Beyond Exorbitant Privilege: George Shultz, the U. S. Treasury, and the Origins of Dollar Hegemony, 1969-1979

Abstract:

Keywords: dollar; hegemony; Treasury; special drawing rights; currency; international monetary system; International Monetary Fund; financial liberalization; exchange rates

Dollar hegemony, or the system of benefits and privileges afforded to the United States through the use of the dollar as the world’s primary reserve, intervention, and transactions currency, has been one of the defining features of the modern world order. The myriad benefits the US accrues from this system are well documented. To briefly summarize, the dollar’s use as an international currency means that most international trade is settled in dollars, almost all international commodities (most notably oil) are priced in dollars, and most central banks hold their currency reserves in dollars. Taken together, a system in which the dollar holds so central a role increases the demand for dollar-denominated assets (mainly U.S. Treasuries), allowing the U.S. to run sustained budget and trade deficits without facing the interest rate spikes and declining welfare that other countries might. Indeed, contemporary observers have argued that the benefits of dollar hegemony have underwritten American primacy over the past 40 years by funding everything from American welfare programs to military power projection abilities.¹

The guiding question of this essay is how the world moved from a system of limited dollar privilege under Bretton Woods to today’s system of unconstrained dollar hegemony. I argue that between 1969 and 1979, American international monetary policy was essential to this development. Guided by its mandate to manage the American budget and its corresponding deficits, during the 1960s and 1970s the U.S. Treasury came to see the dollar’s international role as both a necessary component of its duties and a point of hegemonic advantage. Dollar policy evolved from a purely economic issue to an aspect of American national strategy.

After the closing of the gold window and the end of Bretton Woods in 1971, neoliberal policymakers led by Treasury Secretary George Shultz pushed reforms like floating exchange rates and free capital movement that made an anchor currency for exchange intervention and a common currency for financial transactions even more vital. These were jobs only the dollar could do. As the system evolved toward a more permanent dollar standard under Shultz’s reforms, Treasury officials took further action to secure the dollar’s role in international oil trading and stymie the development of the next best alternative, IMF Special Drawing Rights (SDRs). By the end of the 1970s, a combination of neoliberal thinking, hegemonic ambition, and bureaucratic hierarchy allowed the U.S. to guide the international monetary system through the murky waters of reform and toward dollar hegemony.

The broad strokes of this argument are not without precedent, particularly in the international political economy (IPE) literature. In 1982, David Calleo argued that American international monetary policy was driven by hegemonic and isolationist tendencies rather than economic necessity, and Eric Helleiner has since followed suit (albeit with somewhat greater weight placed on economic and functionlist explanations).² However, both of these authors were limited in their ability to assess American hegemonic financial strategy in the 1970s because most of the relevant evidence was still classified. Conversely, where the IPE literature has posited the argument without historical evidence, the financial history literature has hardly touched the history of dollar policy at all. Instead, it has focused on questions of economic ideology and particular policy decisions (e.g., the closing of the gold window) rather than the totality of U.S. foreign economic strategy.³

The divergence between the international political economy and history literatures has left a lacuna in our understanding of U.S. policy toward the dollar’s international role. Using evidence from government archives and interviews with policymakers from the period, I argue that dollar hegemony was not a product of economic luck but was instead the result of conscious efforts to enhance American political and economic hegemony.

By the time Richard Nixon was elected in 1968, the debate over the dollar’s international role was a well-established feature of international economic discussion. The French maintained throughout the 1960s that the dollar’s special position afforded the U.S. “exorbitant privilege” in its ability to run continuous deficits and fund lavish expenditures simply by printing its own currency.⁴ Charles de Gaulle and his Finance Minister, Valéry Giscard d’Estaing, vocally supported a more prominent role for gold in the international monetary system in order to limit American economic dominance.⁵ For others, persistent U.S. balance of payments deficits from the late 1950s on represented a clear risk to the international monetary system. By the time Nixon took office in 1969, the U.S. balance of payments and its relationship to the dollar’s role had become one of the most sensitive international issues facing the new administration.

