The Center of A Centerless Universe

The Globalization of the world economy dates back to the sixteenth century, essentially back to the point of the discovery of the Americas. From that point hegemony over world trade has dictated hierarchy of power across the globe, in the sixteenth century Spain, in the seventeenth Netherlands, in the eighteen century Great Britain and France, in the nineteenth century Great Britain, and in the twentieth century the United States. Now, in the twenty-first century the US hegemony over the world is waning, it’s military strength remains unparalleled, but it’s financial stability is wavering, especially the strength of the worlds most important currency, the US dollar.

In 1944 at the Bretton-Woods Conference world currency exchange rates were all pegged to the fixed value of the US dollar, which was still based on the gold standard. The US dollar came off of the gold standard in 1971, in what was called the Nixon shock, and the dollar became a floating currency with a variable exchange rate. However, dollar hegemony remained, and the world’s economies were still subject to the dominance of the dollar. The world’s dependence on a strong dollar for economic stability has been one of the biggest factors that caused the 2008 economic crisis, and a driving force in the current financial situation.

In 1997 the Thai government unpegged the Thai baht from the US dollar after stubbornly refusing to devalue the baht. The result was an almost complete collapse of the Thai economy, at a time when Thailand had a large burden of foreign debt. The resulting fear spread across Asia, with the Thai, Indonesian and South Korean economies being hit the hardest. The International Monetary Fund (IMF), another creation of Bretton-Woods, stepped in with loans for the afflicted economies, but a big change in US policy shifted it’s relationship with Asian economies. Alan Greenspan began a long term policy of low interest rates to drive working and middle class Americans to prop up global demand for Asian products. After a decade of low interest public debt more than doubled, and continues to climb.

The end of dollar-gold convertibility was the beginning of a new financial era with a great deal of monetary volatility. The floating value of the dollar was subject to speculation, it’s future value became more important than it’s current value. The US economy became increasingly dependent on interest paying transactions to not only mitigate risk, but more importantly to take advantage of that risk. These practices eventually led to the formation of hedge funds, and the development of risk hedging financial devices like derivatives. The overpopulation of risk takers in the US economy, and some financial institutions across the world is what caused the economic meltdown in 2008. The US government was very slow to acknowledge this problem, for years under Alan Greenspan encouraged it, and in fact there are many that still disagree that more government oversight of these financial practices is necessary.

In 1998 Long Term Capital Management (LTCM) received a government bailout very similar to the bailouts used to curb the recent economic crisis, and LTCM collapse essentially a mirror of what happened to wall street a decade later. LTCM aggressively short selling of bonds based on computer models the company made on small amounts of money on each bond, so the company had to invest in great quantity to make a significant profit, eventually being leveraged to the point of a 25 to 1 debt to equity ratio. LTCM also had off-balance sheet derivative positions with a notional value of approximately $1.25 trillion. After several years of remarkable success the Russian government defaulted on it bonds in August of 1998, and the result was a massive sell off of European and Japanese bonds, as investors fled to the perceived safety of US Bonds. The highly leveraged LTCM was bankrupted instantly, necessitating a $3.625 billion bailout from the Federal Reserve and several corporations. This epic collapse caused a stir on Capitol Hill, but the push back from financial institutions was too great for any new regulations or oversight to be established.

It is very important for the US to maintain a robust economy and a strong dollar, mostly to keep faith in US treasury bonds. The US uses bonds to finance the massive budget deficits the government has been running, and to pay back previously issued bonds as they mature. Without the faith that the US Treasury will be able to buys back matured bonds with a solvent currency the government would come to a standstill. The perceived safety of the investment in US Treasury bonds is essential to the stability of the country.

In todays world the dollar’s overwhelming importance is waning, however, competing currencies are struggling to exert any dominance over the dollar. The US dollar is still the world’s most common reserve currency, and despite doubts about the US economy it is still perceived to be a relatively safe currency to hold. The euro is the second most widely held currency, but the european debt crisis recently had the euro on the brink of collapse, and of all the Eurozone economies, only France and Germany maintain the strength of the euro. Meanwhile, the British pound has stumbled from it’s position of strength. China maintains capital controls on the conversion of the yuan, so it can’t be used as a reserve currency. China, Russia and the Gulf States have called for a new reserve currency to replace the dollar.

The United Nations Conference On Trade and Development proposed a new currency based on the IMF’s Special Drawing Rights (SDR). The SDR is used by the IMF for international payments, and is computed from a combination of dollars, pounds, euros and yen. The combination is reevaluated and adjusted every five years, and it’s value is computed daily, although it’s computation ends up in the form of a dollar valuation. Some variation of the SDR as a universal reserve currency would help stabilize global markets, even though it would not end speculation entirely, it would mitigate the influence of speculators. A universal reserve currency would also reduce the global panics caused by fluctuations of the major reserve currencies.

The interconnection of the global economy is not a new phenomenon, the connections are simply moving increasingly from a macro to micro scale. Individual institutions can bankrupt a nation across the world, and in an environment where the level of systemic risk is so high, governments need an equally high level of oversight and cooperation. Expansion of the G8 to the G20 is a great step forward, but with an absence of any formal structure to the organization it doesn’t achieve very much, other than being a lightning rod for massive protests. Recent economic crises should be a revelation to any doubters that a new global economic system needs to be developed, with strict rules on not only debt and budget deficits, but also guidelines for banking and other financial sectors. The IMF and World Bank need a more balanced leadership, instead of being dominated by American and European interests. The world needs a new Bretton-Woods System that reflects the new realities of a decentralized global economy, and an acceptance that markets are incapable of regulating themselves in any stable way.