The Hidden History of Eurodollars, Part 2: Defending the Dollar System

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1:11Bloomberg Audio Studios. Podcasts. Radio. News.

1:21Tracy, are we still doing this? It seems like it. Actually, what is this supposed to be? Is this a Cold War bunker or something like that? That's a good question. Maybe it's a vault or the Vienna sewage system, like in the third band. Do you remember that? That was a good movie. I should see that. Okay, but in this episode, we've moved on from the immediate post-war period. We are now in the 1960s, a turbulent time for society and politics, but also for Euro dollars, which are the subject of our special series. Yep, this is the second installment of our three-part history of Eurodollars. If you haven't listened to our first episode, you should definitely go back and find it.

2:01We have been tracing the origins of this very particular and special form of money to better understand how it came to be and what it actually does. And our first episode looked at the creation of Eurodollars and their perhaps unexpected communist connections. Yep, that's right. And now we're going to turn the page, new decade, a new chapter in euro dollar's existence. There's something else new that happens right around this time. So dollar swap lines get created. Do you remember those, Joe? I read about them in that Adam Tu's book, Crashed. But yes, they were big in 2008. Then again in 2020, also the eurozone crisis.

2:41They're basically something that no one ever talks or thinks about outside of a crisis. Yeah, I think that's right. So they are dollar borrowing lines for other central banks. And I've seen swap lines described as the international lender of last resort. They tend to, as you mentioned, get tapped during big emergencies. That's when we hear about them. But swap lines basically allow central banks to exchange currencies. And in this case, it is all about getting dollars. And as a reminder, our storytellers for these episodes are Lev Menand and Josh Younger. I'm Lev Menand. I'm a law professor at Columbia Law School, where I study money and banking and the history of central banking.

3:22I'm Josh Younger. I'm a policy advisor at the Federal Reserve Bank of New York. And the views I am going to express are my own and not necessarily those of the Federal Reserve Bank of New York or the Federal Reserve System. When we left off, we were at the end of the 1950s. The euro dollar market was just a billion dollars or so, but it's grown from pretty much nothing. And so it's starting to attract more attention from policymakers at central banks. And now, as we enter the 1960s, euro dollars are even going to hit mainstream politics. Let's take a listen.

4:28So now it's the fall of 1960. Kennedy's run for president in a very tight race against Vice President Richard Nixon. And in the background, the monetary system is in crisis. And it's really showing signs, not just of fatigue, but of potential collapse. And so to understand why that could happen, like what does that even mean, especially in the context of the 1960s, we kind of have to go back to the war. So it's 1944 now. And 44 countries are convening in Bretton Woods, New Hampshire. Small town, big hotel. They took up most of it. It's about 700 people. And the whole premise of this is to find a way to restructure the global economic and monetary system after the war is over.

5:10It's a little presumptuous, right? The war isn't over yet, but they're still planning ahead. And so, you know, we hear a lot about Yalta and Potsdam and the big conferences about the partition of Europe and Berlin and so forth. But this is really among the most important of these post-war planning conferences. It's the brainchild of Harry Dexter White, who most people haven't heard of as well. He's been at the Treasury since the mid-30s. He's a PhD economist, doesn't really like where he ends up for teaching. And Milton Friedman's professor recruits him to go to the Treasury to work for Morgenthau, who's FDR's very long-serving Treasury Secretary.

5:44I think he's the second longest serving after Gallatin, who was Jefferson's secretary. So he has the job for like 12 years, which is a long time to be a Treasury Secretary. And there's really two competing visions going into this conference. The first is the American vision, which is a dollar-based global monetary order in which gold forms the foundation. So your dollars are convertible into gold. All foreign currencies, at least among the victors, are fixed in their exchange rates, are pegged to the dollar. And so everything kind of revolves around the US dollar and the gold stock that the US has accumulated over the course of the war.

6:22The US has two-thirds of global gold reserves at this point. So it's monetary gold reserves. So they have a lot of, let's say, leverage going into this conference, and they know it. And that's been a dream of White since basically he joined the Treasury. He's been pushing for a global dollar system. He really wants the dollar to retake its prior position. Remember, in the 20s, the dollar was the global reserve currency. It was the currency of trade. It lost that status over the 30s on a series of runs on the dollar. So he's very familiar with what happens when this breaks down. And he wants to bring the dollar back.

6:51This is the second bite at the apple. And so he wants the dollar to be part of global trade. He wants to be the unit of account. He actually wants all the invaded territories to use the dollar. So he wants invasion currency to be printed by the treasury. They call them yellow seal dollars. So he wants dollars everywhere, including in North Africa, Germany, etc. And they actually do that in some places. And the British, on the other hand, are very wary of this, in large part because they don't have any gold. And so they have no leverage. But they're worried that the U.S. will come out of this conference with way too much global power, especially relative to the European allies.

