Perry Mehrling on Trump's Echoes of the Nixon Shock

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0:38Canva brings your ideas together in one place with one powerful app. Use AI to move faster. Collaborate easily because great things happen when people create together. No wonder 95 % of Fortune 500 companies use it. Canva lets you bring your big ideas to life as fast as you can think of them. Put imagination to work at Canva.com. Hey there, OddLots listeners. The following episode was recorded May 2nd on the Princeton campus. Obviously, some things have changed since then, but I still think it's a very interesting and relevant conversation. So take a listen.

1:32Hello and welcome to another episode of the Odd Lots podcast. I'm Tracy Alloway. And I'm Joe Weisenthal. Joe, do you feel like you are hearing the term exorbitant privilege a lot more than you used to? Yes. Is that a loaded question? Maybe it is. Yes. You heard it a lot, you know, large budget deficits, right? Those were explainable or people claimed that they were explainable because of something called exorbitant privilege. I've never totally known what that term means. But obviously, with some of the policy volatility in the United States, which is a very nice way of putting it, you hear it again and whether it can last or whether it can be exhausted.

2:10So I had the same reaction to you. I started thinking about it like, why are we hearing this over and over again? And then I was curious when we first started using that term. And I think to your point about what exactly this means, we first started using it in the 1960s and sort of going into the early 1970s. Yes. And it was this idea that because we had built the financial system around the U.S. dollar vis-a-vis Bretton Woods, which we've talked about on the show, that the U.S. was in this, you know, privileged position where it felt like people in other countries were basically subsidizing the U.S.

2:45lifestyle. The constraints that typical countries might face in terms of spending don't, to the same extent, seem to apply to the United States. In general, when it comes to talking about the dollar, I find that there's just a lot of sloppy definitions thrown around. People talk about dollar strength, but they're not always clear whether they're talking about dollar-euro as an exchange rate or dollar share of transactions or dollar share in reserves or the global reserve currency or the global safe haven assets. It's lots of fuzzy defined terms that unsatisfy. That's totally fair. I don't get as mad at fuzzy terms because we don't have all day.

3:21Like, do we have to define everything into like obsolescence? No. But anyway, speaking of someone who probably also doesn't like fuzzy terms, to your point, we have the perfect guest to talk about all of this. And I guess a big moment that keeps coming up on our show quite a few times over recent episodes, and that is the Nixon shock. The Nixon shock. Right. Right. Because people look at the tariffs that Trump announced on April 2nd and the reach for historical analogies about the changing relationship between the U.S. and the rest of the world in part via trade and part via currency. And so much to mine from the past.

3:56So we have the perfect guest and we're actually at the perfect event to do this as well. So we're at Princeton University. That's right. We came down here. We did a podcast, which either if you're listening to this, either it's going to come out or you'll have already heard it, depending on the sequence. We're at a conference. Brendan Greeley invited us down, a conference on currencies and what is a currency and so forth. How to write a biography of a currency. That's the name of the conference. So anyway, yes, a perfect guest at the perfect context to talk about the dollar. OK, so we do have the perfect guest.

4:25We're going to be speaking with he's a longtime Outlaw's guest. Yes. Although he hasn't been on for a while. He's been in a few years. Yeah. We're speaking with Perry Merling, a professor of international political economy at the Party School of Global Studies over at Boston University. Perry, thank you for coming back on the show. Happy to be here. Great to catch up with you in person. Okay, I'm just going to jump in with the exorbitant privilege question because this keeps coming up. Is the U.S. dollar's role in the global financial system a net positive or a net negative for the country? Well, I guess it depends on who you ask.

5:00Yes, for sure. You know, this exorbitant privilege thing, okay, was coming from Europe, okay? So clearly Europe, France in particular, was viewing this as a net positive for the United States and a negative for themselves. But in the United States, there was coming to be a view that it was a net negative, that it was an exorbitant burden. And that, in fact, that something about being the international reserve currency was getting in the way of our manufacturing development and overvaluing our exchange rate. And that became a theory that was accepted by the political forces. Just to be clear, we're talking in the 1960s.

5:37Correct. And there was a French politician, I think, who first said that term. I think it was your scar to say. But the important point is that the view from one side of the Atlantic and the view from the other side of the Atlantic were quite different. So, yes, let me take you back to the 60s. OK. One way to understand Bretton Woods, 1944, OK, was that this was a pass off from sterling pre-World War I to the dollar to build the post-World War II international monetary system. And so the bankers in New York thought, oh, that's just great. New York will become like London. London had been the center of the world money market, the center of the world capital market with sterling before World War I.

