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US Monetary Hegemony Infrastructural Linkages Between States and Markets
The Korean Journal of International Studies 21-3 (December 2023), 383-408
Published online December 31, 2023
© 2023 The Korean Association of International Studies.

Kyuteg Lim [Bio-Data]
Received August 16, 2023; Revised October 19, 2023; Accepted December 12, 2023.
This is an Open Access article distributed under the terms of the Creative Commons Attribution Non-Commercial License (http://creativecommons.org/licenses/by-nc/3.0) which permits unrestricted non-commercial use, distribution, and reproduction in any medium, provided the original work is properly cited.
Abstract
The study of money and finance in the international political economy (IPE) literature has improved our understanding of the persistence of US financial power since Susan Strange’s concept of structural power in the 1980s. Nonetheless, the IPE literature unwittingly accepts the international role of the US dollar primarily as a key reserve currency (store of value) and overlooks its more important essence, ‘money of account’ or ‘unit of account’ that operates inside and outside the US. The neglect of this crucial feature of the US dollar has prevented constructive debate on whether the reserve role of the US dollar imposes a growing burden on the ‘real’ US economy and the US state. This paper argues that there is no direct relationship between the reserve role of the US dollar and US current account deficits. The systemic current account deficits of US in the 1980s were a direct consequence of the state’s control over the dynamics of international financial markets. That is, the US does not really ‘borrow’ money from abroad to finance its deficits in global finance.
Keywords : US financial power, US dollar, US current account deficits, unit of account
INTRODUCTION

In the international political economy (IPE) literature, the study of money and finance has become one of the key dimensions of structural power that Susan Strange characterized in her book States and Markets (1988). The increasing volume of financial transactions has well overtaken the volume of international trade transactions. Despite a series of global financial crises, international financial markets have continued to expand and seemed to be ‘decoupled’ from the process of ‘real’ economic activities such as trade and production. The recent US-China competition that has intensified in the areas of trade and technology has not, however, prevented the growth of international financial markets, the expansion of cross-border financial transactions. As such, it is essential for any IR and IPE scholar to study the significance and influence of money and finance in world affairs.

The US dollar has been one of the defining features of US hegemony in the world economy. Unlike her US contemporaries,1 Strange emphasized the role of the US dollar back in the 1980s as inseparable from persistent US hegemony in the world economy. Since then, the close association between the US dollar and US hegemony has continued to be discussed and debated in the IPE literature. The 2008 financial crisis has revitalized this debate in the context of the rising China (Eichengreen 2011; Vermeiren 2013; Kirshner 2014; Cohen and Benney 2014; Prasad 2014; Oatley et al. 2013; Winecoff 2015; Fichtner 2016; Hardie and Maxfield 2016; Schwartz 2016, 2019). One of the key aspects of this debate is whether US budget deficits and current account deficits should be seen as a warning to the US dollar (i.e., Norrlof 2014). Most economists view these deficits as a burden on the US economy which undermines foreign confidence in the US dollar (Bergstein 2009; Gourinchas et al 2022). Others who sidestep this matter view the contemporary US dollar as still dominant in global finance (Cohen and Benney 2014; Helleiner 2016; Schwartz 2016).

The contemporary role of the US dollar’s reserve status in the world economy is agreed upon by all. What differentiates scholars is how they understand the relationship between the US dollar and US hegemony. On the one hand, a large number of scholars have argued that the reserve role of the US dollar has caused an increasing burden on the US economy and the state because the ‘real’ US economy has experienced US current account and trade deficits. That is, the exporting sector has lost international competitiveness and many jobs. It is assumed that the privileges2 of running the US dollar as a key international reserve currency are no longer held by the US state. For example, Paul Krugman (2013) noted that international seigniorage of the US dollar provides insignificant economic benefits to the US economy. Likewise, Robert McCauley concluded that the US dollar’s exorbitant privileges are not unique but an exaggeration (2005,11). Cohen said that the benefits of running the US dollar are negligible and imposes significant financial burdens (2011, 16-20).

Others do not completely deny that the US dollar will operate as an international reserve currency for a while. The dollar’s reserve role is, however, is increasingly burdening the US economy (Kirshner 2014). The global role of the US dollar undermined the autonomous monetary policy of the US Federal Reserve during the recent financial crisis. The global dimension of US monetary policy also poses a political risk to the US state (Hardie and Thompson 2020). For example, the extension of dollar swaps established between the US Federal Reserve and foreign central banks undermined the legitimacy of the former to US taxpayers, incurring a ‘social cost’ to the society. US financial markets weaken the real US economy by drawing more money into itself, inflating the value of financial assets. Therefore, the mere increased value of financial assets is likely to make the US economy vulnerable to another financial crisis. Furthermore, the US economy was hit hard by Covid 19. In such contexts, the reserve role of the US dollar is considered as a growing burden due to the country’s persistent current account and budget deficits.

