April 27, 2011; Exorbitant Privilege: The Rise and Fall of the Dollar and the Future of the International System. An Interview with Barry Eichengreen

The McAlvany Weekly Commentary
with David McAlvany and Kevin Orrick

Kevin: David, we have watched gold and silver continue to climb, really, without correction.  We have been getting calls, people saying, “Hey, when do you expect the correction?”  But every once in a while, we do get little corrections, and they are expected events, but they are not necessarily something you would read about in the newspaper.

David: If you look back at the last ten years, and look at a chart of either gold or silver, it looks like there has been uninterrupted growth.  In fact, that is not the case.  We have had two steps forward, one step back, two steps forward, one step back, a steady progression which has taken us to some pretty significant levels.

Kevin: That is a normal bull market, isn’t it?  You go up a little bit, and then, of course, the traders take a profit, or what have you.

David: And usually what precipitates those declines is something in particular.  This is a classic case in point.  The 26th of April is options expiration, so you have many leveraged positions which either have to be closed out, or will be worthless.  They will expire worthless.  A bet that the price of metals would be price X by time X …

Kevin: Either up, or down, you could bet both directions.

David: Exactly.  But getting to options expiration, there is typically volatility when you have this date occur – par for the course, no big deal.  I would relish a correction in both metals.  If we could see a 6%, 7%, 8% correction in gold, a good 15% to 20% correction in silver, these would be healthy corrections.  This is what allows for these markets to be extended over a longer period of time.   That’s sort of micro in the markets.  We have the Dow and the S&P moving higher, with the expectation that quantitative easing will continue.  This is the dope that the market really is enjoying.  And it is interesting, if you take it away, if is not renewed in June, you are likely to see some downside volatility.  On that volatility issue, we have the VIX, which has peaked below 15 earlier in the week.

Kevin: Why don’t you explain that a little bit to the listeners?  What does the VIX actually tell us?

David: The Volatility Index is basically an expectation monitor, if you will.  Are we going to see prices go up, or down?  And the lower that index gets, people are really comfortable, and are assuming that there is no downside.

Kevin: So they are just on cruise control when the VIX is low.

David: Exactly.  You see a spike in the VIX when people are concerned about price volatility, when they are concerned about prices going down, particularly in equities.  So, we have relatively high complacency in the stock market.  Every time in the last year where the VIX has slipped below 15, it has, within a matter of days or weeks, spiked to 25-40, and what that means is that we do have a correction in equities around the corner, if you are using that as a forward indicator.

Kevin: What it reminds me of is a guy who is sort of falling asleep at the wheel.  He gets a little too comfortable, the heat is on in the car, he starts to doze, bumps on the side of the road … (laughter) and it wakes you up.  Whoa, wait a minute, wait a minute.  The VIX is a good indicator that way.

This brings us, then, to the subject of today’s conversation, David, because when we talk about corrections, we are talking about a correction versus a particular currency.  In this case, we are talking about the U.S. dollar.  The dollar has enjoyed, for decades, what our guest today talks about as exorbitant privilege, and that is the reserve currency status.  But over the last week or two, especially, we have started to see things that are chipping away at that reserve currency status or the potential of it.  Even the IMF is now talking about China overtaking the United States at a much more rapid pace than what they had originally said.

David: On the same front, Kevin, the IMF said just two weeks ago the U.S. lacks a credible strategy to stabilize its mounting public debt.  They said it poses a small, but significant risk of a new global economic crisis.  They are looking at the balance sheet, the way our foreign creditors are looking at the balance sheet, scratching their heads, saying, “I don’t know if this is going to end well.” And interestingly, Mr. Eichengreen, in today’s interview, actually picks a date and says, “No, in fact, it might not go well, particularly if you are looking out on the time horizon and 2013 is of any interest to you.