7:24And John Maynard Keynes is their champion. He comes up with an alternative arrangement. He calls it Bancor, which is a contraction of bonk and oar in French. I promised earlier I wouldn't do French words, so I apologize for the accent. But it's bank gold, which is the idea is there is no global currency issue by one country. There's only a transnational credit organization, kind of like a bank, where international trade happens on the books of that organization. So it's something like a transnational central bank. And it involves everyone giving up their sovereignty to some extent to facilitate global trade in what he considered sort of a fair and less arbitrary way.

8:02Meanwhile, White is very aware of the potential sacrifice of sovereignty to use the dollars of global reserve currency and the global unit of trade. It's just he would prefer everyone else to sacrifice their sovereignty rather than the U.S. And so in the end, basically the U.S. wins. And they win because Lionel Robbins is one of the UK delegation. This is in Ben Steele's book. He basically says we needed the cash, right? So they don't have a lot of leverage. This is a power grab by the US. The US is by far the biggest economy in the world. It has the prevailing military in the world. And there's an opportunity here for real internationalism and cooperation around global trade and the monetary system that facilitates it.

8:44And the US rejects that. And essentially imposes an alternative system that puts the U.S. much more in the driver's seat and everybody else in a more subordinate position. It's also very human elements. Like by the end of the Bretton Woods conference, it's three weeks long. No one thought it would go that long. They're tired. They're hungover. They went through a lot of liquor at this conference. There's no food left at the hotel. And so, like, everyone just kind of wants to go home. Now, that's not a great reason to sign the world over to the U.S. as a dollar-centric universe. But there really is like a human element to how all of this goes down.

9:19That's kind of one of the themes to this whole story. And multilateralism is hard. And there are a lot of frictions to get countries to cooperate on really, really high stakes issues for their domestic economies. And we'll see in the course of this story how cooperation often breaks down and shortcuts prevail over longer term, higher cost solutions to problems. So the Bretton Woods system is one in which for$35, you can have an ounce of gold from the treasury and specifically foreign central banks. You have to be an official institution. I couldn't get$35 for gold, but the Bonk de France could.

9:57And so the US is, in a sense, the world's banker because they're issuing dollars and they can, in principle, issue more dollars than they have gold. So it's not a fully reserved system. There's leverage embedded in the international system. And so that happens pretty quickly because global trade expands and the US monetary gold stock is not increasing. Actually, most of the gold production is in Russia, so they're not giving it over so easy. And so over time, the world needs more and more dollars, and the value of those dollars implicitly starts to decline. Now, what does that mean in the context of a peg from the treasury?

10:32If the treasury will always buy your dollars for an ounce of gold for$35, what does it mean for the value of the dollar to go down? Well, that's not the only gold market in town. And soon, on the continent, in London, at the metal exchange, it costs a little more than $35 to buy an ounce of gold. And that's really a consequence of non-monetary demand. So you have some speculators, a huge fraction of gold in the world is held up in jewelry. That's a real thing. So there's reasons you would want gold other than to back your currency, I think it's fair to say. And there are more and more of those reasons and more and more demand for those purposes over time.

11:03And so this introduces a fundamental instability into the Bretton Woods system, because if a foreign central bank is exporting to the US, the US is running a balance of payments deficit, That means they're importing more than they are exporting. Dollars are piling up in Europe. Those dollars can, in principle, be exchanged for gold at$35 an ounce. That gold can be sold for$35.15 an ounce in London, and sometimes much more than that. And so slowly at first, then all at once, so to speak, the U.S. gold stock starts to decline at the same time as their dollar liabilities are going up. So now you owe more gold, in principle, to more people, but you have less of it with which to pay them.

11:42That's a bank run. or at least a slow motion bank run. And so people get really worried that this is going to just accelerate and they need some way, essentially the staunch of the bleeding. So you have a couple of options. And I should say this becomes an election issue in Kennedy-Nixon. I mean, it comes up in the third debate. There's a big shock to the price of gold in October of 1960, where the price goes to$40 now, which is kind of insane if you can buy it from the treasury at 35. and it kind of sticks there for a little while. And so Nixon is out there saying, well, Kennedy's going to blow up the dollar.

12:15Mr. Vice President, in the past three years, there has been an exodus of more than$4 billion of gold from the United States, apparently for two reasons, because exports have slumped and haven't covered imports and because of increased American investments abroad. If you were president, how would you go about stopping this departure of gold from our shores? Well, Mr. Vong Friend, the first thing we have to do is to continue to keep confidence abroad in the American dollar. That means that we must continue to have a balanced budget here at home in every possible circumstance that we can. Because the moment that we have loss of confidence in our own fiscal policies at home, it results in gold flowing out.

