Josh Hendrickson on the Treasury Standard and Global Dollar Dominance

From the collapse of the Bretton Woods system to the present, the US has continued to further implement its Treasury Standard across the globe as an effective economic and geopolitical tool.

Josh Hendrickson is the chair of the department of economics at the University of Mississippi and is the author of a new paper that looks at dollar dominance through the broad historical perspective of what is called the “Treasury Standard.” Josh is also a returning guest to Macro Musings, and he rejoins the podcast to talk about this paper and the Treasury Standard concept. David and Josh also discuss the state’s monopoly over money, the path to global dollar dominance, the path dependency of the dollar system, and a lot more.

Read the full episode transcript:

Note: While transcripts are lightly edited, they are not rigorously proofed for accuracy. If you notice an error, please reach out to [email protected].

David Beckworth: Josh, welcome back to the program.

Josh Hendrickson: Great to be back.

Beckworth: It's good to have you on, and this is quite an interesting paper. We'll circle back to it in a few minutes. Before we do, Josh, though, I read your Substack, Economic Forces. You co-author it, but this week was your week, I believe, and you had an article out on the apparent breakdown in the relationship between consumer sentiment, how people feel, and real hard economic data. And you cite two articles, a recent one and an older one, to reconcile what's going on there. So, maybe walk us through that, because I think it's very interesting, and there's one article that was cited that many people may not know about, but I think is important and needs to be, maybe, better appreciated, so please share it with us.

Consumer Sentiment vs. Economic Data

Hendrickson: Yes, so the motivation for the post was [that] I keep seeing all of these articles in the media that are like, "Hey, things are great," and like, "Why don't you guys just recognize that things are great?" The general public doesn't seem to realize how great things are, and I think part of this is motivated by the fact that there's a lot of good economic data out there, and so people who pay attention to that stuff are looking at that data, and maybe they just assume that the general public just doesn't know about that data or something like that. I feel differently about this, because I feel like if things are really going great, you don't have to tell people that they're going great. They usually are aware of them. They don't have to know what the aggregate statistics say. They have a sense that things are going well.

Hendrickson: The motivation for the post was that I wanted to– well, it's actually like a follow-up on a previous post, because what I've been trying to do is to try to figure out where people are coming from, what is this, and after I wrote my post from like two weeks ago on this sort of broader topic, I came across this paper. So, this is a paper— it's from Larry Summers and co-authors at Harvard and the IMF and places like that. That's probably how people will be familiar with the paper.

Hendrickson: Basically, what they argue is that there's always a tight relationship between consumer sentiment and inflation and the unemployment rate. And so, if inflation is coming down, if unemployment is coming down, consumer sentiment tends to rise. When unemployment rises, when inflation rises, consumer sentiment tends to fall. And so, what we've seen recently is that inflation has been coming down pretty dramatically, but consumer sentiment has not been rising. We've got falling inflation rates, we've got low unemployment rates, and yet consumer sentiment is still low, and so this is a puzzle.

Hendrickson: I think that's one motivation for why all of these articles that say, "Hey, guys, things are really great. Why aren't you noticing that things are great?" And the purpose of this paper is to basically say, "Well, maybe we're getting this inflation calculation wrong. Maybe there are things that the general public thinks about, in terms of the cost of living, that these price indices don't pick up on.” And so, in particular, what they focus on is, they focus on things like interest payments. What they do is, they add in the pre-1983 version of housing, which includes interest costs.

Hendrickson: They incorporate interest costs on personal loans and things like that. And when you do that, what you find is that— if you just make those minor adjustments to the CPI— what they find is that you get a much higher peak in terms of the highest rate of inflation that we experienced post-pandemic, and also, that even as of the end of 2023, that inflation was still much higher using their measures than what the official statistics said. And so, then, what they did is they said, "Okay, well, let's suppose that we replace our measure of inflation with the official measure."

Hendrickson: They basically say, “If we put our measure in, and we track consumer sentiment, what they find is that they can basically explain about 70% of the gap between what we would predict consumer sentiment would be and what we're actually observing.” To me, that's a pretty significant indication that, maybe, we should be a little bit more humble about telling people how great things are, because there are all of these other costs, and things that affect the cost of living, that can explain why consumer sentiment is low. We shouldn't just focus on the official statistics that we usually use. We should try to understand why people feel the way that they feel.

Beckworth: Yes, and the title of that article, for those who are interested— and we'll have a link to it in the show notes— but the title of that article, it's an NBER working paper, it's, *The Cost of Money is Part of the Cost of Living: New Evidence on the Consumer Sentiment Anomaly.* The authors are Marijn Bolhuis, Judd Cramer, Karl Schulz, and Larry Summers, but most people will call it Larry Summers et al, because Larry is well-known, and he's promoted this pretty widely. So, that's the paper that's recently come out, and they have a very interesting chart in there.

Beckworth: If you look at the chart, the measure tracks the official CPI usually, but recently, it's been a big divergence, and if I'm reading the chart correctly, inflation got as high as 18%, and right now, it's still in the double digits. It's still really high, even though the official one is down around 3%. So, people are still seeing that, and your point is that that's what people are saying, "Hey, we still feel this burden." And to be very clear, because I know there might be some people out there saying, "Oh boy, here we go. Is this like a shadow stats thing?" Absolutely not, right? Josh, this is a legitimate exercise, and let's use that as a segue into this other paper, which I think is very important and hasn't been appreciated enough, but why is this a legitimate exercise? What theoretical paper can we look to that says, "Hey, this is a very smart exercise?"