Kevin: Let’s go ahead and put Mr. Eichengreen in perspective for our listeners.  This is a man who writes for Foreign Affairs.  He has written a number of academic books, published by Oxford University Press.  He would fall into the category of a Keynesian economist.  We have talked to Keynesians throughout the years, we have talked to Austrians, we have talked to monetarists.  There are different mindsets.  But, David, we truly are under a Keynesian regime, like it or not, right now.  So we actually have to consult the guys who have those central bankers’ ears.

David: Kevin, one of the most important things we can do on a regular basis is to understand the context that we are in.  So, to look at our political elite and wonder, “Who is the whisperer?  Whose is the informed opinion that they are relying on so heavily?”  That is where a Barry Eichengreen fits into the picture, because he has been professor of politics and economics at UC Berkeley for a good many decades, and he is an established academic.  He is well regarded for many of his books:  Golden Fetters, European Economy since 1945, Global Imbalances and the Lessons of Bretton Woods.

When it comes to monetary history and the interplay between politics and economics, this is a guy who is central, from any administration’s perspective, primarily because, whether it is Republicans or Democrats, guess what they are, primarily, when it comes to their economic views?  They are Keynesians.  So, who could they go to for an opinion?  The “best and the brightest” within that sphere.  And that is the role that he plays.  He is a seer, if you will, within a particular community, and it is vital, not only for our listeners, but our clients, as well, to understand that the decision-makers today have their influences, and if you want to see where we are going, it is an orchestrated – not an accidental – but an orchestrated decline in the dollar.

There are reasons for it.  There are influences behind those opinions, and there are things that are being put in place today which have a strong intellectual basis.  That is the importance of talking to a Barry Eichengreen, and maybe even reaching out and getting the book, Exorbitant Privilege, and seeing it as a script, not necessarily as an analysis.

Kevin: There you go.  Well, David, something that you have encouraged the guys here at the office to do for years.  We read a book a month, but they are not always books written by people that we agree with.  What is interesting is, if you read from all sides, you are going to make a much more objective decision on your investments than having a real strong political view one way or another.  That can really hurt your pocketbook.

David: Kevin, I have to say, this is an author whom I have learned a tremendous amount about, and my appreciation for his work is that, as an academic, he has gone through so many details, that for you and I as non-academics, we would simply be bored out of our minds.  But he has distilled them down, and saved us years, or decades worth of research and work, and put them into a format that we can spend a day, spend a weekend, spend a week going through.

Kevin: A monetary history education.

David: That is exactly right.

Kevin: David, let’s go ahead and talk to the author of Exorbitant Privilege, Barry Eichengreen.

David: 1977 was a very good year for both the United States and Portugal.  For us, we had 80% of international foreign currency reserves denominated in U.S. dollars, and for Portugal, that was one of the best years for port in a hundred years.  Some things have changed since then.  Now we are at only about 60% of foreign currency reserves.  They are still making great port, not quite the 1977 vintage, but we want to take a look at some of the things that are coming into the currency market, specifically, and our current international monetary regime.

The dollar has been the supreme player.  We have existed in a unipolar world for some time, and there are things that have been changing, and may actually be coming to cusp sorts of events, where we could see a more rapid change, even from this point.  This week we have had the U.S. debt put on negative watch by S&P.  Goldman has looked at GDP estimates, and revised them from 3¼ to 2½ and then to 1¾.  Our economy apparently is not growing as fast as they were anticipating it would.

What we see happening internationally is a recognition of balance sheet frailties in the United States.  The BRIC countries are seeking to diversify through settling trade in their own currencies, and they are looking for alternatives.  Do they have alternatives?  Will that include the SDRs suggested by the IMF many decades ago, or will it be new up-and-coming currencies like the euro, the renminbi, or what have you?  Today we have Barry Eichengreen joining us to explore past, present and future, as we try to wrap arms around what is happening in the international monetary regime and what it means for us today.  Thanks for joining us, Professor.

Barry Eichengreen: Good to be here.

David: Let’s start with the most newsworthy and present tense.  The S&P company has looked at U.S. debt and has determined that we are not quite as stable as we were once considered to be.  Maybe you can explore what they are looking at and what this implies.