6:16And all the bankers knew that. And they had been chomping at the bed to do this for a long time. OK, so that's what they thought they were doing in building up during the 50s. But in the 60s, there started to be political resistance in the United States and the United States government started to put taxes on people who came from abroad to float bonds. And and they tried to prevent it from happening. They tried to prevent it from happening. This is sort of American politics that Americans are very suspicious of finance. Probably, you know that. OK, especially globalist financiers. Yeah. Yeah. And so that even.

6:49So there came to be some view that this was very bad for America, you know, and so they tried to kill the private capital markets throughout the 60s. OK, there were various interventions. I go through in my book on Kindleberger. But the denouement of all of this was 1971. OK, August 15th, actually, 1971, when Richard Nixon took the dollar off gold, which was the promise that had been made at Bretton Woods, and increased tariffs by 10 percent. This was intended as leverage for forcing our allies to revalue their currencies. So if you have the view that the dollar is overvalued because it's a reserve currency, you can force your allies to revalue their currency.

7:27So that happened, actually, in December of that same year, 1971. The yen went up and there wasn't euro then. So this is August 15th, 1971. on. Okay. The reason I go through this in some detail is that I think that the current events, the events of the last, is it only two months? Okay. Yes. Two months. Yeah. Are quite analogous to what is going on. Okay. And in fact, some of the theories that were around back then have been re-emerged, you know, and so it's as if no time has gone by. Okay. And Mr. Trump is replaying the Nixon handbook, but times 10 because he's doing much more tariffs. Of course, the world is much bigger than this was really just a U.S.

8:09versus Europe spat. Okay. You know, even, you know, getting Japan to revalue was not such a big, Japan was not a big player yet in 1971. You know, Europe was the main object of this. And the pound sterling and the French franc and the Deutsche Mark, you know, they were separate currencies at that time. They had, the euro had not just happened. So the world is now much more global. And so it's quite a different kind of a shock. It's a much more comprehensive shock. I think a Nixon playbook times 10 is a very promising headline. I literally just wrote it. I know it's a very promising headline for this episode.

8:43I'm just curious, the premise that the dollar is this global reserve asset leads to an overvaluation. You know, a country cares about overvaluation because it wants to have competitive exports or that seems to be one theory. Does that actually bear out in the facts? Because when I, you know, as I sort of said in the intro, you can talk about a dollar strength in terms of its reserve status or trade status or dollar yen, dollar euro. Is there actually a stable relationship between the dollar share of X versus the exchange rate? Well, this is a debate among economists, and there's empirical studies on both sides.

9:21I incline to say no, okay? And in particular, there no now, OK, because so much of the dollar system is offshore. So you can get dollar reserves if you want, you know, by having a euro dollar deposit in France, you know, that is not touching the U.S. shores at all. So some of this argument, you know, is outdated, you know, that the globalization of the dollar, the fact that the U.S. refused to make New York into London has led the world to become a dollar system. And so I don't know that those arguments work quite so well. I'm not sure those people who are making them, you know, have paid attention to the way in which the world has changed since 1971.

10:05Well, speaking of what changed after 1971, there's one more historical question that I want to ask you. And please forgive me for not remembering this from your book. But Charles Kindleberger, what did he think was going to happen after Nixon unveiled all his policies. So he was very worried about this because he had just finished this book, The World in Depression, that made the argument that when Sterling was forced off gold in September of 1931, that the failure to do the pass off to the dollar at that time meant that there was no world currency. And so there was a collapse of world trade and we had world depression.

10:46And the reason he calls it the crime of 1971 is that, in fact, the U.S. was not forced off of gold. This was a decision by the president to just abrogate these agreements. So he felt this was a failure of responsibility that was just wrongheaded and it came out of nowhere and there was no reason to do this. But Nixon was very clear about this, that he saw the dollar system emerging and he just wanted to kill it. And it was America first and he wanted to kill it. And as I say, the bankers wouldn't let him, but that's a little bit longer story. But that's not what happened, right? We didn't have deflation.

11:20We had inflation in the mid-1970s. And we saw the rest of the financial system sort of expand to absorb what had been lost through the Nixon crime. I'm doing air quotes here. He certainly didn't kill the dollar system. He did not kill the dollar system. It took a while to put it back together again. I grew up in the 70s. I think I'm a little older than you. I was in high school in the 70s, and it was not a pleasant time to be alive. Stagflation. You've heard the word stagflation. So where you have unemployment and inflation at the same time. And it was about there was a breakdown of the international monetary system.

11:52The story, the important date for that is maybe 1973, because I haven't filled in the rest of it, that after the stabilization of exchange rates in December of 1971, the revaluation of the yen, as I say, Nixon took advantage of that new fixed exchange rate to try to get himself reelected. by leaning on the Fed to lower interest rates. And the Fed did lower interest rates. But the rest of the world did not. And so now you have a real problem because with a fixed exchange rate, you have free money by borrowing in dollars at a low rate and lending in Deutschmarks in Germany. And the central bank of Germany has to defend the exchange rate.