Between 1960 and 1969, the view of the dollar’s key currency role among American policymakers underwent a drastic shift from that of an economic convenience to a point of hegemonic interest. The notion of a U.S. “dollar policy” that sought to preserve the dollar’s international role was born out of discussions of the U.S. balance of payments deficit and the dwindling credibility of the gold-exchange standard. Robert Roosa, the Under Secretary of the Treasury for Monetary Affairs, and C. Douglas Dillon, the Treasury Secretary, stood at the forefront of dollar policy and established it as part of the Treasury’s mandate in the early 1960s. Both came to office with strong beliefs in both the value of a U.S.-centric international economic system and the benefits of the dollar’s role.⁶

Roosa, however, was truly the original architect of American dollar policy. Roosa had worked at the New York Federal Reserve Bank for fifteen years and came to the Treasury with strong convictions about the U.S.’s role in the international monetary system and skepticism about the potential for international cooperation. The experience of most economic policymakers in the immediate postwar period left them with the distinct impression that the U.S. stood alone in its capacity for world economic leadership. Early on Roosa wrote, “Most of us in the Treasury and Federal Reserve felt that so much was still unknown as to the nature and extent of the readiness of other countries to join new multilateral efforts that it was as yet impossible to design a system that would best meet the world’s needs, including the United States.”⁷ As a consequence, he and his colleagues saw the dollar’s central role as both an inevitable result of American economic dominance and a source of national prestige, influence, and earnings.⁸ Previous experience in international economic dealings and doubts about the capacity of other countries to shoulder international monetary burdens left Roosa with the view that the dollar had to remain the cornerstone of the international monetary system.

As Treasury Under Secretary, Roosa constantly worried about the “hazards of despair and economic disruption” that would result from any challenge to the dollar’s role and devoted substantial effort to the development of a policy to defend the dollar’s role and the deficit spending flexibility and seigniorage benefits it offered.⁹ In 1961 and 1962, Roosa designed a comprehensive program to facilitate “improvisation of defenses to protect the dollar” that included publication of U.S. monetary reserves, currency swaps (to limit gold conversions), forward contracts with foreign governments, intergovernmental capital transfers, and coordination in the London Gold Market.¹⁰ Roosa saw the dollar’s role not just as an economic boon but also as a point of national prestige wrapped up in the U.S.’s newly minted role in the postwar world. “It is a role which naturally accompanies our leading economic and political position,” he argued, and as such considered it a central component of the national interest.¹¹

The emphasis of early dollar policy on the preservation of this role was as much a product of national pride as of economic value. In a 1962 statement before the Joint Economic Committee of Congress, Roosa argued that difficulties arising from the dollar’s reserve role were “byproducts of our leading position among Western nations” in military expenditure and aid distribution.¹² Under Dillon and Roosa, the Treasury developed an almost knee-jerk opposition to any policy that might diminish the dollar’s role. Between 1961 and 1964, they consistently opposed any proposal to devalue the dollar or to create new forms of international liquidity. In 1962, for example, the Council of Economic Advisers (CEA) and the Department of State endorsed a plan to negotiate a freeze on US gold conversions, actively limit accumulations of dollar reserves by foreign governments, and augment international liquidity with IMF resources. In response, Dillon argued that this would “seriously impair the position of leadership which the United States now has with respect to these countries” and that it would “make it extremely difficult, if not impossible, to contemplate a future monetary system in which the dollar may be used as a key currency.”¹³

The Treasury’s mandate to manage the U.S. budget and balance of payments created a strong institutional incentive for its officials to protect the dollar’s role, as the deficit spending flexibility it afforded the U.S. eased the Treasury’s burden and limited the need to make difficult choices between costly policies. Without as much need to worry about budget deficits (as the dollar’s role ensured demand for U.S. Treasury debt), the Treasury no longer had to worry about whether the U.S.’s expansive security interests would trade off with economic objectives at home, a point clearly not lost on Dillon.¹⁴ The Treasury thus became home to the dollar’s most fervent supporters and the source of a great number of policies designed to buttress its role. The combination of the Treasury’s official mandate with economic and nationalist rationales for defense of the dollar’s role combined to make the key currency role a central objective of American international monetary policy.