Barry: Well, it is clear that S&P is worried  that, starting in 2013, the markets will lose patience with the U.S. political class, and all the debt that we are issuing, and that the dollar’s safe haven status could be jeopardized.  So my own view is that the S&P is not the canary in the coal mine.  They are simply telling us what we already knew.  The one thing they did was to put a date on the forecast that everybody is already worried about.  Starting in 2013, the market could grow impatient and fed up with chronic U.S. budget deficits.

David: We have current budget deficits.  We also have the outstanding stock of debt.  Roughly two-thirds of that has to be rolled over in the time period between now and 2013.  Do you think rollover risk factors into the S&P concerns?

Barry: I cannot speak for S&P but I think it should factor into investors’ concerns.  The treasury department is now embarked on a campaign to try to lengthen the maturity structure of the debt to reduce this rollover risk.  I think the very fact that they are engaged in that process is an indication that economists and officials in charge of U.S. economic policy are painfully aware that this risk does exist.

David: We looked this week at the Chinese Central Bank, Governor Zhou Xiaochuan, who is also concerned about, not only dollar holdings, but specifically, Treasuries, and is suggesting that they create new vehicles through which to diversify away from the U.S. dollar.  That certainly has implications for funding of future liabilities.  We need to, at least according to the congressional budget office, finance upwards of a trillion dollars a year, each year, for the next ten years.  If we do not have someone there to support the debt markets, where do you see interest rates going in that environment?  Do we see a 100 basis-point jump, a 200 basis-point jump?  Is this something where we are moving toward not only a dollar crisis, perhaps, but also a debt crisis?

Barry: I can imagine two different scenarios.  In the first one, foreign central banks, including People’s Bank of China, stopped adding to their holdings of U.S. Treasury debt.  The studies that were done of the last decade suggest that interest rates on U.S. Treasury bonds were 50-100 basis points lower than they would have been otherwise because of those foreign central bank purchases.  So, my scenario number one would be one in which interest rates go up by 50-100 basis points.

Scenario number two is darker.  That is one in which foreign central banks grow alarmed about fiscal and financial stability in the U.S. and they not only stop accumulating, but they actively dispose of some, or all, of their holdings, and that would be the dollar crash scenario in which the exchange rate collapses, interest rates shoot up, and so forth.  I am not predicting scenario number two, but I do think it is something to worry about, and that is why there needs to be a sense of urgency around budgetary negotiations.

David: On that point, the budgetary negotiations that are taking place in Washington, what was agreed in order not to shut down the government was roughly 38 billion dollars in cuts.  As a percentage of the deficit, that is only about 2.4% of the problem solved.  How do we make progress on that point?

Barry: I think we need to have a debate, number one, about entitlements.  So, say what you will about Paul Ryan’s plan – I personally am not a fan – but it ought to have put the issue of entitlements reform on the table, whether we are going to cut spending on Medicare and Medicaid, for example.  It is interesting that there seems to be some public support for the Ryan plan, but, at the same time, when you poll Americans, and ask them if they want to see cuts in Medicare, or cuts in entitlements, three quarters of Americans say no.  So we need a debate over that issue.

Finally, I think it is going to be, to put a label on it, impossible to solve this problem through spending cuts alone.  So politicians consider it poison to talk about tax increases, or about allowing the Bush tax cuts to expire, or even about revenue enhancement, but I think we are going to have to get there, and have a discussion about that, if we are ever going to solve the problem.

David: Certainly there is popular concern with recent news of General Electric moving back to a strong state of profitability and in recent years paying hardly anything in taxes.  I think that will be something that is voted for positively in terms of tax reform and an increase in revenues.  Certainly there is openness to that, if nothing else.

We have had problems in Europe.  We explored some of these in a conversation with Otmar Issing many months ago, actually, prior to many of these crisis issues coming to a head, and gleaned some insight.  We have progressed further into the midst of this crisis.  It is a fiscal crisis.  It is not solvable along the same classic monetary lines that you would expect, where you can just print more money if you have fiscal problems, because that, in fact, was an issue of sovereignty given over to the ECB, and these individual countries are no longer in control of their monetary destiny.

