Perhaps the crucial difference between then and now, however, is that Britain was a net exporter of capital while the United States today is the opposite. For the United States has used its dominance of the international bond market not to export capital – which in net terms it did until around 1972 – but to import it. This greatly reduces the financial leverage of its foreign policy: for you cannot have ‘dollar diplomacy’ without dollars. In short, the global hegemon of the present age of globalization has much less financial leverage than that of the first age. And this is one of the reasons why, although the United States has a few quasi-colonial dependencies, it cannot exercise the kind of formal and informal control over the world economy wielded by Britain in her imperial heyday.
PLANKTON
Does that matter? Some would say not. In 1999 the American journalist Thomas Friedman imagined a conversation between the former US Treasury Secretary Robert Rubin and the Malaysian prime minister, Mahathir bin Mohamad, inspired by the latter’s denunciation of globalization at the 1997 World Bank meeting in Hong Kong:
Ah, excuse me, Mahathir, but what planet are you living on? You talk about participating in globalization as if it were a choice you had. Globalization isn’t a choice. It’s a reality. There is just one global market today and the only way you can grow at the speed your people want to grow is by tapping into the global stock and bond markets, by seeking out multinationals to invest in your country and by selling into the global trading system what your factories produce. And the most basic truth about globalization is this: No one is in charge, not George Soros, not ‘Great Powers’ and not I. I didn’t start globalization. I can’t stop it and neither can you …146
Table 18. A tale of two hegemons, 1870–1995
Source: Crafts, ‘Globilization and Growth’, pp. 26, 27, 30, except for British emigration figures from Mitchell, European Historical Statistics, pp. 5, 8, 47; Social Trends, 1995, p. 23, table 1.14.
Here, as at the beginning of this chapter, we encounter the idea of the international financial markets as a power beyond human agency – certainly beyond the control of the United States government. To Friedman, this is a good thing: a check on politicians, and a marked improvement on the first age of imperialist globalization. (In this same book, Friedman gloats to the prime minister of Thailand that he helped bring him to power by selling shares in East Asian emerging markets, hence contributing to the depreciation of the Thai currency, and hence undermining the prime minister’s predecessor.)147
Yet can the huge and volatile markets of the present really be thought of as powerful in their own right? A shoal of plankton may occupy more water than a sperm whale. But to say that the financial markets rule the world is to say the plankton rule the sea. The movement of plankton is not predictable; nor is it the product of a single conscious will. Friedman uses a similar metaphor: he describes international investors and the supposed ‘masters of the universe’ who act on their behalf as an ‘electronic herd’. The trouble is that a herd – especially one without a herdsman – is prone to stampede.
The next chapter considers the various attempts that have been made to reduce the risk of stampedes – sudden capital withdrawals and currency crises – by erecting monetary ‘fences’.
11
Golden Fetters, Paper Chains: International Monetary Regimes
Ex uno plures.
Converse of the motto printed on every US dollar bill (E pluribus unum).
In Ian Fleming’s Goldfinger (1959), the implausibly titled Colonel Smithers of the Bank of England gives James Bond a brief explanation of the gold standard in the era of Bretton Woods: ‘Gold and currencies backed by gold are the foundation of our international credit,’ he explains to the great secret agent, whose ignorance of monetary matters outside the casino seems more or less complete. ‘We can only tell what the true strength of the pound is, and other countries can only tell it, by knowing the amount of valuta we have behind our currency.’ But gold is being stolen from the Bank by the sinister bullion-dealer Auric Goldfinger, who has already accumulated £20 million of the stuff. And while demand for gold continues to grow inexorably – for hoarding, for dental fillings and for jewellery, as well as for central bank reserves – the supply is nearing exhaustion:
‘Just to show you, from 1500 to 1900… the whole world produced about 18,000 tons of gold. From 1900 to today we have dug up 41,000 tons. At this rate, Mr Bond,’ Colonel Smithers leaned forward earnestly, ‘– and please don’t quote me – but I wouldn’t be surprised if in fifty years’ time we have not totally exhausted the gold content of the earth!’