By the time Nixon entered office in 1969, however, it was clear that the ad hoc measures introduced over the past nine years were not enough. Prior to the 1968 election, the U.S. Task Force on Balance of Payments Policies was convened to assess the current situation with respect to the balance of payments, the international monetary system, and the dollar’s international role. In October 1968, the task force submitted a first draft that explained that an international monetary crisis was imminent, the new administration would likely have to suspend gold convertibility now or in the near future, and an opening was needed to remake fundamental aspects of the international monetary system.¹⁵ An earlier draft even advocated closing the gold window to create such an opportunity for reform, arguing that this move, combined with limited exchange rate flexibility, would allow the dollar to devalue (boosting U.S. exports) or force countries with currencies pegged to it to absorb additional U.S. deficits without demanding gold, solving the balance of payments problem.¹⁶

That the dollar’s role was a valuable aspect of the international monetary system is seemingly assumed in the report but not explicitly discussed. This attitude makes sense in light of the lack of plausible alternatives at the time. By this point, France’s attempts to link international reserve assets to gold had failed and SDRs were still on the drawing board. As the report itself notes, even without gold convertibility most countries would probably still peg their currencies to the dollar.¹⁷ The elimination of “largely fictitious” convertibility would likely have no effect on the dollar’s key currency status.¹⁸

Despite the perceived security of the dollar’s role, the Nixon Administration still faced a looming balance of payments crisis that could shake the international monetary system to its core. In 1969, President Nixon authorized the creation of the Volcker Group, an interagency group headed by Treasury Under Secretary for Monetary Affairs Paul Volcker tasked with forming the administration’s policy toward the international monetary system. Although the Volcker Group was interagency in nature and included members from the Federal Reserve, Department of State, and CEA, it was housed within the Treasury Department and took on the distinct feel of its home agency. When it came to dollar policy, the Volcker Group quickly fell in line with its Treasury predecessors. Its first major publication, an analysis of major options in international monetary reform, took a hardline stance that the dollar’s role was not only highly beneficial but that it might be in the U.S.’s interest to expand it.¹⁹ Nixon, famous for his disregard for the complexities of international economics, left most of the decision-making on international monetary policy to senior officials at the Treasury. The Volcker Group, given a high level of independence to direct international monetary policy through the Treasury, quickly became ground zero for an aggressive dollar policy and a staging ground for international monetary reform.

Although no international monetary system had ever existed without gold or other commodity backing prior to 1971 and a dollar standard was unthinkable to most, in the early days of the Nixon Administration this bold policy was discussed as a potential cure-all to America’s economic woes. The Volcker Group’s assessment of the benefits of the dollar’s existing role was straightforward and blunt. In their June 1969 account of international monetary policy options, they argued that the deficit financing benefits of the dollar’s role had funded over 70 percent of U.S. deficits over the last decade and “permitted the United States to carry out heavy overseas military expenditures and to undertake other foreign commitments, and to retain substantial flexibility in domestic policy.” On the whole, they found, “it has facilitated a role for U.S. leadership and influence more or less commensurate with our relative size and economic power.”²⁰ The Volcker Group’s analysis set the stage for the dollar’s role to become an essential aspect of American hegemonic policy. While earlier policymakers were generally supportive of the dollar’s role, the Volcker Group became the first to connect the spending flexibility it afforded the U.S. with the ability to project power abroad.