What is the way forward?  Is the way forward a greater cooperation at fiscal levels?  A greater connection politically?  Is that even feasible?  We have seen, whether it is Westphalia, or some of the other German states in absolute revulsion to Germany bailing out these other countries.  There are other issues involved, of course, in those elections, but it does not seem that there is popular approval, if you will, for a move toward greater political and fiscal connection.

Barry: Well, I think I would disagree a little bit with your characterization, which, I think, reflects Otmar Issing’s characterization, that Europe’s crisis is a fiscal crisis.  The recent crisis is a fiscal crisis, but elsewhere in Europe, it is basically a banking crisis, so step #1 toward solving it will be to strengthen Europe’s banks, and I think there has been progress there in the last couple of weeks.

Commerce bank, one of the big German banks, has announced it is going to raise more capital.  One of the big Italian banks is following.  One of the German state banks, one of the Landesbanken, has been instructed to raise more capital, and the European banking authority, kind of the EU overseer of the banks, has announced that they will hold the banks to pretty high capital standards in the second stress tests that are coming in a couple of months.  That is good news.  Once the banks are strengthened, it will be possible to restructure the problem debts of countries like Greece and Ireland and Portugal without bringing down the European banking system, without blowing a hole in their balance sheets, and that, I think, will be enough to draw a line under the crisis.

That is the good news.  The bad news is that there is going to have to be cooperation among governments, between countries, about how to do this and how to coordinate the bank recapitalization and the debt restructuring.  There are those revolts in Germany which you described.  There was the election of 19% of the vote earned by the True Finn Party with Sunday’s election in Finland, and they are opposed to financial assistance to the crisis countries, so it is going to be a hard political task to get the cooperation they need.

David: When we look at the U.S., we have seen a change over time.  We once were a creditor nation.  Looking at our own balance sheet and the issues that we have to sort through, if we are going to maintain reserve currency status, or perhaps that is something that is already slipping and cannot be maintained.  We would love your opinion on that.  But has becoming a net debtor put the U.S. in a precarious position, compromising our international influence?

Barry: Well, it certainly doesn’t help.  It creates a pressure point that, in principle, foreign governments can exploit in a dispute with the United States.  So one could imagine a dispute between the U.S. and China over Taiwan in the future, or over a policy toward Iran, and China could use its leverage in the U.S. Treasury market to get the U.S. to compromise.  That is what we, the United States, did to the U.K. in 1956 when they were part of the Suez invasion, and we threatened to sell sterling to get them to withdraw.

I think the situation now is different because the U.S. is big, and the U.S. Treasury market is big, whereas the U.K. sterling market was small 50 years ago.  If China were to sell Treasuries, big-time, in response to a dispute with the U.S., they would essentially be shooting themselves in the foot, as well, because they would be taking big losses.  But I do agree with the premise of your question, that it is not helpful to be in debt to the rest of the world.

David: When we talk about Great Britain and the Suez Canal, you have noted that a nation whose economy does not grow, loses political and strategic power.  In what ways are we witnessing that in the U.S. today?

Barry: I think to be a global power and a global financial and monetary power, in particular, you need three things:  First, you need a big platform.  You need a big and growing economy.  Second, you need liquid financial markets.  Third, you need stability – stability that breeds confidence in your currency, globally.  So the problem you alluded to earlier, that growth forecasts for the U.S. are being revised downward, is a real one, if we balance our budget by cutting spending on infrastructure and education and training for our workers.  It is going to be that much harder to grow the economy.

I think it is inevitable that the other poor economies will continue to catch up with the U.S. over time.  We were 50% of the world economy after World War II.  Now we are closer to 20% or 25%.  That is a natural evolution, but if we underperform in terms of growth, we accentuate that problem, and the migration away from the dollar takes place faster than it needs to.

David: Considering the dollar exchange rate, should further depreciation occur, is there a level at which American standards of living would be significantly impacted, in your view?