12:59And he initially kind of brushes it off. He says, oh, I guess Dick Nixon thinks I can trade gold in London. Like, that's hilarious. And eventually his advisor is like, you have to actually address this. People are really worried that your policies are going to lead to a collapse of the dollar. And so he puts out a formal statement as the candidate, pledging his support for the dollar. So this is really becoming an issue of national security. People associate the dollar with the core of NATO and the free world. And Eisenhower is pretty explicit on this point. Kennedy's pretty explicit on this point.

13:32I mean, And the collapse of the dollar is like not an acceptable outcome because it really reflects a collapse of the anti-communist alliance that's developed in the past 10 years. So it's kind of core to the U.S.'s sense of itself that the world remain on a dollar standard, that the dollar remains strong. Part of what's gone wrong here is Harry Dexter White in crafting this new system that puts the dollar at the center has given something up to everybody else. And that's the peg of the dollar to gold at$35 an ounce. And the power that is given up by the U.S. to all those foreign central banks to allow them to withdraw gold at that exchange rate.

14:15And at the time that this is done, the U.S. has so much gold stock. But what has happened is we have recreated 19th century conditions by essentially bringing back a gold standard and the rigidity that goes with it and the runnability on the currency that goes with it. We're not used to the idea of running on the currency in the United States today. But that was a problem that countries experienced a lot when they had convertibility to gold. And so we're in the post-war world here, and we have brought back convertibility to gold, all the risks that go with it and the rigidity that goes with it, because we no longer have the ability to control the elasticity of the money supply.

15:09There's this sort of bomb built into the system where if everybody decides to redeem all at once, the money supply is going to start contracting rapidly. They're going to have a crisis of confidence. And so here we are in 1960, in some sense, at the apex of U.S. power, confronting the possibility that we could be in 1932 all over again with a series of withdrawals and the U.S. dollar breaking the peg. And that comes to take on this great significance, the idea that we won't be able to maintain the peg. Of course, from an optimal design perspective, you really want to be able to adjust that peg.

15:54But you've said it's going to be$35. And now suddenly in the Cold War world, in global politics, and even in domestic politics, this idea of the dollar maintaining its value takes on this great sense of significance and increasingly U.S. policymakers are in a bind.

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17:25Easy Cater, your business tool for food. To learn more, visit easycater.com slash podcast. So in a speech to the IMF in September of 1962, Kennedy is very clear on this point that the dollar, the importance of the dollar in the fight against communism is critical to his administration. The security of the dollar, therefore, is and ought to be of major concern to every nation here. To undermine the strength of the dollar would undermine the strength of the free world. We are taking every prudent step to maintain the strength of the dollar, to improve our balance of payments. and to back up the dollar by expanding the growth of our economy.

18:07We are pledged to keep the dollar fully convertible into gold and to back that pledge with all our resources of gold and credit. This is the thing. You can fix the problem one of two ways. You can change the peg slash change the system, or you can find ways to reinforce it through sort of makeshift measures. These are the shortcuts. And so Kennedy thinks this issue is public enemy number two. Number one is nuclear war. Number two is the stability of the dollar. He actually tells Arthur Schlesinger this over the course of the campaign and then into his early presidency. And so the question is, how do you do it?

18:42So among those two options, he commissions a task force. He's elected. He turns to Adlai Stevenson and he says, what do I need to focus on? And Stevenson says, definitely the dollar. In fact, this whole system isn't working, so we probably want to think about a new one. And Kennedy doesn't like that answer because Kennedy is sensitive to a lot of different things. One is he's portrayed as young and inexperienced. There's actually memos in the campaign about how to deal with the youth and inexperience issue. And so he's very sensitive to any sense that he's not up to the job. And he tells his advisors, if this thing falls apart, it's going to be on me.

19:13Right. And so he doesn't like that generically. He's also like fundamentally an institutionalist. He doesn't love the idea of dramatic change. He doesn't like taking those risks. And so he basically doesn't like what Stevenson and George Ball have to say. So he says, I want a new report. So he gets Alan Spruill, who is the outgoing, I think he'd left a couple of years earlier, president of the New York Fed, to write a different report. And that new report says, don't mess with it. It's probably fine. It's not a crisis. The public's impressions are wrong. But you need to address this forcefully.

