The Credit Crisis

Is the International Role of the Dollar at Stake?

R a m a a Va s u d e va n

As the first tremors of the looming financial crisis ripped through

Wall Street, with the meltdown of the subprime mortgage market in the
summer of 2007, the dollar plunged sharply. Perversely however, even
as some financial pundits were foretelling its collapse, the deepening of
the crisis following the bankruptcy of Lehman Brothers in September
2008 actually saw the dollar gain ground sharply (for the first time since
the steady decline that began in 2002; see chart 1).1
Chart 1. Nominal major currencies dollar index
120

110

100

90

80

70

60
1996 1998 2000 2002 2004 2006 2008
Source: Federal Reserve, "Nominal Major Currencies Dollar Index," http://www.
federalreserve.gov/releases/h10/Summary/indexn_m.txt.

Ramaa Vasudevan teaches economics at Colorado State University. She is a member of

the Union for Radical Political Economics and the Dollars and Sense collective.
24
T H E C R ED I T C R I S I S AND T H E D O L L A R 25

For any other country a financial crisis of this magnitude would

have sparked a full-scale currency crisis. Why then has the deepening
of a crisis centered in the United States actually seen the reverse, the
strengthening of the dollar? The answer lies in the continuing role of
the dollar as international money.
In Finance, Imperialism, and the Hegemony of the Dollar, in the
April 2008 issue of Monthly Review, I argued that the privileged role of
the dollar as international money has been critical to U.S. imperialist
hegemony. The explosion of private financial flows globally helped the
United States preserve and establish its pivotal place at the center of
the international financial markets and impose a dollar standard.
However, this process also created the conditions for its own unravel-
ing. The present crisis, an outcome of this unfettered growth and ris-
ing dominance of finance, lays bare the contradictions of the mecha-
nisms of the dollar standard.
Two developments summarize the process so far: (1) When panic hit,
the U.S. dollars status as international money asserted itself, and the
dollar rose against all currencies other than the yen. (2) The implosion
of the financial system, however, has threatened the foundation of dollar
hegemonyits central role in the proliferating web of global private
capital flows. The current crisis is thus also potentially a crisis of dollar
hegemony.
Dollar Hegemony

The Bretton Woods negotiations at the end of the Second World War
paved the way for establishing the dominance of the dollar as interna-
tional money. This role was sustained by the confidence that the United
States with its vast reserves of gold would honor the commitment to
provide gold to foreign central banks in exchange for dollars at a fixed
rate of $35 per ounce. By the end of the sixties, the growing trade deficit
and the burdens of its military interventions in Vietnam created a huge
dollar overhang abroad. In the face of increased demands for gold in ex-
change for dollars the United States unilaterally abandoned gold convert-
ibility. This, however, did not lead to the dismantling of dollar hegemony.
Instead, the refashioning of the international monetary system into a
floating dollar standard in the postBretton Woods period was associ-
ated with the aggressive pursuit of liberalized financial markets in order
to encourage private international capital flows denominated in dollars.
In the 1970s the Eurodollar markets served as the principal means of
recycling oil surpluses from the oil exporters to developing economies,
 26 M O N T H LY R E V I E W / A P R I L 2 0 0 9

particularly in Latin America. This process became a tool of resurgent

U.S. political dominance. The 1970s military dictatorships in Chile,
Indonesia, and Argentina, and the Chicago School free market
regimes that followed, were bolstered by repression and supported by
the readily available loans from U.S. banks flush with oil funds. Once
this cheap bonanza of credit came to an end with the debt crisis in 1982,
a new wave of neoliberal reforms and financial liberalization was
imposed through the IMFWorld Bank rescue packages. The crisis was
deployed to further entrench the dominance of the dollar and U.S.
imperialist agenda. In country after country the IMF and World Bank
imposed structural adjustment policies during the crisis phase that
destroyed all attempts at independent economic development while
engulfing their financial systems in the ambit of dollar hegemony.2 This
set in motion another surge of dollar denominated private capital flows
to emerging markets and a fresh round of crisis in the 1990s when
capital flowed back to the United States.
Chart 2: Private capital flows to the United States and
to emerging markets (billions of dollars)
1000

800

600
Billions of dollars

Net private flows to United States

400
Thousands

Private flows to developing markets

200

-200

-400
1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003 2006

Source: U.S. Bureau of Economic Analysis, Global Development Finance.