On the other, a growing number of scholars have emphasized the persistent US hegemony in global finance despite its debt. Carla Norrlof (2014) argued that this is a direct result of US economic size and military power. Her argument is primarily based on the measure of national economic variables such as GDP, capital markets, and military spending (ibid, 1048). Others have emphasized that persistent US financial power should be viewed as a transnational phenomenon that extends well beyond the US. The 2008 global financial crisis has rather reinforced the key position of US power in global finance networks (Fichtner 2017; Winecoff 2015, 2020). For instance, Fichtner (2016) argued that US financial power is derived from Anglo-American financial networks, which include five English-speaking countries and offshore financial centers. Similarly, others view the contemporary global financial system as a hierarchical structure in which the US is positioned at the top of the global financial system (Oatley et al. 2013; Winecoff 2015; 2020).

Nonetheless, they largely bypass the core debate on US monetary hegemony: whether the reserve role of the US dollar imposes a growing burden on the US state and the ‘real’ US economy, addressed by the ‘declinist’ school.3 They overlook this aspect and primarily view US financial power as the financial network of the world economy in which US centrality is based. In this way, the US dollar has continued to be implicitly discussed and debated in the IPE literature. However, the contested aspect of US monetary hegemony has not been effectively engaged in the contemporary IPE literature.

One of the problems is that the IPE literature merely accepts the contemporary role of the US dollar as an international reserve currency. The reserve status of the US dollar does not, however, have room to characterize the important feature of the US dollar (as ‘money of account’ or ‘unit of account’) operating inside and outside the US. Those who argue for the persistency of US financial power do not provide a full picture of the global role of the US dollar as money of account in world financial markets. For example, Norrof’s systematic analysis of US monetary capability overlooks the external role of the US dollar as money of account and therefore structural dimensions of US power in global finance. She noted that ‘they [declinists] are right that the gap in monetary power between America and other Great Powers is contracting’ (2014, 1054). Others like Prasad (2015) have argued that the 2008 financial crisis rather consolidated the reserve status of the US dollar as store of value, but he misunderstands the US dollar’s denominating role of cross-border transactions (unit of account) as store of value (xvii).

Despite being extensively discussed and debated, the existing IPE literature still obscures the nature of US monetary hegemony and, therefore, structural dimensions of US power in an era of globalized finance. For example, US budget and current account deficits are often understood as a ‘confirmation of US hegemonic decline’ (Seabrooke 2001, 125). The close association between the reserve role of the US dollar and US current account deficits can be traced back to the famous Triffin Dilemma: the growing role of the US dollar as international liquidity causes balance of payments deficits, in particular US current account deficits, which would undermine foreign confidence on the US dollar. This theoretical claim has not been really revisited among IPE scholars. The Triffin Dilemma is largely embraced in the IPE literature. The reserve role of the US dollar is assumed largely to cause US current account deficits, and the US appears to ‘borrow’ money from abroad to finance the deficits (Bernanke 2005; Cohen 2006; Li 2008; Eichengreen 2011; Prasad 2014).

This paper argues that the direct relationship between the reserve role of the US dollar (foreign holdings of US dollars) and US current account deficits, assumed by many economists and IPE scholars, is not obvious. The crucial role of the US dollar goes well beyond a store of value and has little to do with US current account deficits. Rather, what caused systemic US current account deficits is the unprecedented rise of US’s world monetary authority over the dynamic of international financial markets, underpinned by the US dollar in the 1980s. That is, the US economy began to experience systemic current account deficits only after the global rise of US monetary authority inside and outside the US economy in the shifting market trend towards the issuance of debt securities in the world economy. In this regard, US current account deficits can be seen as a sign of US monetary power in the world economy rather than a burden on the US economy. Foreigners have continued to purchase dollar-denominated assets, such as US Treasury securities, in search of risk-free global financial assets.

In defense of the claims made above, the paper first explores the key issues of the linkage between the US dollar and US hegemony during the Bretton Woods era. It then characterizes the crucial feature of the US dollar that distinguished it from the British pound in the 1960s and 70s. The historical transition from the British pound to the US dollar is highlighted to show the external role of the US dollar operating well beyond a store of value. Further, the paper briefly focuses on the structural dimensions of US monetary hegemony, which have been largely neglected in the existing IPE literature. Finally, the paper demonstrates that the systemic US current account deficits are mainly caused by the US Federal Reserve’s reassertion of monetary authority over the dynamics of international financial markets. US’s indebtedness is a clear sign of its world monetary power in the global economy.

THE CONTESTED ROLE OF THE US DOLLAR IN THE BRETTON WOODS ERA

The reserve role of the US dollar did not distinguish its more important feature as money of account or unit of account from the British pound during the early Bretton Wood era. The Triffin Dilemma largely focuses on the relationship between the US dollar as a store of value and confidence problem and ignores its growing role in the world economy. In particular, the extension of the US dollar as an international unit of account needs to be configured as an amplifying monetary process of international financial dynamics. That is, the extending role of the US dollar as an international unit of account was decisive to facilitate a historical transition from the British pound to the US dollar in the 1960s. The US dollar’s crucial feature is not an international store of value, as many have believed, but an international unit of account shared between US domestic actors and foreign actors in making international financial markets.