19:46But don't do anything drastic. And so he basically takes that to heart implicitly. The question is, who's going to execute on this? And you think about this from the perspective of Kennedy, who's just been put into this very difficult job. And his advisors come to him and say, actually, we have an international monetary system with a basic flaw in it, which is the dollar is pegged to gold at$35 an ounce. And it's ultimately going to have to break that peg. This system doesn't work. We should do something else. You're like, is there some way to keep the thing going? And that's what leads to the second report.

20:22and that's what leads to the growth of the Eurodollar market because it turns out that the way to keep the thing going is to develop this offshore dollar alternative. Yeah. So now we can meet some actual characters in this story. So there's the treasury team that comes in with Kennedy is head by, at least with respect to this issue, is two people in particular. One's Douglas Dillon of Dillon Reed. His father founded Dillon Reed. He's one of the wealthiest people in the United States, the former ambassador to France, And he was selected in part because he owned a vineyard, Aux Brions, actually, so a very well-known vineyard in Bordeaux.

20:54So he had French roots, sort of, and does a good job. He's put at state. He's a contender for Secretary of State when Dulles leaves. He ultimately doesn't get the job. But Kennedy wants to put someone at Treasury who has a good business reputation, who is well-respected, has government experience. And people generally like this guy. He's seen as one of those consummate bureaucrats who's sharp and thoughtful and a good listener and clear and all of those things. And so he brings with him Bob Russo. Bob Russo is from the New York Fed. He actually served in the Second World War under Charlie Kindleberger.

21:26Charlie Kindleberger is the father, in some sense, of the idea of the dollar as a key currency, or at least a big proponent of it. But they were doing strategic bombing targets together. Kindleberger was his commanding officer. So he had some connections to this idea through his wartime experience of a global dollar system. And their bias, both of them, is to reinforce the existing system. They kind of want to find a way to save the Bretton Woods arrangement. So here's Bob Russo looking back from a few years later. We got them to recognize after the big flurry at Kenway Head, October 20th, 1964, when the market went up to a$40 price.

22:07At that time, that was looked as though it was quite a threat to the stability of the monetary gold price, and got them alarmed. And so after that, when it was clear, particularly by the time President Kennedy came in and made it firm that we were going to continue to support the$35 price, and then the London price began coming down, it was fairly easy to persuade these other countries that, you know, we ought to be together in this because as gold comes back into the market now we the United States don't want to have to just have it appear that we're always taking all the gold out putting it in sometimes to a course but why don't we share this as a buying pool when it comes into the market at 35 then we won't be in there bidding against each other it'll be an orderly arrangement would be a little bit of like a cartel, but in the interest of the world monetary system.

23:13On the other side, you have Walter Heller. Walter Heller is the chair of the Council of Economic Advisors. Kennedy's trying to balance out Dylan's somewhat conservative Eisenhower administration reputation with someone who's much more on the New Deal liberal side of things. And the New York Times calls him a prototype of the liberal economist. He's very well known for his tax policy views. And he often talks in terms of human flourishing, We should adjust the tax code to promote human flourishing. And he brings with him Jim Tobin, who is a very well-respected economist. He won the James Baker Clark Medal, which is kind of like a Nobel Prize-ish thing in 55.

23:46So he's already very well established. And he comes in as one of the economists on the council, and in particular, the one tasked with international issues. And so they think this whole thing is flawed from the start. And their push to the president-elect and eventually the president is to do something brand new and think about all kinds of different arrangements. And Heller sends out a ton of memos that kind of list. He says he does it with Roussa, but it's clear who's who in this. And it turns into a pretty contentious argument. I mean, there's actually in the Kennedy Library archives, they have little political cartoons the deputy national security advisor drew making fun of Bob Roussa and all the stuff he's trying to do at the same time.

24:21And some of these memos are kind of derogatory, like no one really believes what this guy is writing. So there's a lot of tension between the Treasury and the White House. Kennedy appoints Dillon, who is a prominent member of the opposing political party. So here we have this new Democratic administration coming in, and one of the most important cabinet posts goes to a very wealthy Wall Street scion from the other political party. And so the battle within the administration is also for the future of financial policy, in the Democratic Party, where you have the New Deal liberals, the FDR crew, fighting this basically interloper who's Dillon and losing.

25:12Because time and again, as Kennedy himself notes, Dillon thwarts the New Deal liberal economists in the administration. And Dillon is the one who ultimately crafts the policy of the administration and the policy that comes to dominate Democratic administrations that succeed Kennedy as well. And so this is a very important turning point in how the executive branch in Democratic administrations approaches financial policy. And it's no longer the FDR vision that is in the driver's seat. And ultimately, every time they're pitted against each other, the Treasury basically wins those arguments because the Treasury is advocating stability and the CEA, the Council of Economic Advisors, is advocating upheaval.