T H E C R ED I T C R I S I S AND T H E D O L L A R 27

From 1973, up until about 2003 (the run-up to the present crisis) the
periods when flows to emerging markets surged were also periods with
a net efflux from the United States. As the surge comes to an end in the
wake of capital flight and crisis, as in the Latin American debt crisis in
198283 and the Asian crisis in 199798, private capital flows are sucked
back into the United States (see chart 2).3
The privileged role of the dollar provided the United States with an
international line of credit that helped fuel a consumption binge. Cheap
imports allowed consumption to be sustained despite stagnant or de-
clining real wages. The export-led economies of Asia (first Japan, later
East Asia and China) in turn depended on mass consumption in the
United States to drive their economies. But the dependence on cheap
imports precipitated growing trade deficits. Unlike other deficit coun-
tries the United States could, because of the dollars role as interna-
tional money, finance its growing deficits by issuing its own debt in the
form of the holding of reserves and U.S. Treasury bills (T-bills) by the
creditor countries.
The United States has played the role of the banker to the world,
drawing in surpluses from Asia and the oil exporting countries, and
recycling these in the form of private capital flows to emerging markets
in the periphery. The countercyclical pattern of the private flows to
emerging markets, noted above, was critical to the mechanism by
which the dollars role was preserved. These private capital flows
served as a safety-valve mechanism, enabling the export of crisis to the
debtor-periphery. While the United States has not been immune to
episodes of financial fragility in this periodsuch as the 1987 stock
market crash, the savings and loan crisis of the late 1980s and early 90s,
the collapse of Long-Term Capital Management in 1998, or the dot-com
bust at the turn of the centurythe corresponding financial crises were
far greater in the periphery. By 2007 however, this mechanism had be-
gun to lose some traction.
This Time it Is Different

By 2007 the United States absorbed 65 percent of global capital

imports compared to 34 percent in 1995, a culmination of more than a
decade of worsening global imbalances. This was accompanied by a
growing stockpiling of foreign reserves by emerging markets. The
emerging economies turned from being current account deficit
countries through the 80s and 90s to acquiring increasing surpluses
since 2002. By 2006 developing countries were financing more than 70
28 M O N T H LY R E V I E W / A P R I L 2 0 0 9

percent of U.S. current account deficits (see chart 3). At the same time,
after the experience of the Asian crisis, emerging markets perceived
the need to increase precautionary holdings of foreign reserves in
order to insulate their economies from the impact of capital flight.
Reserve holdings by developing countries rose to about $2.7 trillion in
2006 of which about 60 percent are held as dollars. Thus the periphery
was not vulnerable to capital flight and foreign exchange fluctuations
in the same way as it had been in the previous decades.
Chart 3: Current account balances of the United States
and developing countries (billions of dollars)
600

400

200
Developing countries account balance
Billions of dollars

-200
U.S. current account balance
-400

-600

-800

-1000
1973 1978 1983 1988 1993 1998 2003

Source: U.S. Bureau of Economic Analysis, Global Development Finance.

Another difference is that the countercyclical pattern of flows that

characterized the period from 1973 is no longer in evidence after 2002
(see chart 2). After the collapse of the dot-com boom in 2002, instead
of launching a new credit bubble in the emerging markets, the policies
followed by Alan Greenspan helped stoke a bubble in the U.S. housing
market. Buyers across the globe began investing in U.S. mortgage-
backed assets, and over a trillion dollars of funds from around the
globe were swallowed up by the U.S. subprime markets. This helped
T H E C R ED I T C R I S I S AND T H E D O L L A R 29