From this simple connection came the idea to expand the dollar’s role into a pure dollar standard. If the U.S. were able to suspend convertibility into gold while retaining the dollar’s reserve role, it would remove the existing limits on deficit flexibility and seigniorage and amplify the associated benefits. With this possibility in mind, the option of closing the gold window became not only a solution to balance of payments problems but also a potential boon to American hegemony. A March 1969 Volcker Group paper on the possible suspension of convertibility summed it up perfectly – were the U.S. to close the gold window, any subsequent approach should have the aim of preserving “the reserve currency use of the dollar to the fullest extent possible.”²¹ By creating a monetary crisis, the U.S. could give itself an opening to push the international monetary system in its desired direction and expand its enviable position.

Of course, the policymakers of the Volcker Group were astute enough to understand that a pure dollar standard was not likely to receive a favorable international reaction, particularly from countries like France and Germany already wary of the dollar’s role. Although no action would be taken until 1971, hypothetical discussions of this transition provide clear evidence that American policymakers contemplated the use of sophisticated diplomatic techniques to bring the rest of the world on board. In particular, members of the Volcker Group discussed waiting to act until a crisis hit in order to avoid the perception that the move was a U.S. power play.²² As the potential advantages of a dollar standard became clearer, U.S. dollar policy evolved from an attempt to preserve the existing system to a potential waiting game in the hopes of achieving something better.
The Dollar’s Role After the Closing of the Gold Window

The rapid deterioration of both the U.S. balance of payments and international cooperation from 1969 to 1971 quickly renewed the vigor of the Nixon Administration’s international monetary reform planning. The Europeans’ growing recognition of the spurious nature of gold convertibility and mounting evidence that the U.S. had moved to give higher priority to domestic economic policy over international concerns (especially the balance of payments deficit) drew hostility from across the Atlantic and undercut the likelihood of a coordinated solution.²³

By spring of 1971, it had become clear that suspending gold convertibility had to be upgraded from a possible nuclear option to a likely course of action. Archival evidence indicates that the Treasury began developing a fully formed contingency plan for closing the gold window as early as March 1971. The earliest evidence of such planning are drafts, written by an unnamed Treasury staffer, of a speech for President Nixon and a Treasury press release announcing the suspension of the dollar’s convertibility into gold.²⁴

According the final version of the plan, the U.S. intended to present the initial suspension as temporary, achieve a lower par value for the dollar in terms of other currencies, and only then announce that it would no longer use gold conversion to maintain the new par value.²⁵ In fact, an explicit aim of suspension was to phase gold out of the international monetary system altogether.²⁶ This objective raises the question of what sort of system the U.S. envisioned to replace the gold-exchange system. The plan conceded that this would likely entail a replacement of gold with SDRs as the primary reserve asset for international settlements and source of international liquidity growth.²⁷ However, as discussed below, the Treasury saw this as likely a necessary concession; it had not abandoned hope for maintaining or expanding the dollar’s role if conditions allowed it.

Beyond the demonetization of gold, the basic goals of the plan included (1) improvement in the U.S. balance of payments position through exchange rate realignment and flexibility, (2) a more equitable distribution of security spending burdens, (3) the removal of trade and capital controls, and (4) the maintenance of domestic policy flexibility.²⁸ If these goals themselves seemed relatively innocuous, the menu of American tactics to ensure they were achieved was not. The contingency planning documents reveal that the U.S. was willing to allow a significant monetary crisis to develop without intervention, to reduce U.S. military protection of other countries, and to intervene actively to stymie unfavorable foreign responses.²⁹ The Treasury had come to the conclusion that a favorable solution to the balance of payments crisis was necessary if the U.S. were to continue funding its international power projection abilities, international aid, and military interventions. In the face of a weakened and declining dollar, they worried: would they “be able to fight a Vietnam War or keep troops in Germany?”³⁰ It seems it was well understood that a stable dollar was essential to the American hegemonic project.