Barry: I think that were the dollar to lose its exorbitant privilege as the world’s currency, the currency used not only by central banks for reserves, but in international transactions of all kinds, the dollar would be likely to fall by some 20%, and that would translate over time, I suggest in my book, to about a 3% decline in U.S. living standards.  That is one year’s worth of normal economic growth.  It is not a disaster, but Americans would definitely feel it in the pocketbook.

David: We are not likely to continue consuming and investing a trillion dollars more than we produce each year.  You were talking earlier about exorbitant privilege.  The trade deficit is likely to come in line.  Isn’t the budget deficit of greater concern?  Could you look at those two deficits and say, “No, this is actually the greater concern?”  What is your view?  Which has been the greater advantage to us?  Being able to finance trillions of dollars of debt in the Treasury market, having that liquid financial market and with stability, being able to finance things into the future, or the exorbitant privilege that you speak of in regard to trade?

Barry: I think the budget deficit is, or soon will become, the fundamental problem, and external deficit of the United States, the trade and current account deficit, is the symptom.  So the fact that foreigners have an appetite for dollars means that they lend to us more freely than they would otherwise.  The question is:  What do we do with that funding?  Do we run yet bigger government budget deficits as a result, because we can currently place Treasury debt at low interest rates?  Does that remove some of the urgency that could be attached to the budget discussions?

I think the answer has been yes.  If we take that foreign funding and we invest it recklessly in a real estate bubble, rather than investing it in infrastructure, education, training, and other things that enhance the competitiveness of the U.S. economy, then yes, it becomes part of the problem.  But, fundamentally, in my view, the problem going forward will be the budget deficit, and I still worry that we do not have the kind of frank dialogue around that, and discussion across the aisle in the Congress that we are going to need to solve it.

David: The Obama Administration has estimated that the interest component on the national debt will be rising from just under $200 billion a year, to about $554 billion over the next five years, assuming a gradual increase in interest rates.  You suggested a couple of scenarios where, in fact, we could see interest rates bump up even more than that, perhaps even putting greater pressure on the interest component.  At what level are you concerned about the interest component on our national debt?

Barry: We will be in a situation when interest rates return to normal levels in 2013, or thereabouts, where, if nothing is done, one-quarter to one-fifth of all federal government tax revenues will go to debt service, leaving that much less for other purposes, so I am worried about 2013, like S&P, when the debt-to-national income ratio in the United States will be approaching 100% if nothing is done.  If at that point, interest rates are back up on Treasury debt, or back up at 4% or 5%, I think that is quite an alarming scenario, and the numbers it suggests are larger, in terms of the increasing debt service and burden, than the administration forecasts that you mentioned.

David: How do we keep our foreign creditors from viewing a mild inflation, whether it is 1½ to 2% target, or some other number?  Let’s say it gets ahead of us and it is 3½ or 4%, how do we have them satisfied, owning U.S. dollar-denominated assets, since we really are moving toward a subtle form of default?

Barry: Well, it is going to be hard.  In other words, private foreign investors have already begun to effectively curtail their purchases of U.S. Treasury debt.  It has been mainly the Fed and foreign central banks, almost entirely, who have been buying the new debt issuance, so I do think the scenario that you described is a plausible one.  The Fed is not going to be consciously attempting to inflate away the value of the debt, but it will come under pressure not to raise interest rates as quickly as otherwise, because raising them will make the federal budget situation even more difficult to solve, as we were discussing a moment ago.  That will translate into more inflation if nothing is done about the deficit problem.

You ask, “What can we do about this?”  I think the answer is to put in place a credible medium-term fiscal plan, so even if we cannot eliminate the budget deficit in the short term, indeed, I would argue it would be undesirable to eliminate the budget deficit in the short term because the economy needs that spending support right now, with slow growth and unemployment above 8%, but a plan about exactly what we are going to do starting in 2013 would be what those foreign investors need.