During the Bretton Woods system, the US dollar was widely regarded as an “international common good.” The 1944 Bretton Woods agreement placed it at the center of the international monetary system. The final draft of the agreement stated that the par value of national money was expressed ‘in terms of gold or in terms of the United States dollar of the weight and fitness in effect on July 1, 1944’ (De Vries 1976, 41). The value of US dollars was fixed to a certain amount of gold; that is, \$35 per ounce of gold. Other countries fixed the value of their currencies to the value of US dollars. With capital controls in place across borders, the stability of international exchange rates contributed to the exponential growth of the world economy without a single financial crisis. Undeniably, the stability of the Bretton Woods monetary system promoted a greater volume of international trade. ‘[T]he real annual growth rates of GDP in the 1960s stood at 5 percent in member countries of the Organization for Economic Cooperation and Development (OECD), 4 percent in Latin America, and 6 percent in Asia’ (James 1996, 148). This era was called “the golden age of capitalism” (ibid).

The growing role of the US dollar in the expansionary world economy soon became a concern to the US state, its economy, and the Bretton Woods monetary system. According to Robert Triffin, the international liquidity necessary for financing expansionary international trade was primarily based on US balance of payments deficits. To put it another way, the US economy faced a dilemma: either providing international liquidity would increase US balance of payment deficits, causing foreigners to lose confidence in the US dollar or reducing the US balance of payment deficits, leading to a lack of international liquidity which would turn the world economy to a dangerous deflation, as experienced in the 1930s (Triffin 1961). Indeed, Triffin’s concern about the Bretton Woods monetary system and the world economy was largely shared among government officers and academic economists. He provided a solution to the dilemma by creating a new international reserve asset, called Special Drawing Rights (SDRs), at the International Monetary Fund in 1969 (IMF 1970, 28).

Since then, it has been widely accepted that the reserve role of the US dollar causes US current account deficits, the famous Triffin Dilemma in the economics and IPE literature. Running the US dollar as a key reserve currency has been assumed to burden the US manufacturing sector, losing international competitiveness. US current account deficits have thus been seen as a recurring threat to foreign confidence in the US dollar and state. For example, Benjamin Cohen points out that the unique role of the US dollar enables the US to enjoy its current account deficits; however, ‘there is a potential limit, set by the willingness of foreigners to go on lending. The ability of the US to postpone adjustment ultimately rests on foreign confidence of private actors and foreign central banks’ (2006, 45, emphasis added). Furthermore, since the 2007-2009 global financial crisis, US has increased the burden of international dollar management (Hardie and Maxfield 2016). The benefit of running the US dollar as an international reserve currency no longer seems obvious to the US state (Helleiner 2017; Germain 2020).

However, what is not evident in the Triffin Dilemma is the role of the US dollar in underpinning financial markets across borders. Triffin largely focused on the linkage between a feature of the US dollar as a store of value and foreign confidence. ‘For international reserves to keep pace with the growth in world trade required an ever-expanding supply of dollars . . . was incompatible with the preservation of a store of value for the dollar. This would cause a confidence problem regarding the exchange value of the USD’ (Lai 2021, 13). Many scholars focus on the confidence problem raised by Robert Triffin but ignore the US dollar’s growing importance as a unit of account, a core monetary feature of the production of cross-border credit and debt relations called financial globalization. In essence, the confidence problem of the US dollar seems to derive from the placement of money in the sphere of international exchange. Triffin largely characterized the essence of the US dollar as a medium of exchange in facilitating international trade (1961). As Europeans’ dollar holdings increased, the Bretton Woods system gave the US dollar its well-known reserve status as a store of value.

Regarding the international role of the US dollar as a reserve currency or a store of value does not distinguish its essential characteristic—as unit of account—from other international currencies, such as the British pound, during the Bretton Woods system. Eichengreen and Flandreau argued that the US dollar rose as a challenger to the British pound in the mid-1920s but was by the pound surpassed in 1933 largely due to the devaluation of the dollar (2009, 379). Drawing on the archives of 18 central banks’ foreign exchange reserves, their study shows the British pound and the US dollar shared ‘reserve-currency status in the interwar period’ (2009, 403). As they argue, the British pound and the US dollar might share the reserve status in different countries. However, it seems doubtful whether in the 1930s, the US possessed the financial capacity to either promote the international role of the US dollar or play an international lender of last resort in governing the world economy, as assumed in Charles Kindleberger’s The World in Depression (1973). The US’s financial capacity appears to be incompetent because a third of all US domestic banks failed (Ingham 1994), and the US Federal Reserve was equally incompetent to set any clear goals (Palyi 1972; Galbraith 1975). Neither the US Federal Reserve nor the US domestic financial markets were able to lead a world financial role in that decade. It was only after the end of the Bretton Woods system that the US Federal Reserve began to expand beyond the domestic markets from the international banking crisis of the mid-1970s (Spero 1980; Helleiner 1994).

