Page 4 of 5 CHINA'S DOLLAR MILLSTONE, Part 3 History of monetary imperialism
By Henry C K Liu
concepts such as the labor theory of value and the idea of surplus value. These
concepts argue that the value of a commodity is determined by the amount of
labor required for its manufacture, not by its exchange value in a market
manipulated by capitalists.
The value of the commodities meant for purchase by worker wages is set higher
than the value of the commodities workers produce with their labor. The
difference, called surplus value, is the profit for capitalists who own the
capital. When surplus value becomes excessive, overcapacity and insufficient
demand will result because workers who produce the products cannot afford to
buy them with their low wages. Globalization of trade under dollar hegemony in
the 21st century via cross-border wage arbitrage to
deny the labor theory of value will lead to the collapse of neo-liberal
free-market capitalism. It is a scientific phenomenon, unrelated to ideology or
morality.
As productivity improves through industrialization, the fruits of production
are increasingly kept from the workers who contribute most to its production,
through the exploitation of labor by capital via the capitalistic structure in
the economy. The workings of this artificial structure are presented as
economic laws of the market. If and when these exploitative features of market
economy are removed, capitalism will be replaced by socialism as feudalism,
having lost its economic function, had once been replaced by capitalism.
It is when the capitalist class employs armed suppression of this evolutionary
development that revolution by the working class is made necessary. Socialist
revolutionaries seek to destroy only the political structure that insists on
foiling the organic evolutionary process from capitalism toward socialism.
Capitalism by itself has already exhausted its socio-economic function in
history and its demise needs no further coaxing.
The collapse of the Paris Commune of 1871, suppressed with bloody ferocity by
the French bourgeoisie, consolidated a reactionary backlash that dissipated the
First International, an international socialist organization founded in 1864
and which aimed at uniting a variety of different progressive political groups
and trade union organizations that were based on advancing the cause of the
working class through the theory of class struggle. Marx praised the Paris
Commune and introduced the concept of the dictatorship of the proletariat as a
defensive countermeasure against anticipated capitalist reactionary barbarism.
By 1880, a popular movement to restore protective tariffs against British
commercial dominance emerged, but tariffs were impediments rather than
effective barriers, which were finally brought on by the start of World War 1
in 1914. As with the US today, Britain, the finance hegemon in the 19th
century, and despite the export of manufactured goods of the industrial
revolution, consumed more goods from abroad than it sent out, with exports
increasing eightfold while imports increased by 10-fold between 1800 and 1900.
In the decades before 1914, Britain had an annual import surplus of more than
$750 million on average. She was able to do this because of pound sterling
hegemony as the US is able to do the same today because of dollar hegemony.
What many trade economists fail to understand is that a trade surplus is not a
plus for an economy when trade is denominated in a foreign currency even if
that currency is backed by gold. When trade is denominated in a fiat paper
currency backed by military power, a trade deficit by that currency-issuing
country is pure monetary imperialism against its trade surplus partners. For
the monetary hegemon, such as the US after the Cold War, factor income from
overseas investment more than out weighs the loss of domestic factor income
from wages.
Council of Economic Advisers chairman Martin Feldstein, a highly respected
conservative economist from Harvard with a reputation for intellectual honesty,
was not only among the first to understand the obscure relationship between
trade deficits and the reserve currency for trade. He was also the first to
propose it as US national policy.
Feldstein pointed out the benefits of a strong dollar in president Ronald
Reagan's first term, arguing that the loss suffered by US manufacturing for
export was a fair cost for national financial strength derived from a strong
currency that had the advantage of being the reserve currency for trade. But
such sophisticated views were not music to the ears of the uninformed
chauvinistic Reagan White House, nor the Treasury under Donald Reagan, former
head of Merrill Lynch, whose roster of clients included all major manufacturing
giants. These had yet to catch on to the escape valve of outsourcing
labor-intensive manufacturing to low-wage countries and to recognize that it
was more profitable to import low price-goods from overseas than to export
non-competitive over-priced products overseas.
Feldstein, given the brush-off by a White House run by astrology, went back to
Harvard to continue his quest for truth in theoretical global geo-economics
after serving two years in the Reagan White House, where voodoo economics
reigned.
Feldstein went on to train many influential economists who later would hold key
positions in government, including Larry Summers, Treasury secretary under
president Bill Clinton and later a failed president of Harvard University;
Lawrence Lindsey, dismissed presidential economic advisor to President George W
Bush; and Gregory Mankiew, chairman of the Bush White House Council of Economic
Advisers, who sparked an uproar by saying, in the same intellectual tradition:
"Outsourcing is a growing phenomenon, but it's something that we should realize
is probably a plus for the [US] economy in the long run." Whether that is true
depends of course on which part of the US economy one is housed.