David: You mention, in your book, a meeting between Richard Nixon and the then-head of the Federal Reserve and pressure was certainly brought on the Fed at that time to devalue or goose the system, if you will, a little bit, create a little bit more liquidity, and in essence, create a little bit of inflation.  Help me with my concern about Fed independence.  In these periods of financial stress and strain, how are they able to maintain political independence?

Barry: The basic answer is that they are not able to maintain it, so central banks are embedded in the political system, like it or not.  They have to work as hard as they can.  They have to run as best they can to limit the challenge to their independence, to limit the erosion of their independence.  The Fed has already come under a lot of political pressure because of the unprecedented kinds of interventions in which they would have to engage during the financial crisis, and now the difficulty of backing those out.

But I think what the Fed needs to do to protect itself is to communicate clearly what its priorities and intentions and strategies are.  So I think, actually, it is a good thing that Mr. Bernanke has gone on 60 Minutes and the Fed has decided he should hold press conferences several times a year as a way of communicating what they are doing and why, and as a way of trying to remind the public of their mandate and reassert their independence of the politicians.  That is, effectively, all they can do.

David: This is a question relating somewhat to the Taylor rule.  We have kept a zero interest rate policy for some time.  We experimented with that in 2002-2003, and in your book you argue that perhaps the administration at that time kept rates too low, perhaps by as much as 3 percentage points too low.  Are we in a similar situation today under a different Fed administration, no longer Greenspan, but Bernanke, and does this tie at all into Knut Wicksell’s idea that if you keep interest rates too low, too long, they ultimately will go much, much higher?

Barry: I think there is something to that idea.  It is clear that the appetite for risk is back, and part of that is because of the very low interest rates and very low funding costs that investors who want to take a bet in U.S. stock markets, or Brazilian stock markets currently face.  What I would add to the point, however, is that hindsight is 20/20, that we can look back, I could look back in my book at 2002-2003 and say the Fed overestimated, with benefit of hindsight, the risk to the economy from 9/11.  But we didn’t know that at the time.

I think, in contrast, the risks to the U.S. economy and financial system in late 2008, early 2009, from Lehman Brothers, were very grave, and the Fed was fully justified in terms of lowering interest rates to support the economy and the financial system at that time.  Now we are paying a price for that, several prices for it, one of which is the return of excessive risk-taking.  But this is simply another way of saying that we dug a very deep hole for ourselves by allowing the financial crisis to take place, and, indeed, we are now paying the price of that.

David: As we move toward a conclusion today, in a recent article, you had on April 11th written about a tripolar currency system.  We have had the unipolar, dollar-centric monetary regime since 1944.  It has changed somewhat in the post 1971 era, where we have a free-floating system.  What do you see as the future for a monetary system?  Is it something that we, as Americans, should be concerned about?

Certainly, Great Britain is still a great country, even though they are not the leader that they were, controlling either the world’s land mass that they did, or having the kind of influence in the capital markets that they once had.  What should our concerns be as Americans when we look at the idea of a tripolar currency system?  Is it one of greater stability, or one of downgrade for us?

Barry: I am hopeful that it can be a more stable system than the one we have had for the last 20 years.  One way of understanding the financial crisis which we have been through is that there was an imbalance, or a tension, between what is an increasingly multipolar world, where we are no longer the only big economy.  There is also Euroland and China, among others.  There is a tension between this multipolar world economy and a still dollar-dominated, or dollar-centered monetary and financial system.

The world through which we lived was one in which, when we hang ourselves, we Americans, by engaging in reckless financial excesses, foreigners give us more rope.  They lend to us more freely, because they need our dollars for international transactions.  I think in a world where there are alternatives to the dollar in the global sphere, where there will also be the euro and the Chinese renminbi, the U.S. will feel market discipline more regularly, and earlier, if we show signs of engaging in those financial excesses again.

Ultimately, that will make the world a safer financial place, so I think ten years from now, when there will be three global currencies, we can look forward to greater financial stability.  The problem is that ten years is a long time, and history tells us that we tend to get a financial crisis of one sort or another, not every ten years, but more like every three years.