The widely accepted reserve status does not allow us to identify the more powerful feature of the US dollar and the nature of US monetary power in contemporary global finance. The dollar’s reserve role prevents us from understanding the contemporary role of the US dollar operating in global finance in which foreigners not only hold dollar-denominated assets produced within the US but also actually use the US dollar as a unit of account to either lend dollar-denominated loans to others or issue various forms of debt such as bonds and commercial papers outside the US. The concept of the US dollar as a store of value is indeed static and passive rather than dynamic in the making of global financial markets.

Up until the early 1960s, foreigners held British pounds in their reserves, accounting for about 40 percent of world foreign exchange reserves (Schenk 2010, 22-23). The foreign holdings of British pounds are surprisingly as much as US dollars held by others during the Bretton Woods era. The reserve status of international money does not tell us much about how international financial markets can be monetarily featured; that is, how market actors (public and private) actually use international money to issue credit and debt relations across borders. The dominant conception of the US dollar as an international reserve currency rather obscures its expanding role in the making of international financial markets. Therefore, it is essential to identify a crucial feature of the US dollar distinguished from the British pound during the 1960s, even though they shared the international reserve status back in the interwar period.

Less attention has been paid to the external role of the US dollar as ‘money of account’ or ‘unit of account’ in the rapid development of offshore financial markets in the 1960s, which has little to do with US current account deficits (He and McCauley 2012). The external operation of the US dollar induced foreign actors (public and private) to issue various forms of credit and debt relations outside the US market in the 1960s (Strange 1976; Helleiner 1994). The crucial role of the US dollar as an international unit of account underpinned international financial markets, indicating a historical transformation from the British pound to the US dollar in the world economy. If we pay close attention to the linkage between the role of the US dollar as international unit of account and international financial markets, it is not obvious that the reserve role of the US dollar causes the US economy to fall into current account deficits.

THE END OF BRETTON WOODS AND THE STRUCTURAL DIMENSION OF US POWER

The end of the Bretton Woods system ‘institutionalized’ the infrastructural role of the US dollar as a unit of account, as foreigners used the same dollar as a secured way of issuing credits and debts across borders. The demise of the Bretton Wood system ‘locked’ foreigners to use the US dollar as an international unit of account for the issuance of various credits and debts in uncertain international financial markets (Amato and Fantacci 2012; Lim 2022). The monetary event consolidated the international role of the US dollar in the world economy (Strange 1986, 1988; Seabrooke 2001, Vernengo 2021) in two interlinked ways. On the one hand, foreign market actors (mainly Europeans and Japanese) continued to use the US dollar as money of account as a secured way of issuing various forms of credit and debt through the offshore financial market. The creation of credit and debt denominated in the US dollar increased international demand for dollar-based assets in the world economy. On the other hand, their governments were forced to accumulate safe dollar assets such as US Treasury securities in international financial markets (Schwartz 2019; Lim 2022). The interlinked monetary dimensions of international financial markets have reinforced the infrastructural role of the US dollar across borders in the world economy. Eric Helleiner noted that during the 1970s, ‘the basis of American hegemony was being shifted away from one of direct power over other states to a more market-based or “structural” form of power’ (1995, 323). The end of the Bretton Wood system was a shift of US hegemony from relative to structural power (Seabrooke 2001, chapter 4).

It is widely viewed that the US state reinvigorated its financial power in the 1970s by forcing oil-producing countries to price oil in US dollars. The losing foreign confidence in the US dollar was restored by the pricing of petrodollars, a key pillar of US dollar hegemony (Parboni 1986; Gowan 1999). Of course, this somewhat contributed to the international consolidation of the US dollar in commodities markets. However, the focus on the US dollar as unit of account and commodities overlook its growing role in emerging global financial markets in the 1970s. It is a partial explanation in the broad context of the world economy. Unlike her US contemporaries, who primarily viewed the concept of power as national resources in the 1970s and 80s (Krasner 1982; Keohane 1984; Gilpin 1987), Susan Strange emphasized and distinguished structural power from relational power in global finance. Borrowing her words, the US exercises ‘the structural power to extend or restrict the range of options open to others [public and private] … in the field of finance’ (1990, 259).

Building on her insight, the structural dimensions of US financial hegemony can be characterized in several ways of monetary and financial dynamic processes. First, the nature of US financial hegemony is to establish its own money (the origin of money of account) as international money of account through which foreigners use to issue various forms of credit (loans) and debt (bonds) or securities (stocks) in international financial markets. At the same time, US domestic actors (public and private) use the same money of account to issue various forms of credit and debt inside the US sovereign monetary space. The shared feature of the US dollar as money of account has been a core monetary feature of international financial market development since the 1950s. During the early Bretton Woods era, most European countries imposed tight controls on capital movements such as currency convertibility, whereas the US state did not impose limitations on the foreign use of the US dollar outside the US (Strange 1976; Helliener 1994). The US had strict controls on its domestic financial markets such as ceilings on deposit rates and walls on different financial sectors (Sobel 1998). The US approach to the foreign operation of the US dollar is seen as its broad strategy towards ‘creating a more open, liberal world market economy’ in the 1950s and 60s (Strange 1990, 261).