Finally, Smithers comes to the point. ‘The Bank can do nothing about [Goldfinger’s smuggling], so we are asking you to bring Mr Goldfinger to book, Mr Bond, and get that gold back. You know about the currency crisis and the high bank rate? Of course. Well, England needs that gold, badly – and the quicker the better.’1
In fact, it turns out that Goldfinger has bigger fish to fry than the Bank of England. As Bond aficionados will recall, he plans, with the aid of the Mafia and a lethal nerve gas, to rob the US gold reserve at Fort Knox, which at that time contained $15 billion of gold bullion (‘approximately half the supply of mined gold in the world’). Moreover, Goldfinger himself is a mere operative of the Soviet counter-espionage organization SMERSH. Their ultimate objective is nothing less than ‘to take the golden heart of America’ to Russia.
In 1959 Goldfinger would have been stealing precious metal worth $35 dollars an ounce. It seems reasonable to assume that the disappearance of such a large quantity of gold from the US reserves would have driven the dollar price of gold up sharply, thereby destabilizing if not demolishing the Bretton Woods system of fixed exchange rates. In the event, however, there was no need for a Goldfinger to bring this about. Bretton Woods disintegrated just over a decade after Fleming’s book was published, the victim not of a Soviet-backed heist, but of the rising costs of the war in Vietnam and the ‘Great Society’ welfare programme. On 15 August 1971, after prolonged pressure on the dollar–gold exchange rate, President Nixon suspended convertibility of the dollar by ‘closing the gold window’. Henceforth it would no longer be possible for anyone in the United States to exchange dollar bills for the precious metal. The dollar price of gold immediately took off; which is to say that the gold price of the dollar collapsed. By January 1980 the price of gold had reached an historic peak of $850 per ounce.
More than forty years on, it is tempting to wonder if it would now be worth Goldfinger’s while to rob Fort Knox, with the price of gold down to around $260 per ounce. Such a robbery would certainly come too late to save the Soviet system, SMERSH and all. But there is an organization that might derive benefit from such a robbery: that of the world’s gold producers. If they still yearn to see the price of the yellow metal return to its 1980 peak, then the only man capable of doing it is Goldfinger.
Since the late 1990s it has been the gold producers who have felt themselves the victims of robbery. In May 1999 the British Treasury announced the government’s decision to sell 415 tonnes2 – more than half – of its gold reserve held in the vaults of the Bank of England. What would Colonel Smithers have made of this? Almost immediately the price of gold fell by more than 10 per cent. For most of January and February 1999 it had hovered around $290 an ounce. By the second week of June the price was just over $258, the lowest price in twenty years. Shares in gold mines fell by around a quarter. And of course the value of the Bank of England’s gold fell too, at a notional cost to the British taxpayer of some $660 million.
It was not just the British decision to start selling off gold that alarmed the bullion market in 1999. Potentially of equal importance were the implications for gold of European Economic and Monetary Union (EMU). The European Central Bank did not – as it might have done – exclude gold completely from its balance sheet. But its decision to hold 15 per cent of its reserves in gold (860 tonnes) was more than counterbalanced by the diminished needs of the eleven n
ational central banks which, in January 1999, became to all intents and purposes subsidiaries of the ECB. In all, the National Central Banks held some 12,447 tonnes of gold on the eve of EMU, around 17 per cent of their total pre-EMU reserves. But under the single currency they could no longer count other EMU currencies as foreign currency reserves, and they were also obliged to value gold at its market price (something a number of them, including the German Bundesbank, had not been doing). This meant that on 1 January 1999 the proportion of gold in their reserves rose overnight to almost a third of the total.3 It therefore seemed likely that other European countries would at some point join Britain in selling gold. The Swiss central bank was also poised to start reducing its gold holding from 1,300 tonnes, around half its total reserves.4 As the year 2000 approached, the International Monetary Fund came under political pressure – not least from the British Chancellor of the Exchequer Gordon Brown – to fund developing country debt ‘forgiveness’ by selling off part of its large reserves, the second largest in the world.5 The twilight of gold appeared to have arrived.