We go back to those three things that you mentioned, having a platform, a growing economy.  Certainly China has that.  Euroland, in total, does, with certain engines of growth, primarily.  Liquid financial markets.  You certainly see that with the euro more than the renminbi.  I am trying to look at those three things that you said that we need:  Liquid financial markets, stability, and a growing economy, to see which of those apply today, or are likely to apply more so in the future, for China and Euroland.

Barry: Euroland, first they need to work on the growth.  They need to work on the market liquidity, because they don’t yet have an integrated treasury bond market, Euroland-wide, and they need to work on the stability in places like Greece and Ireland and Portugal.  In the case of China, they have had the growth, although there is debate at the moment about whether and when China will slow down.

They need to continue to work on the stability because there are also worries about Chinese financial markets and a housing bubble and so forth.  But most of all, they need to work on the market liquidity.  I think they are serious about that.  They have said by 2020 Shanghai will be a true international financial center, which means, they will have to have liquid markets that are open to the rest of the world.  China is moving in that direction.  They are, in fact, making faster progress than many people appreciate.

Looking at things this way reminds us that the greatest strength the dollar has, in terms of remaining the leading global currency, is that the obvious rivals, the euro and the renminbi, have plenty of problems of their own.

David: So, being the incumbent does have some privileges.

Barry: In normal circumstances.  Think about an incumbent politician.  Normally, incumbency makes it easier to get re-elected, but if there is widespread dissatisfaction about the policies of the government, voters turn around and say, “Throw out the bums.”  My worry is that if there developed widespread dissatisfaction and skepticism about U.S. economic policy in the medium term, there could be, similarly, a flight from the dollar and that would not be a good thing for the U.S.

David: Perhaps this last question is more on the political than the economic side, but as Harold James pointed out in his book, The End of Globalization, there exists potential international conflict in the period ahead, as individual nations prioritize domestic constituency groups over international cooperation.  It is a similar theme that Mr. Kagan picks up in his book, The Return of History and the End of Dreams.

I am interested in what your opinion would be.  What risks do we run today of seeing the world move toward greater insularity, and away from a cooperative relationship?  Would that include the re-emergence of capital controls, as individual countries clamp down on their version of security and stability?  Might the EMU be the reasonable test case to watch and see how this unfolds?

Barry: My view, contrary to Harold’s, is that globalization has come very far and is now very deeply embedded.  I do think there will be strains, and that we will continue to see more use of capital controls by countries that are having trouble managing financial implodes.  There will be trade disputes between the U.S. and China, and difficulties in the Congress in ratifying proposed bilateral trade agreements.  I am pessimistic about the successful conclusion of the Doha round of trade negotiations.

But all that said, I don’t see globalization being rolled back.  I think global supply chains are too fully developed.  I think Chinese foreign investment has gone too far for the Chinese to turn their backs on globalization.  They need our technology and they need foreign energy too desperately to do that.  So, clearly, there will be strains, there always have been, and I think governments have always prioritized the needs of domestic interest groups over international cooperation.

It is only when we have had extraordinary leadership, as I think we did briefly at the beginning of 2009, that leaders have been able to come together around the necessary cooperation.  I don’t know if all this renders me an optimist or a pessimist.  I don’t know how much cooperation we are going to have, but I do think that globalization will survive.

David: If you will allow one more question, the inflation issue is one that is becoming of greater concern as we talk to people all across the country.  There is one thing that I am recalling from a conversation with Giulio Gallarotti, and that is that while the gold standard would never be reintroduced, and gold is no longer a part of our money system, something that has a discipline, should be, or needs to be, introduced into our money system.  What are your thoughts on that?  Should we be concerned about inflation?  And is there something that needs to change with the dollar in the way the Fed handles our currency, to introduce a characteristic, perhaps, of the gold standard without going back to gold, specifically?