12:29And so they have to absorb all of this. And they did until they couldn't or decided not to. And so after 73, there was just floating exchange rates. And so I think that is a kind of incipient breakdown of the international monetary system where you don't have stable exchange rates. And Kindleberger thought that that could be a replay of the hot money periods of the 1930s where speculators would say, I need to be safe. Oh, I should be in the pound sterling. And then they would say, no, I think maybe the pound sterling is going to devalue. I have to be in the French franc. No. And as a consequence, they're destabilizing all the exchange rates.

13:04And with the exchange rates fluctuating like that, how can you plan? So it basically broke down capital flows, short-term capital flows, long-term capital flows, trade. So the whole thing broke down. And so he was afraid that that would happen. But it didn't happen because the bankers wouldn't let it. And in particular, the BIS played an important role in providing currency swaps for countries that were under attack. They were taking the opposite side of some of these trades. And gradually, we built what we now experience as the offshore dollar system, where there's dollars borrowing and lending offshore.

13:36Doesn't touch New York at all. That happened during the 1970s as a consequence of these policy actions in 71 and 73. And by 1979, when Volcker comes, this is the time when the United States is now taking responsibility again. OK. And you now have the infrastructure, you know, where it is offshore. OK, so maybe it's more politically acceptable than it was in the 60s. And then we go to the races. You know, it takes a little while for the, you know, go to the races, double double digit interest rates at 20 percent interest rates. I remember that, too. You know, I was in college then and taking out student loans.

14:13And so it wasn't until 1985 at Plaza where the rest of the world sort of they actually agreed to some parodies and so forth. So but the system got put back together again. That's the story. And I think maybe that's a hopeful story. for this moment. The Nixon Playbook.

14:44Your best restaurant location gets five-star reviews. How do you make every location like your best location? Your best paper mill has been operating at peak productivity. How do you make every mill like your best mill? Your best data center has optimized every drop of water. How do you make every data center like your best data center? The answer is Ecolab. Better performance, better outcomes, better impact. Ecolab. Now every location is your best location. How many vendors does it take to meet all your organization's food needs? Just one. Easy Cater, the workplace food platform that lets teams order from a huge variety of restaurants, over 100 ,000 nationwide, all through a single vendor.

15:30In addition to all that variety, Easy Cater also gives you full visibility of your organization's food spend with invoicing, centralized reporting, and seamless integration with expense management systems, all on one platform. Easy Cater, your business tool for food. To learn more, visit easycater.com slash podcast. Before we get to the current moment, this is just a theoretical question. When you look at the world economy, either in the past or specifically now, does it inevitably tend towards sort of like one dominant currency? I mean, you know, there's obviously countries hold other currencies, too.

16:07They hold euros and they hold some Swiss franc, probably, and maybe a little gold, etc. But is there a tendency towards like a power law distribution where one typically becomes the currency kind of like in social networking? It's like there's Facebook and then everyone else. I don't think that's the right analogy, power law distribution. I know what you're talking about there. There is a tendency, but it comes from sort of efficiency in exchange. Okay. Kindleberger always made the analogy that before we had the Fed, there was not par clearing between California and New York. Right. So that was itself a sort of tax on trade inside the United States.

16:41And you weren't really sure how it was going to work. And there wasn't par check clearing and so forth. With the creation of the Fed and with war finance, that all went away and we got par clearing. So he was always impressed by the analogy, if this was a good idea for the United States, maybe we should do this for the world as well. And he saw, as I said, this hot money. When you have multiple key currencies, you are inviting speculation. So you're destabilizing the exchange rates. And therefore, that's a tax on trade and on capital flows. You don't want to do that. OK. Now, the analogy with the United States, you know, in retrospect, went too far because he was a big advocate of fixed exchange rates.

17:17And it seems like that's a bridge too far. That's too demanding. So we do not have fixed exchange rates. We have managed floating exchange rates that are managed through joint intervention of sort of the club of six, the major central banks. This is another Kinderberger point, that if you stabilize the core of the system, then you stabilize the system as a whole, that there will always be countries that are facing crises and so forth. But as long as you stabilize the core, you'll be all right. The system as a whole will be all right. That's why the global financial crisis was such a problem, because that came from the core.

17:52It threatened the core. You may remember. I don't know if you were doing odd lots yet then. Not quite, but we both got our start in journalism in 2008. You're a financial journalist. And, you know, they thought the world was going to come to an end and that was the end of the dollar and all of that. But in fact, what happened was the expansion of the dollar system to the global south because of zero interest rates in the north. And so this offshore dollar system that, as I was saying, was given a big boost by the Nixon shock of 1971. In retrospect, as I say, it was not pleasant to live through.