The classical gold standard era
The gold standard was an international standard that determined the value of a
country's currency in terms of other currencies through the monetary value of
gold as expressed in each currency. Because adherents to the gold standard
maintained a fixed price for gold, rates of exchange between currencies tied to
gold were necessarily fixed. For example, the United States fixed the price of
gold at $20.67 per ounce from 1834 until 1933; Britain fixed the price at 3
pounds 17 shillings and 10.5 pence per ounce until World War l and restored it
in 1925. The exchange rate between dollars and pounds - the "par exchange rate"
- necessarily came to $4.867 per pound sterling during these periods.
Other major trading countries joined the gold standard in the 1870s. The period
from 1880 to 1914 is known in monetary history as the classical gold standard
era. During that time, a majority of trading nations adhered in varying degrees
to the gold standard. It was also a period of unprecedented economic growth,
with relatively free trade in goods, labor and capital without being hampered
by government or market exchange-rate manipulation.
Between 1880 and 1914, the period when the United States was on the gold
standard, inflation averaged only 0.1% per year. This was because the physical
supply of gold was in sync with the rate of economic expansion, and not because
of the endogenous effect of the gold standard. Nevertheless, the demonetization
of silver gradually destroyed the myth that the gold standard could keep the
value of money stable without the anchor of bimetallism.
Also, stable currency was generally associated with the gold standard partly
because international trade during the classical gold standard era was a
relatively small portion of all national economies. Trade for Britain was
largely an intra-empire affair dominated by the pound sterling. Today, for
nations that fall into the trap of excessively high foreign trade dependency,
generally viewed as above 35% of GDP in total two-way trade, exchange rate
issues related to a reserve currency denominated in foreign fiat currency, such
as the dollar, can and will do great damage to their national economies in
cyclical financial crises.
Gold standard restoration problems
As noted before, the commercial value ratio between silver and gold was 61.6/1
on August 25, 2008 with the market price for silver at $13.45 and that of gold
at $829. The commercial value of gold was four times higher than the monetary
value of gold set by bimetallism. A return to the historical gold standard now
would drive any government bankrupt unless gold was set at a monetary value
higher than its highest recorded commercial value, which is about $1,000 so
far.
The US Treasury now owns 261 million ounces of gold. At its peak in December
1941 it owned 650 million ounces. As of August 30, 2008, the US national debt
was $9.65 trillion. The price of gold required to pay back the national debt
with gold held by the US would have to be US$36,983 per ounce. The rise in the
price of gold necessary to keep up with the rise in US national debt at current
rate is US$8.15 per ounce per day. There is no free market for gold. The price
of gold is the most manipulated item in government intervention of the market.
When there is no free market for gold, there is no free market for anything
else. Free markets have never existed in civilization for that matter. Free
market fundamentalism is merely a fantasy.
To restore the gold standard, the gold price would have to increase constantly
even it there is no inflation because the rate of physical production of new
gold is far below the accepted rate of economic expansion in modern time. The
monetary inelasticity of gold is the strongest obstacle to a restoration of the
gold standard.
World War I and the decline of Britain
Prior to World War I, Britain's economy was the world's strongest, controlling
40% of the world's investments and 80% of world trade, mostly due to its vast
network of colonies. However, by the end of the war, Britain owed 850 million
pounds sterling, mostly to the United States, with interest payment taking up
40% of the government's budget. Attempting to protect her financial advantage
against rising German challenge was a fundamental cause of the war.
Spoiled by pound sterling hegemony that had reduced industrial productivity in
the British Isles in favor of financial manipulation, having to reply heavily
on exploiting the wealth of her colonies, Britain fell into debtor-nation
status from war spending, allowing the US to become the world's strong
financial power. Even though the British Isles was also exempted from war
destruction in World War I, British productivity suffered from the disruption
of her network of far-flung colonies.
The Federal Reserve under Benjamin Strong after World War I tried to help
Britain maintain the gold standard as a way to rebuilt Europe's war-torn
economy under British leadership, a move that contributed significantly to the
1929 crash on Wall Street.
The export of capital meant that an older and wealthier country, instead of
using its entire national income to raise the standard of living of its own
people by raising wages and investing in better houses and more efficient
factories, diverted an increasing large portion of the national income for
overseas investment to increase trade.
Banks of rich countries lend money to banks of less-developed countries not to
improve the living standard of the borrowing countries, which in turn lend
money to support foreign trade in those countries. Capital then comes from
profit from keeping both domestic and foreign wages low, creating a structural
widening of income and wealth disparity both among nations and within nations.
Workers of the world over forego better income to support capitalist of the
world.
In the US, economic expansion from the 1850s on was largely finance by French
capital and by British capital after the fall of Napoleon III.
By 1914, Britain controlled $30 billion in foreign investment, about one
quarter of her national wealth. France controlled $8.7 billion, about one sixth
of her national wealth, and Germany controlled $6 billion of overseas
investment, at a faster rising pace than the two leaders. It was this German
threat to British/French overseas investment supremacy that led to World War 1,
by the end of which Britain lost about one quarter of her overseas investment,
France about one third and Germany the entire amount, all to the US.