finance the purchase of homes all over the country, and enabled the
growth of debt financed consumption. The financial bubble in the
United States led to the emergence of a new pattern of dollar recycling
that channeled capital flows from the surplus countries in the
periphery towards U.S. markets.4 The exploding of the bubble with
the collapse of the subprime mortgage market was associated with a
reversal of the recycling mechanisms that exported fragility to the
periphery through the 80s and 90s. The unraveling of the shadow
banking system in 2007 was followed by a panic pull-out of foreign
private capital from U.S. assets. This further exacerbated the crisis.
Private capital inflows to the United States dropped significantly in
2007. This is when the dollar went into a sharp decline, which was,
however, soon reversed.
In the initial stages of the subprime crisis the impact was largely
contained within the North Atlantic capitalist core of the United
States and Europe (particularly the United Kingdom). Emerging mar-
kets were relatively less exposed to the market for mortgage-backed
securities. Capital flows to emerging markets continued to rise and
flows to developing countries surged in 2007 by about 40 percent
from its 2006 level. Commodity exporters, in particular, were thriving
on the basis of the boom in prices as investors went scrambling for
returns to the commodity futures markets.5
A Safe Haven in a Global Crisis

However the events in the first two weeks of Septemberthe res-

cue of Fannie Mae and Freddie Mac, the bankruptcy of Lehman
Brothers, the fire sale of Merrill Lynch, and the rescue of AIG
heralded the complete freezing of credit markets. Financial institu-
tions hoarded cash and demanded ever widening premiums before
lending to one another. The contagion effects of the credit crisis in the
United States now spread globally, leading to capital flight from
Eastern Europe, Latin America, and Asia. At a time of world crisis
when markets do not have any confidence in the ability of debtors to
honor their debts, and have frozen lending, T-billsin other words
international moneybecame the safest bet.
The dollar began to rise against a host of currencies (excluding the
yen) as U.S. investors repatriated funds, speculators turned increas-
ingly averse to risk amid the growing turmoil, and market operators
sought dollars to meet their lenders demands. Investors and banks
also began to withdraw their money from investment banks and
30 M O N T H LY R E V I E W / A P R I L 2 0 0 9

hedge funds. The result was the fire sale of assets; deleveraging cre-
ated a sudden desperate need for cash in the form of dollars.
Even as the credit machinery remained jammed and the U.S.
Treasury and the Federal Reserve (hereafter referred to as the Fed)
were floundering through the different incarnations of the Troubled
Assets Relief Plan, the global demand for T-bills grew. Though the Fed
had cut short-term interest rates, the intense demand for Treasuries
from financial institutions pushed the yield even lower, briefly below
zero on December 8, 2008. Panicked institutional investors were more
than willing to lose a little for fear of losing a lot, and dollars in the
form of T-bills seemed the safest port in the storm.
Marx had argued that capitalisms propensity to financial crisis
arises where the ever-lengthening chain of payments, and an artificial
system of settling them, has been fully developed.6 The growth of
finance which developed as a powerful force shaping dollar hegemony
over the past three decades has bred such an artificial chain of
payments internationally.7 In Marxs analysis a credit crisis manifests
the breakdown of the chain of payments that constitutes the financial
system. This breakdown creates a frenzied clamor for money as the
safest and most liquid, riskless asset. This collapse of the credit
mechanism to its monetary rootsmanifested in the resurgent demand
for T-billsis a classic sign of monetary crisis in the history of
capitalism.8
The Crisis Hits the Periphery

Writing a year ago in Monthly Review, before the credit crunch had
taken hold of the global financial system, I had suggested that the
surge of capital flows to emerging markets through 2007 might create
the conditions leading to a fresh wave of financial crises in the
periphery and the revival of flows back into the United States. By the
time the full force of the panic hit in September 2008 capital had begun
flowing back to the United States, and outflows from emerging market
bond and equity funds reached $29.5 billion between June and
September 2008 (the highest level since at least 1995). The commodity
bubble in developing countries also collapsed, as investors fled from
all forms of risk, and export demand fell with the impact of recessionary
forces in the United States, United Kingdom, and Europe. The
accumulating surpluses and reserves in emerging markets began to
erode. Stock markets crashed in Asia and Latin America as investors
began pulling out and seeking the safety of the dollar.
T H E C R ED I T C R I S I S AND T H E D O L L A R 31