The record is mixed as to the extent to which the U.S. sought to preserve or expand the dollar’s role during this period. The contingency planning documents indicate that although U.S. officials were concerned with the reduction of the reserve currency role (the intervention and transactions role was not discussed), they were willing to sacrifice it to some extent in order to achieve balance of payments equilibrium.³¹ Although the dollar’s role was valuable, it could not be preserved if other countries refused to hold dollars or the international monetary system collapsed under the dollar’s weakness. Above all, the U.S. objective in international monetary reform was to maintain enough leverage to prevent a return to a gold-based system with substantial restrictions on trade and capital flows.

On this view, the resolution of the balance of payments crisis was of paramount importance because it was needed to sustain American bargaining power and international prestige. As the contingency plan notes, a firm plan was necessary “so that the U.S. could try to guide responses along lines it (and the world) would find constructive.”³² If the crisis were resolved successfully, the U.S. could claim credit for keeping its monetary house in order and diminish the need for more extreme measures like capital and trade controls.

However, the Treasury had far from given up on the dollar standard. The plan specifically notes that suspension would give the U.S. the chance to “appraise, against actual developments, the degree to which we and the world might tolerate, as an alternative to proposed reforms, the de facto system we had thrust upon the world by suspension.”³³ It seems that the Treasury still held out hope for the success of a dollar standard but understood the low probability of achieving it.

As the dollar’s position worsened, contingency plans became reality and Nixon was forced to act. When Nixon decided to convene the Camp David meeting on August 12, most of the officials invited had already made up their minds in favor of suspension. By all accounts, the discussion of whether to close the gold window was mostly one-sided. As George Shultz described it, “The closing of the gold window was not really a decision. By the time we got to that point, the amount of dollars out there was far greater than the gold we had and there was starting to be a run on the bank, so to speak. The gold window had to be closed.”³⁴

On August 15, 1971, President Nixon announced the closing of the gold window and, as a consequence, the end of the Bretton Woods system. The U.S. would no longer maintain the dollar’s fixed parity to gold and instead would (at least until an agreement was reached) allow the dollar to freely float. From an economic policy perspective, the results of this decision were monumental. With the entire international monetary system in flux, the U.S. was now positioned to guide fundamental reforms of the world’s monetary standard, system of exchange rates, and the role of international institutions.

In many ways, the dollar’s role served as the lynchpin of all of these questions: a dollar standard would raise the attractiveness of exchange rate flexibility for the U.S. and minimize the need for an expansive IMF role, while a reduction in the dollar’s role would necessitate greater exchange market intervention from the U.S. and a larger role for the IMF to regulate currency markets and manage international liquidity. With such a wide-open field for reform and the need to answer these pressing questions quickly, the debate over the dollar’s role reignited with renewed vigor.

This new iteration of the dollar debate differed in three aspects from previous instances. First, the closing of the gold window had already forced the world onto a dollar standard.³⁵ This shift moved the point of departure for any reform to one that already favored the dollar’s role and made a failure to depart from the status quo a favorable outcome. Second, the uncertainty surrounding the issue brought in new perspectives and interlocutors concerned by the expanded range of potential outcomes. Unlike the 1960s, where the dollar’s role was the purview of a few Treasury analysts, the dollar debate now became a key battleground for the Treasury, CEA, Office of Management and Budget (OMB), and even private commentators. Third, this explosion of new perspectives broadened the spectrum of known views on the desirability of the dollar’s role. For the first time ever, policymakers gave serious consideration to the possibility of abandoning the reserve currency role and relinquishing some aspects of the dollar’s international status.