Second, the US state possesses the capacity to maintain contracts (foreign credit and debt relations) denominated in the US dollar in international financial markets. The most sought forms of the US dollar in times of uncertainty are produced only within the US: the origin of the US dollar as unit of account. Short-term US Treasury debts became de facto international money and risk-free assets in emerging international financial markets of the 1970s (Lim 2022). During the decade, many countries, such as Germany and Japan, purchased a growing volume of US Treasury debts (BIS 1973). US Treasury debts were highly demanded collateral for private market actors to facilitate financial transactions (Gabor 2016). The US Treasury has met the growing demand for Treasury debts by globalizing the US government debt markets. From the mid-1970s, the US state has succeeded in selling long-term debts on a regular and predictable basis, called auction sales (Garbade 2021, 423). The regularization of long-term US Treasury debts reduced the cost of financing government debt and promoted economic growth (Allan 1976). US massive military spending during the 1980s made it possible to finance growing US budget deficits by effectively selling US debts. In other words, US military spending cannot be separated from the linkage between the international role of the US dollar and the internationalization of the US Treasury debt market.

Third, the US dollar’s shared money of account between foreign and domestic actors has necessarily extended the role of the US monetary authority over governing the process of financial globalization. The production of cross-border credit and debt relations requires the US dollar to be used as an international unit of account. As Strange highlighted before, monetary policies of the US state directly impact the value of financial assets across borders, which can turn countries into a short-term balance of payment problems (1990). More specifically, the process of securitization transforms traditional bank loans and mortgages to negotiable securities in secondary markets4 (Cerny 1994, 331). Securitization, along with derivatives, has dramatically increased the price sensitivity of global financial markets across borders (ibid, 322). This means that a great degree of financial trading across national markets has drawn attention to US monetary policies, which influence much more on dollar-denominated credit and debt relations than any other central banks. That is, US financial power is structural to change ‘the options to other governments, to foreign banks and trading companies’ (Strange 1990, 266). That is how Strange distinguished US structural power from Japanese relational power in global finance (ibid).

Finally, the US state can spend without default risk. The US state is able to finance its government deficits at extremely low interest rates even in times of crisis, such as the 2008 financial crisis. During the recent crisis, foreign investors (public and private) continued to finance the US despite extremely low interest rates (Helleiner 2011, 81). As seen below in Figure 1, the US state has exploded budget deficits since 2008. The US Federal Reserve cooperated with the US Treasury to manage almost zero interest rates on US government bonds between 2008 and 2014 (Tymoigne 2014). That is, it is the extraordinary capacity of the US monetary hegemony to spend without the risk of default. This not only helps finance US government debts but also provides advantages in the real US economy, such as technological advances (Vernengo 2021, 543). Indeed, the US Federal Reserve acted like a fiscal agent of US state finance during the crisis (Buiter 2021). In other words, as long as the US state issues its own debt denominated in its own money of account (the origin of country), it can manage the cost of financing government debt to a certain extent that it does not cause high inflation (Kelton 2020). As a result, the US state is not likely to face a default risk on its own debt, even though two political parties would struggle to agree on deficit financing.

There is little doubt that the US economy has experienced a decline in the manufacturing sector. Since the systemic current account deficits in the early 1980s, the concept of US current account deficits is largely viewed as a recurring threat to the US dollar and monetary power. In the economics literature, the national balance of payments, similar to the balance sheet of private banks, shows that any country experiencing current account deficits must borrow money from abroad or use reserves to finance current account deficits. Borrowing means to issue US debts such as US Treasury debts which are purchased by foreigners. Therefore, it is assumed that the US economy borrows money from abroad to finance US current account deficits. The US dollar’s reserve role assumes that the US economy runs current account deficits to provide international liquidity to the world economy. Yet, the US borrows money from abroad to finance current account deficits (Bernanke 2005; Cohen 2006; Li 2008; Eichengreen 2011; Prasad 2014). The Triffin Dilemma is often invoked by many as a warning sign of the decline of the US after the 2008 financial crisis.

The economic assumption, however, ignores the crucial role of the US dollar as international unit of account in the world economy. What the US state (or economy) sells is US debt, but denominated in the US dollar as unit of account. That is dollar-denominated US debt. The relationship between foreign holdings of US dollars and US current account deficits is fundamentally assumed to derive from the essence of money as a means of exchange between money and commodities in the ‘real’ world economic processes such as in international trade. In this way, the famous Triffin Dilemma is premised on the fact that US current account deficits are viewed as the primary way of providing international liquidity for the world economy. It is misleading to assume that the word dollar liquidity is determined entirely by a ‘real’ economic feature of the issuing country, its current account deficits. As discussed above, Europeans actively used the US dollar as international unit of account to issue new credit and debt relations in the offshore financial market in the 1960s and 70s, which has little to do with US current account deficits. That is, Europeans and others have contributed to the creation of world dollar liquidity for the issuance of credit and debt relations through offshore financial markets outside the US. Their own making of world financial markets has increased world demand for safe dollar-denominated assets produced within the US.