Capital flight from the emerging markets has precipitated a fall in

some emerging market currencies of as much as 50 percent, fueling
currency crises in Iceland, Hungary, and Ukraine. Eastern Europe has
been particularly vulnerable.9 With current account deficits approaching
7 percent of GDP and private capital inflows amounting to 11 percent
of GDP in 2007a level that exceeds that of developing countries in
Asia and Latin Americait is not surprising that a severe financial
crisis erupted in Eastern Europe. But where the crises of 198283 and
199798 in Latin America and East Asia were effectively deployed to
further U.S. hegemony, the current economic collapse of the shock-
therapy neocapitalist regimes in Eastern Europe is a challenge to U.S.
imperialism, not an opportunity.
Although the emerging markets are besieged by capital flight and
confront the contradictions of their export-led development strate-
gies, the unraveling in the periphery has not, in the much more serious
world crisis of today, resulted in a renewal of the financial system at
the center. The inflows to the United States are largely in the markets
for U.S. Treasuries rather than into the battered private financial sys-
tem. The European Union is denied similar recourse since there is no
comparable market for sovereign debt at the level of the European
Union. As a result, paradoxically liquidity in the U.S. markets remains
at all-time highs. The real problem is that despite all this liquidity the
credit machinery has refused to restart as banks and financial institu-
tions remain wary of lending, and are simply stockpiling excess re-
serves. In other words the supply of money is way up but its velocity
is even further down, keeping deflationary forces strong. Consequently,
the international financial system shows no signs of revival.
Signs of Strain

The Fed lies at the heart of the international financial system. It has
to juggle the conflicting claims of maintaining U.S. imperial interests
and domestic imperatives.10 The response of the Fed and the U.S.
Treasury to the current crisis is shaped by these twin domestic and
international imperatives.
The Fed normally regulates the volume of credit in the economy by
calibrating the Federal Funds rate (the rate at which banks lend surplus
funds to one another) to expand or contract credit flows. But the
implosion of the financial system undermined the efficacy of traditional
policy tools. While the Fed has reduced its target interest rates to near
zero, there has been virtually no impact on kick-starting lending.
32 M O N T H LY R E V I E W / A P R I L 2 0 0 9

In these circumstances the strategy that the Fed has adopted to

arrest the downward spiral of asset prices is to foment inflation by
expanding the money supply.11 The Fed is injecting short-term liquidity
into the financial system by buying T-bills (in exchange for newly
created cash reserves) and holding them on the central banks balance
sheet.12 This policy of inflating your way out of a crisis of falling asset
prices is called quantitative easing. Moreover, the Feds policy under
Bernanke is not restricted to the purchase of government securities but
also involves qualitative easing or credit easingtaking onto its
balance sheet a wide range of financial assets of lower quality than
short-term Treasury obligations. One implication of this policy is that
the Feds balance sheet is set to expand almost without limit. Its
balance sheet rose from $874 billion in August 2007 to $900 billion
before the fall of Lehman Brothers. Over the few months since, it has
surged to about $2 trillion. During the last quarter of 2008 the share of
Treasuries on the asset side of this ballooning balance sheet declined
from 90 percent to 21 percent as the Fed acquired riskier assets,
including mortgage-backed securities and commercial paper.13
One reason why this massive injection of funds is not translating
into reflation is because financial institutions are hoarding money in the
form of excess reserves kept at the Fed. From normal levels of around
$7 billion, these reserves are currently pushing $1 trillion and are still
rising. The problem is again that this credit crisis has resulted in a col-
lapse of the paper edifice of the bloated financial system, forcing it back
on its monetary base.14
By reassuring investors that it will hold overnight lending rates at
near zero for the foreseeable future, the Fed has essentially given traders
a cost-free way to borrow overnight and invest the proceeds in higher
yielding assets. The implicit hope is that the increased borrowing will
be used to purchase higher-risk financial assets and revive the securities
markets and financial flows into the United States. In other words
foster another bubble! The financial press is already warning of the
possibilities of a Treasuries bubble.15
The danger is that this policy would propel a flight of currency from
dollar markets. The announcement of the zero-interest-rate policy and
quantitative easing halted the rapid rise of the dollar after four months
in which the U.S. currency recorded its biggest gains since 2002.16 While
the U.S. Treasury bill continues to remain a globally sought safe haven,
that status is unlikely to remain unscathed. The market for Treasuries is
likely to face a glut of T-bills in search of buyers, as the Fed balance sheet
T H E C R ED I T C R I S I S AND T H E D O L L A R 33