At the Fed, staffer Robert Solomon continually asserted that the benefits of deficit spending flexibility were behind the U.S. and that there was no point in preserving the dollar’s role. Characteristically, the Fed view that the U.S. should begin pushing for an SDR-based system seems to have fallen on deaf ears.³⁶ This is not to say that the Treasury was entirely immune to such arguments. Even Treasury Secretary John Connally, an avid proponent of closing the gold window, was willing to consider a reduction in the reserve role. He was far more concerned with the achievement of exchange rate flexibility and realignment of the dollar’s competitive position. Volcker, too, expressed a willingness to consider diminishing the dollar’s role contingent on exchange rate realignment and greater flexibility.³⁷ This position was influenced by both the centrality of these reform objectives, as conceived in the contingency plan, and shared skepticism over the willingness of other countries to continue accumulating dollar liabilities. This more moderate Treasury position was best articulated by George Willis in a position paper on U.S. goals for international monetary reform. He acknowledged that, “international confidence in the dollar has been seriously jeopardized,” contributing to fears that deficit spending flexibility might go the way of convertibility. However, Willis – ever the dollar hawk – for the first time affirmed that the Treasury’s mission included fostering the dollar’s role “as a major transactions currency” and “achieving a sustainable role for the dollar.”³⁸

Although the Treasury was willing to contemplate compromise on the reserve role, they remained committed to the intervention and transactions role. This mix of doubt and residual commitment to the dollar’s role left the Treasury in an intermediate position toward the end of 1971. The willingness of the Treasury to commit to a pro-reserve role stance was contingent on whether other countries would continue to take on dollar liabilities, a question that could only be resolved via international negotiation and direct policy signaling. The differences between the Treasury, CEA, and Federal Reserve were largely attributable to different beliefs on the future of the deficit spending benefit. Although history has shown the miscalculation of the CEA and Fed in doubting that this benefit would continue, at the time the future was far from clear.

Fortunately for the dollar hawks, the signal they needed came in the form of the Smithsonian Agreement. The agreement, signed in December 1971 after several rounds of international negotiations, included an appreciation of other currencies against the dollar (of varying amounts in the range of 10 percent) and a widening of exchange rate margins to 2.25 percent above and below the newly established parities.³⁹ What is striking about the Agreement is not what it did but what it did not do: it acceded to all or most of the Americans’ desired reforms without altering the current structure of the international monetary system, a pure dollar standard. That the Europeans were willing to prioritize adjustment and interim stability over attacking the dollar’s role was a strong signal that they were not completely uncomfortable with a dollar standard. While it certainly was not their preference, it also was not unconscionable. With this first victory behind them, the Nixon economic team set to work on the questions of broader reform. As Paul Volcker put it in February 1972, once the Smithsonian Agreement went into effect, “the stage will be set for proceeding with more fundamental international monetary reform.”⁴⁰

In February 1972, Under Secretary Volcker created a committee called the Volcker Group Alternates tasked with formulating papers and alternative proposals “with respect to various aspects of the long-range reform discussions.”⁴¹ Predictably, the Treasury quickly exerted its established dominance to guide the direction of the Alternates. Long-time Treasury official Jack Bennett became the voice of the Alternates and the group’s chief line of communication with the President.

In light of the success with the Smithsonian Agreement and avoidance of anti-dollar lobbying in the international arena, Bennett took the opportunity to renew the Treasury’s commitment to the dollar’s international role. His earliest position, from March 1972, presents the reduction of constraints on American spending capability as a primary objective of international monetary reform. He endorsed this goal as a way of “providing the government with the means of conducting appropriate levels abroad of military expenditures and of economic assistance activities.”⁴² Just as the early views of the Volcker Group reflected the confluence of military and international monetary objectives, so too did the views of Bennett and the Volcker Alternates. Bennett fought to protect the dollar’s reserve role and advocated encouraging foreign governments to hold dollars and minimizing the role of the SDR.⁴³

By May 1972, the Alternates and Volcker Group had coalesced around a set of core structural reforms but disagreed on whether dollars or SDRs should become the system’s primary reserve asset. More importantly, no one was anywhere close to a complete position on a U.S. strategy for international monetary reform. Part of the administration’s lack of direction stemmed from Secretary Connally’s lack of economic experience. Although he was a shrewd political operator and a forceful presence on the international stage, Connally had no overarching economic direction. He was comfortable delegating the specifics of international monetary strategy to Volcker and the members of his study groups. When he resigned on May 16, 1972 and was replaced by George Shultz, that all changed.⁴⁴