“The tradition of English common law shares much with the natural law notion of legitimate law being ‘discovered’ by judges rather the ‘created’ by rulers.”

“The way in which people freely choose to conduct commercial transactions with each other across borders is examined by both private and public tribunals in order to discover what the commercial law must be.” “Good law was always old law, and old law is what emerged by dint of its consistency with what people came to expect as just behaviour from others.”

They refute the anti-globalist arguments favouring naive national sovereignty. “Ralph Nader and Lori Wallach’s self-justifying condemnation of the WTO is that in joining it ‘the [Clinton] administration voluntarily sacrificed US sovereignty.”

“Stiglitz champions the role of national governments in correcting international market failures. Liberal Enlightenment thinkers championed the role of markets in correcting government failures.”

Arguments against globalisation are generally arguments defending the status quo against competitive challenge whether at home or from abroad and thus have nothing to do with globalisation.

Unfortunately the authors sometimes get their facts wrong. In an amusing aside the authors note that “’In God We Trust’ was added to American dollar bills only after their gold backing was dropped in 186212.”Unfortunately every “fact” in that statement is wrong. The US did not even adopt the gold standard until 1873 as the authors note on page 81. The national motto first appeared on paper money in 195713.The motto was added to coins in the 1860s and in accordance with Act of Congress passed on 3 March 1865, the motto was added to the gold double-eagle coin, the gold eagle coin and the silver dollar in 1866. Similarly their assertion that by replacing the acceptance by surplus countries of US dollar assets rather than demanding gold the new system produced a multiple expansion of credit is wrong as long as national central banks (and in particular the Federal Reserve) control their own liabilities (base money).

However, these occasional lapses do not diminish the power of their arguments.

Along with the greatest era of globalisation the world has ever experienced, the gold standard that facilitated it produced significant episodes of inflation and deflation but essential no long run change in value for over a century. While the authors lament its passing, they acknowledge that governments that would not play by its rules, in particular the United States in pursuit of Keynesian stimulus in the 1960s, might do better to float their exchange rates and manage their own domestic currency. But with the legal and technological freeing of capital movements, exchange rates and payments balances between countries are now more driving by relative investment incentives (capital account) than trade (current account). The result has been dramatic and damaging swings in exchange rates.

While the large US trade deficits in the 1990s called for a depreciation of the dollar, the 54 per cent drop against the Euro in just three years (from February 2002 to February 2005) was surely dramatic. Countries whose exchange rates are fixed to the dollar, like the Cayman Islands, experienced a sharp increase in the price of European and non-dollar based goods and services, pricing many European workers out of the Cayman market. But the 24 per cent appreciation over just seven months in 2008 and again the 22 per cent appreciation over the seven months since November 2009 cannot possibly be seen as equilibrating adjustments.

Robert Mundell has called the 2008 appreciation as one of the most ill-advised monetary tightenings in the Federal Reserve’s history and with very damaging results for the US and world economies.

Steil and Hinds conclude their excellent book with the relatively modest seeming, yet revolutionary, proposal that the Federal Reserve pay more attention to exchange rates. It is a modest proposal only in that it is pragmatic and doable. The Fed could have prevented or moderated the sharp and inappropriate appreciation of the dollar in mid 2008 by buying Euros and thus increasing the US money supply more than it did. Year on year growth rates for M2 fell from 7.5 per cent to below 5 per cent per annum over that period.

“The best hope for salvaging financial globalisation, then, is a renewed statutory framework for the Fed, one which explicitly acknowledges the global role of the dollar and the dependence of the US economy on foreign confidence in it…. Printing the world’s reserve asset, is one which America will in the future have to do far more to sustain14.”Their proposal is well worth serious consideration.

The views expressed here are his own and not those of CIMA. 


1. See also Warren Coats, “Do We Need A New Global Currency?”, Cayman Financial Review, Issue 18 First Quarter, 2010.
2. Page 8
3. Page 12
4. Page 91, quoted from Jack Weatherford: “History of Money” 1997, New York: Three Rivers Press.
5. Page 13
6. Page 22
7. See also, David Russell Mean, God and Gold: Britain, America and the Making of the Modern World (Alfred A. Knopf, 2007).
8. Page 26
9. Page 33
10. Page 41
11. Page 45
12. Page 70
13. US Treasury fact sheet:
14. Page 246