Episode 4: The rise (and potential fall) of the USD as global reserve currency.
11 May 2022
Today we continue our river boat ride on the river of economic history.
By the mid 1970’s the USD had firmly entrenched itself as the dominant global means of trade, and even though several crisis had resulted from the US moving off the gold standard, the world was now a very different place.
The second oil price shock occurred in 1979 as a result of two connected factors. Both taking place in Iran.
Firstly, in a dramatic turn of political events, a regime change took place in Iran when in a religious revolution took place. The US allied Shah was overthrown and the infamous hardliner Ayatollah Khomeini was installed as Iranian supreme leader. It was also at this point that the mad dog of Iraq, he who would create many regional crisis over the next few decades, Saddam Hussein, decided to go to war with Iran.
The result of all of this was a dramatic rise in the price of oil, again causing shortages and rationing across the world.
Of course, much like today, all of these conflicts, coupled with the economic policies of the past decade in the U,S led to inflation rising alarmingly over a long period of time.
Since the USD was now the reserve currency of the world, the U.S was able to spend (and borrow) more than they ordinarily would have been able to, and inflation was now entrenched in the U.S in by the late 1970’s.
Enter a man by the name of Paul Volcker.
By 1980 inflation in the U.S was at 14%. Nixon and Carter even tried to introduce price controls – every leaders playbook when stupid policies lead to price increases – they blame price gougers, and attempt to legislate prices. Every inflationary crisis in history has the same story. Blame the speculators, not the policies. (recall Mugabe in Zimbabwe……it was not the fact that Zimbabwe was printing trillions of new currency every day, it was the speculators causing havoc)
Volcker became FED Governor in late 1979, and within months he decided to act …..raising U.S short term rates to over 21%, before inflation started to fall.
Understandably these rising rates had dramatic effects on the global economy. The U.S experienced two recessions during this period, unemployment rose as the economy struggled to come to terms with the new normal.
Volcker is known as the man that “killed inflation”. At least that is until recently.
Subsequent FED Governors were able to keep rates relatively low, because the specter of double digit rates, and the impact on the populace remained an implicit threat that kept inflation trending down for decades to come.
Throughout this period the USD remained the dominant trading currency despite multiple crisis or arguably because of them.
When Volcker eventually tamed U.S inflation, the U.S was able to enjoy a relatively stable few years. Interest rates began to decline, the economy picked up and the cold war was now being fought in far flung places like Afghanistan and Angola/Namibia.
Everyone was happy – until one fateful day in 1987, which ever since has been known as black Monday. More about that in the next episode!
Cause and effect, decisions and consequences – these things remain forever linked. History is the best (and least listened to) teacher.