It then becomes imperative to explain what really caused US current account deficits systemically in the early 1980s and what US financial hegemony means in the market shift from international bank loans to the issuance of debt securities in the 1980s. Before discussing this, it is necessary to discuss the shifting role of US corporations in the post-WWII era as they played a part in the decline of the US manufacturing sector. By the early 1970s, US corporations made large foreign direct investments in advanced manufacturing sectors such as automobiles, chemicals, and electronics in Europe. The annual output was estimated at over \$200 billion in the early 1970s (Gilpin 1975, 16). US corporations also made a large foreign direct investment in petroleum. As a result, Robert Gilpin noted that the US became ‘more of a foreign investor than an exporter of domestically manufacturing goods’ during the 1970s (ibid, 17).

The Cause of US Current Account Deficits and the Rise of US World Monetary Power

The real cause that led to the fall of the US economy into systemic current account deficits in the 1980s was the new beginning of the US state as a world monetary authority over the dynamic of international financial markets (Lim 2019). In October 1979, Paul Volcker, the new Chairman of the Federal Reserve, attempted to control high inflations and instigated an operational shift away from the traditional approach (managing the federal funds rate) to directly targeting total banking reserves (Greider 1987).

It is generally accepted that the unprecedented act of the US Federal Reserve was believed to restore the foreign confidence in the US dollar. The primary reason for the Federal Reserve’s tight monetary policy was assumed to restore international financial markets’ confidence on the US dollar (Cerny 1993; Gill 1993). High inflation of the economy undermined foreign confidence on holdings of US dollars, and the US state, therefore, faced under pressure from international financial markets to implement monetarist policies to control inflation.

However, what is under-studied in the existing IPE literature is how the US Federal Reserve actually reobtained the effectiveness of monetary policy over private market actors, including banks. Direct control over total banking reserves simultaneously created extreme volatility in short-term interest rates in the US money and the Eurodollar markets. The resultant market uncertainty was intentional to discipline market actors (Lim 2019). Highly volatile interest rates intensified the uncertainty of the domestic money and the Eurodollar market. They increased the debt burden of developing countries which had heavily borrowed dollar-denominated loans from offshore financial markets during the 1970s (Strange 1990, 261). The US Federal Reserve maintained highly unstable interest rates until the mid-1982, when the US economy fell into a recession along with the impending crisis of international debt (Lim 2019, 324). There is no doubt that high interest rates harmed the US manufacturing sector, such as the car industry. As seen in Figure 2, the US economy fell into a deeper current account deficits never experienced before.

Despite this growing sign of the US economic weakness, a large amount of foreign capital dramatically flowed into the US financial markets since the US state brought inflation under control in 1982. There was a large capital flight from Latin American countries: \$15.3 billion from Argentina, \$32.7 billion from Mexico, and \$10.8 billion from Venezuela (Khan and Hague 1987). Including different sources of funds, a large volume of capital flowed into the US market: \$85 billion in 1983, \$103 billion in 1984, \$129 billion in 1985, and \$221 billion in 1986 (Krippner 2011, 101). It seems that the US still appears to ‘borrow’ money from abroad to finance its current account deficits. However, this should have raised foreign investors’ concern in purchasing US dollar assets such as US debt securities. They, nonetheless, continued to place their money in the US financial markets and purchase dollar-denominated assets simply because they were regarded as risk-free assets in the uncertainty of international financial markets, created by the US Federal Reserve’s monetary policy. To be precise, foreigners were ‘entrapped’ into financing US debt in search of risk-free assets in times of market uncertainty. That is exactly what happened during the 2008 international financial crisis. After the collapse of Lehman Brothers, particularly in September 2008, banks and financial institutions faced a ‘global shortage’ of US dollars (McGuire & von Peter 2009). In particular, banks lacking access to Federal Reserve money were squeezed to bid for US dollars and drove LIBOR rates to unprecedented levels (Mehrling 2011, 121). In this context, the US Federal Reserve provided unlimited amount of dollar liquidity by accepting a wide range of illiquid assets as collateral. US Treasury securities were ever more in demand as they were considered as risk-free assets during the crisis (Prasad 2014).

The unprecedented act of the Federal Reserve in the early 1980s caused the US economy to fall into systemic current account deficits. However, the October monetary targeting aimed to create market uncertainty as a reassertion of the US Federal Reserve’s monetary authority over domestic and international financial markets. The Federal Reserve’s main concern was not to restore foreign confidence in the US dollar but to reobtain its effective monetary policy over the dynamic of international financial markets. Simply put, it is not historically and empirically obvious that the reserve role of the US dollar causes US current account deficits. If this claim is held as legitimate, the US economy should have fallen into deeper current account deficits since the end of the Bretton Woods era.