True, total blackout is still some way off. There were bouts of gold-selling by some Western central banks in the 1970s and 1980s, but these did not escalate into demonetization.6 Moreover, the bullion market was granted a stay of execution in September 1999, when the European central banks announced a five-year ceiling on gold sales of 400 tonnes per year.7 It is nevertheless worth pondering what would happen if, like the Bank of England, all major central banks decided or were told to reduce their gold holdings by around 50 per cent. If Germany, France, Italy, the Netherlands, Portugal, Spain and Austria were to do so, 5,753 tonnes would be released onto the market. If (and this seems much less likely) the United States and Japan were to reduce their gold reserves by half, then a further 4,446 tonnes would be for sale. If these figures are added together with anticipated British, Swiss and IMF sales, the total amount of disposable gold could be as much as 12,224 tonnes: about four to five years of total world mining production.8 And of course it is a great deal easier to get gold from a central bank vault than from under the ground, provided one knows the combination.
THE TWILIGHT OF GOLD
In long-term perspective, of course, the fall in the price of gold was to be expected. On the basis of the average purchasing power parity of gold over two hundred years, the price of gold should have been just $234 per ounce in 1997.9 The surge in gold prices that occurred during the 1970s was historically anomalous, reflecting a sudden increase in demand for gold following the American suspension of convertibility and the rapid depreciation of most Western currencies relative to oil and other commodities.
Gold has a future, of course – but mainly as jewellery, the demand for which accounted for more than three-quarters of all the gold sold in 1992. The average Saudi bride wears five kilograms of 24-carat gold jewellery. India alone consumes around 700 tonnes of gold per annum, compared with less than 300 tonnes in 1993; all told, the Indian public holds approximately 10,000 tonnes. To set this figure in perspective, the world stock of gold above ground at the end of 1997 amounted to 134,800 tonnes, of which central banks held less than a quarter (31,900 tonnes). The annual production of all the world’s gold mines in 1998 was 2,500 tonnes – less than four times the annual consumption of India alone. Luckily for gold producers, the cultures most addicted to gold as a decoration are currently enjoying rapid growth of both population and income.10
Gold also has a future as a store of value in parts of the world with primitive or unstable monetary and financial systems. This is because of its long-run ‘tendency … to return to an historic rate of exchange with other commodities’.11 Since 1899 the price of a loaf of bread in Britain has risen by a factor of 32; the price of an ounce of gold by a factor of 38.12 Indeed, an ounce of gold buys approximately the same amount of bread today as it bought in the time of Nebuchadnezzar, king of Babylon, more than 2,500 years ago.13
It should be emphasized that, contrary to popular belief, gold has been a poor hedge against inflation in Britain and the United States.14 The purchasing power of gold has actually increased more in periods of deflation like the 1880s and 1930s; whereas during war-induced inflations it has lost ground relative to industrial commodities needed for military purposes.15 The real attraction of gold is that it is accessible and exchangeable even when established monetary institutions fail. In the American banking crises of the pre-1914 period, in the extreme hyperinflations of the early 1920s and in the banking collapses of the early 1930s – these were the times when a hoard of gold was worth its proverbial weight. In the Second World War, as national financial systems buckled in the face of invasion and aerial bombardment, gold was the one asset that proved indestructible. It was Britain’s ability to ship it in large quantities to the United States in 1938–40 that kept the flow of imports coming across the Atlantic. Even when ships carrying gold were sunk – as happened to the SS Fort Sitikine in Bombay Harbour in April 1944 – the gold could still be recovered, albeit in a somewhat battered condition.16 Much of the gold that the Nazis managed to steal from the countries they plundered has since been found: it survived, though its rightful owners perished. In any country that has experienced hyperinflation in the past century, gold has also been a better investment over the hundred years than both bonds and equities. Even in the recent Asian crisis, it was remarkable how many financially stricken individuals were saved from complete insolvency by their nest-eggs of gold. Gold will continue to have an appeal as a store of value anywhere where currencies or banking systems are fragile, the countries of the former Soviet Union being obvious examples.