expands and so does the governments need for finance. The increasing
debt overhang may undermine confidence in U.S. Treasuries.
It is quite clear that the U.S. imperial agenda of refashioning the
post-crisis world in a way that preserves dollar hegemony depends
critically on China, which has finally outpaced Japan as the biggest
holder of U.S. Treasuries. China has in a sense been locked into dollar
holdings because selling off its mountain of Treasuries would precipitate
a crash of the dollar and a collapse of its (dollar) asset base. This
balance of financial terror underlay the arrangement where China
stockpiled dollar reserves in order to pursue its strategy of export-led
growth.17 Even though China cannot sell off its mountain, it may not be
able to continue to add to its pile at the same rate either. The slowdown
in Chinese exports, which began to decline sharply in the last quarter
of 2008, would mean a flagging demand for U.S. Treasuries at precisely
the point when issuance is skyrocketing.
The twin challenges for the U.S. imperial agenda are the restortion
of the domestic economy and the refashioning of the battered global
financial architecture to preserve the hegemony of the dollar. Despite
all the talk of the renewal of financial regulation, Main Street prevailing
over Wall Street, the reality is quite different. The slew of policies the
Fed is adopting, and the ones that it has not adopted, suggest that they
want a recovery of the domestic economy without constraining finance.
This was quite apparent in the very distinct trajectories of the fiscal
stimulus and the Wall Street rescue packages through Congress.
However, internationally, the global recessionary forces that have been
let loose with the credit crisis have also sparked a greater clamor for
protection of domestic labor and industry, and for greater regulation
and supervision of international capital flows. If this is sustained by a
return to economically progressive agendas across the globe, and the
strengthening of South-South mutual support networksindepen-
dent of the control of the United Statesit would erode the dominance
of finance, and would further weaken the privileged position of the
United States at the heart of the international financial system.
Notes
1. See W. Munchau, The Dollars Last Lap as Asian credit crisis to dictate conditions to
the Only Anchor Currency, Financial Times, the South Korean government that forced
November 27, 2007. the opening their financial system. The
2. In 1998, what Business Week termed the Asian Swat Team from Washington, Business
SWAT team of U.S. Treasury officials Week, February 23, 1998. As a result the
Lawrence Summers, Timothy Geithner, and Korean stock market became a gambling
David Liptonused the opportunity of the casino for foreign investors.
34 M O N T H LY
3. Ramaa Vasudevan, Dollar Hegemony,
Financialization, and Imperialism, Monthly
Review 59, no. 11 (April, 2008).
4. Kenneth Rogoff and Carmen Reinhart, Is
The US Sub-Prime Market Crisis So
Different? American Economic Review 98, no. 2
(2008), 339-44.
5. The speculative actions of arbitragers,
manipulators, hedgers, speculators, and
index investors promoted the commodity
bubble at a time when speculators were
seeking profitable investments as the market
for collateralized debt obligations crashed.
Randall Wray, The Commodity Bubble:
Money Manager Capitalism and The
Financialization of Commodities, Public
Policy Brief 96 (Levy Economic Institute,
Bard College, 2008).
6. Karl Marx, Capital, vol. 1 (New York: Vintage
Books, 1977), 235.
7. Leo Panitch and Sam Gindin, Finance and
the American Empire, The Socialist Register
2005 (New York: Monthly Review Press,
2005), discuss the integral role of the
process of disciplining labor to the rising
dominance of finance. More recently they
argue that the scale of the current crisis
cannot be understood apart from how the
defeat of U.S. trade unionism played out by
the first years of the twenty-first century.
See The Current Crisis: A Socialist
Perspective The Bullet (September 30,
2008).
8. Marx has a remarkably prescient analysis of
monetary crisis: Whenever there is a
general and extensive disturbance of this
mechanism, no matter what its cause,
money becomes suddenly and immediately
transformed, from its merely ideal shape of
money of account, into hard cash....On the
eve of the crisis, the bourgeois, with the
self-sufficiency that springs from
intoxicating prosperity, declares money to
be a vain imagination. Commodities alone
are money. But now the cry is everywhere:
money alone is a commodity!...Hence, in
such events, the form under which money
appears is of no importance. The money
famine continues, whether payments have
to be made in gold or in credit money such
as bank-notes. Karl Marx, Capital, vol. 1
(New York: Vintage Books, 1977), 23536.
This analysis foreshadows Keyness
discussion of the liquidity trap where
investor confidence has been severely
battered and the preference for liquidity is
absolute.
R E V I E W / A P R I L 2 0 0 9
9. International Monetary Fund, Global
Financial Stability Report (Washington D.C.,
2008).
10. J. Lawrence Broz, The International Origins of
the Federal Reserve System (Ithaca: Cornell
University Press, 1997).
11. This was the policy that Irving Fisher
urged on FDR during the Great Depression.
Jan Kregel, Krugman on the Liquidity
Trap: Why Inflation Wont Bring Recovery
in Japan, Working Paper No. 298 (Levy
Economics Institute, Bard College, 2000).
It was also the basis of the decision to
devalue the dollar by raising the price of
gold. Bernanke, who cut his professional
teeth studying the Great Depression,
argued that The devaluation and the rapid
increase in money supply it permitted
ended the U.S. deflation remarkably
quickly. Ben S. Bernanke, Deflation:
Making Sure It Doesnt Happen Here
(remarks before the National Economists
Club, Washington, D.C., November 21,
2002).
12. FT Alphaville (Financial Times blog, http://
ftalphaville.ft.com/) carried some of the
earliest and most cogent chronicling of this
strategy of quantitative easing.
13. Fed Assets Fall to 1.9 Trillion as Foreign
Currency Swaps Drop, Bloomberg.com,
March 5, 2009. The Feds balance sheet
appears likely to reach $3 trillion following
their announcement of March 18, 2009.
14. In other words, the monetarists have got
the wrong end of the stickmoney supply
responds to the demand for money not vice
versa. This argument, which goes back to
Marx and Keynes, is integral to the analysis
of the endogenous money school including
post-Keynesian economists who see the
financial system as one based on credit
money. See L. Randall Wray, Understanding
Money (Northampton, MA: Edward Elgar,
1998) and Makoto Itoh and Costas
Lapavistas, The Political Economy of Money and
Finance (New York: Palgrave Macmillan,
1999). Also see Steve Keen, The roving
cavaliers of credit, Debtwatch, February
31, 2009, http://www.debtdeflation.com/.
15. John Kemp, Fed Unleashes Greatest Bubble
of All, Reuters, December 17, 2008.
16. John Kemp Fed Cut Sparks Dollar Dive,
Reuters, December 18, 2008.
17. Luo Ping, a director general at the China
Banking Regulatory Commission, while
speaking at the Global Association of Risk
Managements 10th Annual Risk Management
T H E C R ED I T C R I S I S AND T H E D O L L A R 35