Indeed, the Volcker Shock led to an international financial market shift from international bank loans to the issuance of securities such as bonds, commercial papers, and stocks. The Latin American debt crisis of the early 1980s increased the riskiness of bank loans since the bilateral credit and debt relations between private banks and foreign sovereign borrowers locked the former into the payment of the latter. International banks turned away from such international loan businesses and began instead to issue international securities such as bonds (Helleiner 1994, 183; Seabrooke 2001, 123). The issuance of such securities allowed international investors (bond holders) to reduce the riskiness of lending by selling bonds on secondary markets. Such debt financing allowed more flexible investment opportunities (Sobel 1998, 365). As seen below in Figure 3, there was a shift toward the issuance of securities from the early 1980s (Porter 1993, 96).

At the same time, the Shock intensified the risk of interest rates leading to new financial innovation such as financial derivatives in US financial markets (Konings 2011). The concept of derivatives can be traced back to the 1970s, when new financial innovations such as futures and options linked to commodities and US Treasury securities were introduced (Sobel 1998, 366). Since the early 1980s, derivative financial markets have grown enormously, as securitization turned previously unavailable loans such as mortgage loans to marketable (tradable) securities. Their involvement in trading of securities creates ‘explicit linkages across types of financial markets’ (Sobel 1998, 375). ‘One important effect of the growth of derivatives trading is that it links together price movements in one market – say, shares and bonds – with price movements in another – say foreign exchange. Shocks in one market thereby become much more contagious to other markets than in the past’ (Gowan 1999, 53).

The process of securitization enables banks to create credit money by holding new kinds of collateral such as Treasury securities and mortgages (Schwartz 2016). The creation of bank credit money is no longer dependent on bank deposits, which lend loans to firms in the ‘real’ economic sector. Indeed, US Treasury debts as collateral are used and reused again and again in financial markets, creating more liquidity. The process of securitization has further increased international demand for safe assets (Holmstrom 2015, 22). Given the fact that US Treasury debt securities have been regarded as risk-free assets since the 1970s, US budget deficits have become not only a domestic source of US government finance by issuing US Treasury debts but also an important source of meeting global demand for safe dollar assets in global finance. During the 1980s, US budget deficits helped sustain global growth in the context of deflationary monetary policies (Schwartz 2016, 82).

CONCLUSION

This paper has argued that the reserve status of the US dollar does not provide a full picture of the dollar’s contemporary role in global financial markets. The external operation of the US dollar as international unit of account has little to do with US current account deficits. Systematic US current account deficits from the early 1980s were a consequence of the unprecedented rise of the US Federal Reserve as a world monetary authority over the dynamic of international financial markets, in particular US money and Eurodollar markets. A large amount of foreign capital flew into US financial markets despite the US having budget deficits and systemic current account deficits. That is, the US does not really borrow money from aboard to finance its current account deficits, as assumed in economics and IPE literature. But rather, foreigners have been locked into financing US debt in search of safe dollar assets.

The existing IPE literature has largely overlooked the crucial role of the US dollar as unit of account, obscuring the nature of US monetary hegemony in global finance. They often bring back the reserve status of the US dollar to claim its dominance in global finance (Cohen and Benney 2014). However, they have bypassed the core debate on whether the reserve role of the US dollar causes US current account deficits and imposes a growing burden on the ‘real’ US economy. As the paper argues, there is no direct relationship between the two. It is unclear how the reserve role of the US dollar imposes a growing burden on the ‘real’ US economy, as many have believed.

The crucial feature of the US dollar rests on the money of account or unit of account operating inside and outside the US through which domestic and foreign actors use the same money to issue dollar-denominated loans and securities across borders. That is, the infrastructural role of the US dollar as international unit of account has operated between states and markets for the very making of international financial markets. Therefore, the process of financial globalization has necessarily extended the role of the US monetary authority over international financial markets.

As discussed previously, the nature of US monetary hegemony is derived from the operation of the US dollar as international money of account, an underpinning monetary feature of global finance. In this regard, US monetary power is inherently structural rather than relational in the making of international financial markets, as Susan Strange observed about 40 years ago. As was evident in governing the 2008 financial crisis, the US state implemented unprecedented monetary policies to act as a global lender of last resort (MacDowell 2012, 2017; Chey 2013) and bought a large amount of illiquid assets directly as well as US Treasury debts indirectly. As a result, US budget deficits exploded. However, the US state maintained an extremely low interest rate between 2008 and 2014, resulting in a very low cost of government debt payment. Hence, it is clear that the US state does not face default risk on debt despite its enormous debt.