Barry: I think the right way to think about this is in terms of the Fed’s mandate.  The Fed has a dual mandate to pursue two objectives:  The first one is price stability – low and stable inflation.  The second one is full employment.  There are people, I am not one of them, but there are people who say this dual mandate is part of the problem – that we should eliminate the second part, which requires the Fed to worry about the pursuit of full employment, and require the Fed to keep its eye on inflation alone.  If you are one of those folks who is worried about the prospect of runaway inflation in the not-too-distant future, I think the right way to respond to those fears, and the right question to inject into the political debate, is whether we should be narrowing the Fed’s mandate or not.

David: That is very helpful, and I appreciate your time today.  We look forward to continuing a conversation into the future.  Thank you for your most recent contribution, Exorbitant Privilege, The Rise and Fall of the Dollar and the Future of the International Monetary System. This is one of many books we could recommend, but certainly one that is approachable, and gets to some very critical issues being discussed to day or need to be discussed today, and our listeners would be that much more informed and able to contribute to a dialogue, having read your book.  So, thank you for joining us.

Barry: Thank you for the kind words.

Kevin: David, Barry Eichengreen has the ears of an awful lot of decision-makers worldwide, so he has to be careful what he says.  But a couple of things that he focused on over and over were this day of reckoning, possibly in the year 2013.  He was careful not to call it a day of reckoning, but if you read between the lines, he is concerned.

David: Kevin, I think for good reason.  If you look at the BRIC countries’ decision to seek diversification through settling trade in their own currencies, if you look at the Goldman downgrade of GDP growth, if you look at U.S. debt being put on negative watch by S&P, what he is addressing in the book is very central to what is happening in today’s news.  Dollar supremacy, what he describes as the unipolar world, moving to a more tripolar world – that is interesting.  And the fact that this is wrapped up in a bow, particularly – greater global stability?

That has my particular interest, that we are seeing a U.S. downgrade as universally beneficial.  That is worth considering – not necessarily from the standpoint of agreement again, but what is happening is a shift in opinion.  We used to view having a strong dollar as the greatest way forward, and certainly a benefit to U.S. citizens.  Now there is a shift in academia.  A shift in academia ultimately leads to a shift in policy.  A shift in policy ultimately leads to a shift in what we experience as citizenry, and what is that?  We should prize a dollar that is worth less over time.  I am not sure how we get there, but we do, in fact, have some things to learn from this book, Kevin.

Kevin: So, what they are telling us is we should prize it, and maybe it would be best for us, even though that is a downgrade in our standard of living.

David: And I think it is worth going through the different points in this book, whether it is development of U.S. financial markets in the 1920s and 1930s.  In 1930s Britain, seeing the support that they gave to the banking system, very much like what we are doing right now.  There are some interesting parallels as you go back to the downgrade that occurred in Europe circa the 1914 to 1950 period, that World War I, World War II, post Bretton Woods era, and what we are seeing happen today.

Kevin: Yes, from a historic standpoint, there are a lot of parallels to what we have seen before, not only in Britain, but with France now, cashing dollars in for gold back in the 1960s.  He talks about that.   We have that same cashing-in occurring with China and Asia right now.  It is not being done over an official table from the U.S. government, but they have been accumulating a lot of resources.  You have, also, the parallels with the Suez Canal that he talked about.  He mentioned that in the interview, how we applied political pressure on Britain just by not supporting the pound.

David: Kevin, I think the strength of the book was smack dab in the middle where he is talking about the development and the history of the EMU and the euro, and there you see a projection forward, what it will take for the EMU to become that much more significant, including British participation in the monetary union.  There are a number of things that remain questions in my mind where I think more explanation, and I think a deeper exploration, is needed, particularly when it comes to the renminbi in China, and whatever headwinds they are facing currently, seeing new numbers that real estate there is actually in free-fall, the bank raising reserve requirements now to north of 20%, and trying to get ahold of inflation, and what are the consequences of that into the marketplace?

I think for the renminbi to take a regional role, or ultimately a global role, as a foreign currency alternative, we are going to have to see some interesting things occur there, and, in coming months, we will have a few experts that I already have in mind, to address those particular issues relating to China and the growth in Asia that we are seeing, and what might impair it.

Kevin: That will be something that we will continue to investigate, as the months go on, with this program.