Convention, said: Except for US Treasuries,
what can you hold? he asked. Gold? You
dont hold Japanese government bonds or
UK bonds. US Treasuries are the safe haven.
For everyone, including China, it is the only
option. Mr Luo, whose English tends
toward the colloquial, added: We hate you
guys. Once you start issuing $1 trillion$2
trillion [$1,000bn$2,000bn]...we know the
dollar is going to depreciate, so we hate you
guys but there is nothing much we can do.
Henny Sender, China to Stick with US
Bonds, Financial Times, February 11, 2009.

w
Much like those in the 1930s consumer movement, contemporary consumer
activists are increasingly concerned with the direct and indirect effects of com-
mercialism. They worry about its influence on cultural and social institutions
such as the mass media and the educational system. Ironically enough, given
that we live in the so-called information age, corporate conduct, including its
commercial strategies, is more difficult to monitor than ever. Because com-
mercial values have become entrenched in our everyday life and commercial
speech is gaining increased First Amendment protection, consumer advocates
and citizens face a greater challenge in gaining a critical perspective on com-
mercialism. In many respects, corporate branding behaves like an aggressive
virus: It outpaces its critics and is financially well equipped to fend off any
activist remedy.
Inger L. Stole, Advertising on Trial (University of Illinois Press, 2006), 197.