In 1990, Susan Strange criticized her US contemporaries for giving a narrow concept of power as national resources. She argued that the US empire is fundamentally different from the British empire because the US has structural power in the world economy, in particular global finance. Keohane and Palan noted that her concept of structural power is not sophisticated in the theoretical sense. However, her observation of US power has been proven right after the 2008 financial crisis. The paper suggests that US monetary power comes from the infrastructural role of the US dollar operating as money of account between states and markets in the making of global financial markets. The US dollar has underpinned the very inherent process of global financial market transactions across borders. US monetary power has, therefore, structural dimensions which allow the US state to spend ‘without tears’ (Rueff 1972); that is, it is closely associated with Susan Strange’s concept of structural power. US monetary power is not delaying payment and adjustment as typically seen in the economic analysis (i.e., Cohen 2006, 2013). Rather, foreigners (official and private) have been ‘locked’ into finance the US.

The paper implies that the role of world money as a store of value does not provide an accurate measure of the historical process of how one dominant currency is replaced by another in the world economy. It is widely accepted that the US dollar began to play an international role from the 1944 Bretton Woods agreement, even though the US dollar and the British pound shared the reserve status up until the early 1960s. The widespread acceptance of the US dollar as an international reserve currency prevents us from observing the increasing role of the US dollar as international unit of account from the late 1950s, during which offshore financial markets developed rapidly. The growth of international financial markets has indeed consolidated the infrastructural role of the US as international unit of account across borders.

What possibly shifts the process of world money from the US dollar to another may depend neither on the economic size, such as GDP, nor purely on political factors, such as security relations and incentives between inter-state relations. The transition of world money from the current US dollar into another will depend on the making of international financial markets underpinned by the latter’s money as money of account across borders. The shift from the dollar to another is therefore inherently linked to the making of new global order (Lee 2017, 166).

Given China’s massive dollar reserves seen as a ‘dollar trap’ (Jung 2023, 73), it is essential to observe how China’s efforts to promote Renminbi internationalization produce the dynamic of cross-border credit and debt relations underpinned by the Renminbi as unit of account. In this regard, it seems necessary to establish the creation of cross-border credit and debt relations measured in a money of account, transferable among foreigners outside its origin of country. To encourage cross-border relations of credit and debt, measured in the Renminbi, China should be able to provide credible financial assets such as sovereign debts for foreigners in this era of globalized finance.

Footnote

1 For example, Robert Keohane (1984) and Stephen Krasner (1982) have a poor understanding of the end of the Bretton Woods system as US hegemonic decline. For an effective critique of their works on US hegemony, see Leonard Seabrooke. 2001.US Power in International Finance, chapter 2 & 4. Susan Strange (1987, 1990) argued that US scholars overstated the decline of US hegemony in the world economy and more specifically in finance. Eric Helleiner contends that Strange’s position has been proven right in the 1990s (see Eric Helleiner. 2000. Still an Extraordinary Power, but how much longer? The United States in World Finance In Thomas Lawton et al ed., Strange Power, chapter 13). Helleiner observed that capital flows into the US market at extremely low interest rates during the 2008 was seen a structural feature of US power (2011). He recently argued that the 2008 financial crisis widens US structural power (2016). Simply put, Strange’s characterization of US structural power in global finance has been correct before and even after the 2008 financial crisis despite her less interest in theoretical buildings. Her concept of structural power has become more important than the concept of relational power in international relations (Barrnett and Duvall 2005; Oatley et al 2013; Farrell and Newman 2019; Schwartz 2019; Winecoff 2022). Indeed, her conventional concept of the US dollar as medium of exchange and store of value seems to lead to the theoretical underdevelopment of structural power in global finance, even though she often showed insights in her various works.

2 The reserve role of the US dollar provides the US with various privileges such as loose balance of payment deficits, autonomous monetary policy, and no exchange rate risk (see Norrlof 2014)

3 Exception is Herman Schwartz (2016, 2019) who explores the relationship between US current account deficits and the US dollar’s reserve role. Following Strange’s observation of US power, Schwartz argues that US current account deficits are not a burden but a sign of US power in global finance. This paper builds on Strange and Schwartz.

4 The process of securitization indeed transformed social relations of credit and debt from bilateral and unmarketable social relations to complex and marketable social relations. That is, the example of the former is typical bank loans which establish a legal contract between a borrower and a bank. When a borrower gets a loan from a bank, this loan is registered and stays in the bank’s asset side. In other words, traditional bank loans were illiquid and not traded on markets. Mortgage loans operated in the same way before securitization. However, securitization makes bank loans marketable assets which can be sold and bought on secondary markets. On the one hand, the process of securitization allows low cost of financing of house purchase and at the same time provides more flexible investments (Sobel 1998; Schwartz 2016, 82). On the other, the process of securitization makes financial markets exposed to systemic risk since different sectors of financial markets are now much integrated within and cross borders.

Figures
Fig. 1. US Current Account and Government Budge Balances, 1960 – 2012.
Fig. 2. US Current Account Balances: A Historical Perspective
Fig. 3. International Financial Market Activity by Market Sectors
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