Before 1914, world trade was denominated in currencies that adhered to the gold
standard anchored by the pound sterling, with London as the preeminent
financial center. Trade surpluses and deficits at fixed exchange rates caused
an inflow and outflow of gold across national borders. Exchange rates could not
be manipulated by governments or through market forces to correct imbalance of
payments.
After World War I, with a massive gold drain from the British Treasury, Britain
was forced to replace the gold standard with a new "gold exchange standard",
basing the pound sterling on the gold-back dollar instead of directly on gold
held by Britain. The US, being the world's largest creditor nation as a result
of war finance, saw her central bank becoming the world's lender of last
resort.
Historical data showed that when New York Federal Reserve president Benjamin
Strong leaned on the regional Feds to ease the discount rate on an already
overheated economy in 1927, the Fed lost its last window of opportunity to
prevent the 1929 crash. Some historians claimed that Strong did so to fulfill
his internationalist vision at the risk of endangering the US national
interest.
While British restoration of the gold standard did not occur officially until
April 1925, the decision to re-join the gold standard had effectively been
taken some seven years earlier. In the final months of the World War I in 1918,
the UK Treasury and the Ministry for Reconstruction set up the Cunliffe
Committee, headed by Lord Cunliffe, a former Governor of Bank of England.
Committee members included Cambridge neoclassical economist Arthur Cecil Pigou
(1877-1959), a star student of Alfred Marshall (1824-1924) and intellectual
heir to Marshallian orthodoxy of supply/demand and marginal utility. The
committee was to consider the problems of currency and foreign exchange during
the reconstruction and "report upon the steps required to bring about the
restoration of normal conditions in due course". It was the forerunner of the
post-World War II Bretton Woods Conference.
The Cunliffe interim report in August 1918 concluded that sterling should
re-join the pre-war parity of 3 pounds 17 shillings and 10.5 pence per ounce of
gold, equivalent to $4.86 at $20.67 per ounce of gold, saying "it is imperative
that the conditions necessary to the maintenance of an effective gold standard
should be restored without delay".
But before the gold standard restoration decision was implemented, wartime
decontrols and pent-up post-war demand released a happy boom in England and the
US, which history referred to as the Roaring Twenties. The British trade
deficit widened to cause the exchange value of sterling to fall substantially.
Fiscal policy was then tightened and interest rates were raised by the Bank of
England to slow demand and support the pound sterling, turning the boom into
the 1921 slump in England, creating the steepest recorded recession in British
economic history to that date, as unemployment climbed from 1.4% to 16.7%
within a year and wholesale prices fell sharply with deflation.
Britain, a debtor nation by then, was in no position to go along with the US on
a liquidity joy ride.
The deflationary policy stance of the Bank of England brought British prices
down towards US levels and put upwards pressure on sterling exchange rate. The
Bank of England felt comfortable enough with the strength of the pound to lower
interest rates in the summer of 1922 to below US levels. But by the following
summer, with sterling again under downward pressure and monetary policy focused
on restoring the parity exchange rate to $4.86, interest rates had to be raised
again. By 1924, UK interest rates were above US levels.
This monetary policy squeeze achieved its dubious objective of a strong pound.
Sterling rose steadily from a low of $3.20 in February 1920 to $4.32 and then
up to the pre-war parity of $4.86 in the 10 months before the April 1925
decision to re-fix, a 32% currency appreciation to restore the gold standard
that had been demolished by the war. After adjusting for what was, despite the
post-slump deflation, the relative inflation of wholesale prices, which rose by
60% in the UK between 1914 and 1925 compared with 40% in the US, this
translated to a real exchange rate appreciation of well over 10% since 1914.
Historian Robert Skidelsky records that there was general consensus among
monetary economists at the time that the gold standard would anchor the value
of domestic money and prevent inflation. Bank of England governor Montagu
Norman argued in his evidence to parliament that a return to the gold standard
would prevent a "great borrowing by public authorities". Also, the return to
gold was seen as necessary to revive world trade and restore Britain's trading
advantage by restoring the pound sterling as a reserve currency. Finally,
opinion in the City, the financial heart in London, was near unanimous in the
view that a return to gold was necessary to restore it to its former position
as the world's leading banker, and sterling to its former position as the
world's leading currency. In hindsight, many now suspect that the British
ruling circle knew that the gold standard without bimetallism was merely a
fancy fiat currency regime, and that the gold standard was a fraud.
Winston Churchill, as chancellor of the Exchequer, said in his April 1925
budget statement: "If we had not taken this action [restoring the gold
standard] the whole of the rest of the British Empire would have taken it
without us, and it would have come to a gold standard, not on the basis of the
pound sterling, but a gold standard of the dollar."
For Britain, the 1925 gold standard attempt was a final battle of sterling
versus dollar for supremacy. It was Britain's monetary Waterloo. The then young
John Maynard Keynes, later a key framer of the Bretton Woods regime based on a
gold-backed dollar, was not against fixing the pound sterling at its pre-war
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