Nevertheless, as part of the first tier of central bank reserves in developed economies, gold appears to have had its day. Inexorably, we are moving towards a demonetization of gold comparable with the demonetization of silver that began in the 1870s.
From the point of view of the private investor in the West, where the possibility (or at least the memory) of political or financial catastrophe has receded, the twilight of gold makes some sense. As an investment, gold has signally under-performed stocks and government bonds in the United States and Britain in the past century: if your great-grandfather had bought and bequeathed to his heirs an ounce of gold in the 1890s, you would still have an ounce of gold; but if he had bought shares in a UK tracker fund – had such a thing existed – you would now be able to buy around 88 ounces with your inheritance.17 On the other hand, the real returns from holding gold from 1968 to 1996 varied inversely with the real returns from holding stocks and bonds, so that a portfolio that included some gold in that period offered on average a higher return and lower risk than a portfolio composed exclusively of shares.18 But that begs the question: should central banks make decisions about their reserves in the same way that investors structure their portfolios?
Figure 29. Exchange rates of major currencies per US dollar, 1792–1999 (1913 = 100)
Source: Global Financial Data.
In historical perspective, the creeping demonetization of gold is another difference between the globalization of the period 1870–1914 and the globalization of our own time. The process of financial globalization described in the previous chapter went hand in hand with the extension of a system of fixed exchange rates based on gold. In the eyes of many contemporaries, the gold standard was the sine qua non of large-scale international investment. Yet today’s financial globalization is taking place at a time of considerable exchange rate volatility, and apparently with little need for gold reserves.
There have been four periods of global exchange rate stability since the period of monetary chaos caused by the Revolutionary and Napoleonic Wars (see Figure 29). Between 181919 and c.1859 an informal bimetallic system functioned relatively smoothly. Between 1859 and 1871 a succession of wars in Europe and North America disrupted this system. After 1871 the world entered a second phase of currency stability which lasted until 1914: gradually more and more countries abandoned silver in favour of the monometallic gold standa
rd. The nine years of war and revolution from 1914 to 1923 saw renewed exchange rate volatility; but from 1924 until 1931 a restored gold exchange standard operated, only to disintegrate in the face of the Great Depression. The fourth era of international currency stability – under the Bretton Woods dollar standard – ran from 194720 until 1971, when the decision to end the convertibility of the dollar ushered in the current era of more or less freely floating rates.
Although there have been myriad efforts to limit exchange rate volatility in the form of more or less ephemeral international agreements (from the Smithsonian in 1971 to the Louvre in 1987), national currency pegs and boards, regional exchange rate systems and monetary unions, the most important rates are primarily determined by the foreign exchange markets. This may well be the best available arrangement. As Milton Friedman long ago argued, movements in exchange rates offset inflation and productivity differentials with much less friction than adjustments of nominal wages and prices under fixed rates. This is certainly true over the long run. In the short run, however, the rates set by the foreign exchange markets tend to overshoot and undershoot relative to purchasing price parities – that is, the rates implied by differentials in national inflation rates.21 Whatever the reason for this – and economists are divided, if not downright baffled – it is plainly a source of periodic and severe regional instability. Currency crises in Mexico and Asia in the 1990s led to severe recessions as exchange rates nose-dived, busting banks with large foreign currency liabilities, crunching domestic credit and driving the incomes of millions of people sharply downwards.22
The Cash Nexus: Money and Politics in Modern History, 1700-2000 Page 38