18:21OK, was given a big boost by the global financial crisis. OK, and now we have the Trump shock. OK, that's happening. And so I think that the lesson of history may be that the bankers won't let them, you know, but it's going to be painful. It's not going to be pleasant. But I do not think that the dollar system is going away. I guess the obvious question to ask after that is, OK, we have these other moments in time where there was a crisis in the dollar system and yet it came back stronger. And I guess the question is, is Trump different to the policymakers that were in charge at that particular time?

19:00He seems much more interested and willing in trying very, very new things and potentially destroying some really, really big things. Is he going to want to maintain that system? I'm thinking, you know, something specific like the dollar swap lines. You can imagine the headlines if the Fed is extending billions of dollars to Europe or something. Imagine how Trump would feel about headlines about Americans bailing out Europe or something like that. Yes. So this is another thing that is different today than it was back then. As I say, Arthur Burns caved in to Mr. Nixon, helped him try to get reelected.

19:39Economists know this. And it's a shameful episode at the Fed, you know, that that should never be so. That should never be so. So what we're seeing play out right now is quite a different drama. OK, Mr. Powell is not caving in. Mr. Powell is very publicly going and saying that liquidity swap lines are in place and I am not lowering interest rates. OK, until I see that the inflationary effects of these of these tariffs are not going to undermine our economy. And so there is a conflict that is developing there, an immovable object facing an irresistible force. And so it's just started. It's just started.

20:17But that's very different from 1971. And the other thing that's different from 1971 is that the apparatus of the offshore dollar system is up and running. You don't have to create it. It exists. It exists already. And I'm sure it's being put into force already that you can move a lot of this stuff offshore. And you will. It is a little peculiar that we're talking about it's a globalized financial world. The extent to which is a global world is much more true in finance than it is in trade, notwithstanding global supply chains and everything like that. But, you know, it takes a long time to get a car from China to New York, you know, through the Panama Canal or whatever.

21:01It doesn't take any time for money to flow this way and that way. So and they're not putting any tariffs on capital flows. They're not putting it. So the financial system is not being threatened. This financial system that grew up over this period, maybe I shouldn't give them any ideas. Well, I mean, there is some discussion of the possibility. What sort of thing? Well, for instance, maybe, I mean, they've done some stuff around Chinese companies listing in the U.S. And there's talk about maybe you stop U.S. investors from investing in China or something like that. So that's the same thing as the Nixon playbook.

21:36That's in the 60s. You're trying to push that offshore somewhere. And so there will develop other financial centers. And that will take a while. It takes a while to develop. But there are a number of competing financial centers. You know, London was happy to take the euro dollar business. They were like champing in the bed. We know how to do this. We did this for sterling. We just need to change the little symbol in front and we can go. You know, it took a while to make it all go. It was the old guys who remembered, you know, and they had to teach the young things. But the structure was there.

22:04And so it could happen again. But I'm just saying it's there now. You don't need to build it. You don't need to build it. And so I think that the chance that it's going to all fall apart, OK, it's much bigger now. So that makes it harder to manage. OK, but it also means that it's evolved through crisis before from, you know, every time it's counted out, it's come back stronger and not just stronger, but expanding over the face of the globe. There are these phases, you know, in 1971, it was the U.S. versus Europe. Then there's the Asian financial crisis, which I understand as the way we were integrating Europe into the global dollar system, that it expanded and then you had to consolidate.

22:43Now it's gone to the global south. We expanded and now we're in consolidation phase. So I think we could come out of this with a more robust system that's actually energetic and has growth. But politics are the problem. Are the Americans going to be okay with this? Are the American political forces going to be okay with this? Can a new political agreement between countries be made about this? And so that's where I'm out of my depth. I don't really know. I don't really know. What I have observed in life is that the financial system sort of grows, grows, grows, grows. And then the political system decides, should we bless this or should we kill it?

23:21So there's a political settlement. And then you grow, grow, grow, grow, grow. And then it happens again. So that's how I see what's happening now. Now, for me, as a library rat, as I am, you know, there's just too much noise. I don't know what's noise and what signal at the moment. So and I do think that this, you know, attempt to play games with market valuations by announcing tariffs and then taking them off but telling your friends beforehand, you know, is very bad for market liquidity. You know, why would you be a dealer to take the other side of these trades? OK, if they're just going to take this money away from you, you know.

23:54So I think that's another place where there's stress in the system and pushback. You noticed in the last week, you know, the lack of liquidity in treasuries and things like that. I think that's a lot of what that's about. It's that the system seems to be rigged. Let's just talk about the events since April 2nd for a second, because they're really, and you alluded to it already, but there's at least two dimensions. One is the sort of pure economics of tariffs. It's a tax hike. One useful way to think about tariffs, efforts to reshore manufacturing, perhaps efforts to kneecap China specifically.