Hendrickson: There's an old paper by Armen Alchian and Ben Klein called, *On a Correct Measure of Inflation.* This is actually what they argue in their paper, is that when we're constructing a price index, what we're usually doing with things like CPI is that we're confining the things that we put in that index to things that are just current consumption flows. Their point is that if you think about what the purpose of the price index is designed to do, it's supposed to be tracking the cost of some basket of goods with constant utility. In other words, it's designed to basically say, "Look, if you were to buy a basket of goods that didn't make you any better off or worse off than last year, how much would that cost you today given all of the prices that we observe?"

Hendrickson: And so, if the cost of that basket is higher, then that means that you've experienced inflation, right? Prices are rising on average. If that basket has fallen, then that means you've experienced deflation. That means that prices, on average, declined. Their basic point is that, actually, if you just take price theory seriously, and you think about not just a static problem, [but] if you think about a dynamic problem, then you actually need to think about how asset prices and interest rates and things like that fit into these indexes. This is a really important point.

Hendrickson: And they had a little bit of empirical evidence in the paper to show that it appears that the way that we conventionally measure this stuff maybe doesn't have all of the information that we need. But I view this new paper as validating Alchian and Klein's work, because they're explicitly doing what Alchian and Klein said to do. And for the most part, I think that one of the reasons people haven't followed up on Alchian and Klein is— for the same reason that they write about towards the end of their paper— is they say, "Okay, well, if we're really right about this, why hasn't anybody done this or noticed?"

Hendrickson: Their argument is that, "Well, it's really hard to do. How do you put these things in there? How do you put these asset prices in there? How do you choose what asset prices should be in there in the first place? How do you weight them? And do we even have the data?" [There are] certain asset prices that we have regular data on, but other asset prices— we don't necessarily have data on prices, or even if we do have prices, we don't necessarily have quantities, and so how do you construct weights and all these kinds of things?

Beckworth: Right, so, we are far from a world of complete markets and asset prices. So, it's a good idea, and we can maybe get close to it or approximate it, and I want to give the title of that Alchian and Klein article. It's [from] 1973 in the Journal of Money, Credit, and Banking, and the article is called, *On a Correct Measure of Inflation.* I would note that the only concern or criticism I have with the first article, the NBER paper, is that they didn't cite this one. So, maybe by the time it gets published, they'll have cited this important 1973 paper. Okay, so, interesting discussion, and I encourage listeners to check it out. Again, we'll have links to both of these articles in the show notes. Let's switch gears now and go into this other paper that you have written, and it is titled, *The Treasury Standard: Causes and Consequences.*

Beckworth: This is a pretty long paper, and it's also a very, I think, topical paper, because you speak to something that's been in the news [over] the past few years: dollar dominance. In fact, in '22, '23, the theme of dollar dominance was de-dollarization. We were going to lose it because of all of the financial sanctions. I have sitting here in front of me, Josh, books that I just quickly pulled off of my bookshelf related to dollar dominance. I'm just going to read a few of them. I probably could find more, but I got Eswar Prasad's The Dollar Trap. I think that's 2014. I have Money and Empire by Perry Mehrling, a few years back.

Beckworth: I’ve got Exorbitant Privilege by Eichengreen. Now, this one's much earlier, early 2000s. [I’ve got] Bucking the Buck [by] Dan McDowell, and then recently, a new book that came out is Paper Soldiers by Saleha Mohsin. I recently had Steve Kamin and Mark Sobel [on the podcast]. They have a paper on dollar dominance. There's just a lot of stuff happening on this topic. That leads me to my next question for you is, why write this paper, and what value added do you bring to this discussion?

The Motivations for *The Treasury Standard*

Hendrickson: I think that I came at this from a completely different angle, because I don't think I ever intended to write this paper or even a paper like this. I had essentially just been working on more historical papers, and those papers focused on how states have used the monopoly of money to their advantage, right? So, states, since the ancient Greeks, they had a monopoly over the mint, or they had central banks, or they had control over the money supply. And so, I think that we've talked about this before. I have a lot of projects that I've been working on related to national defense, and how states use different tax schemes, different institutions, different financing schemes to pay for stuff.

Hendrickson: And a central focus of that literature is that I don't really argue that states ever know what they're doing. It's kind of like they stumble into these things. But as I was going through this literature, as I was writing papers about this, I kept thinking about the current system, and I kept thinking about whether or not it was related, in some way, to these previous systems. And so, the more and more I thought about it, the more I thought that there's actually this coherent pattern in monetary systems that stretches back as far as we have human record. And that is that states have always wanted to monopolize the money supply. The reasons for doing so are actually more complicated than what you typically think of.

Hendrickson: For example, if I ask a group of undergrads or something, they give me a good answer, but a kind of incomplete answer. If I say, "Why does the state want to monopolize the money supply?" They'll say something like, "Well, because, if you have a monopoly, you can create more money, and you can pay for stuff, and who wouldn't want that ability?" To some extent, that's right, but it's too narrow of an explanation, because it poses way too many questions. First of all, there's physical constraints on your ability to do that. There's also economic constraints on your ability to do that. 

Hendrickson: Just being able to create more money, that's not some magic wand, because people's expectations adjust to the behavior of the rulers. And so, if everybody knows that you just debase the currency all of the time, people look for other ways to store their wealth. They look for ways to avoid holding too much money or something like that, because they want to avoid the debasement. And so, what I argued is that there seems to be this pattern that goes on, from very early on in human history until now, where states have this desire, and that they behave in certain ways, and they behave in those ways in order to get the desired outcomes from that monopoly, but they have to change and adapt over time.

Hendrickson: They can't just have the same system, because there are innovations in the private sector or something like that. Just because you have a monopoly over the mint, that's great, but once people start using bills of exchange, and once banking emerges, and banknotes emerge, well, now your monopoly over the mint doesn't generate as much revenue as it used to, because people have substituted some of those gold coins for pieces of paper, and other things happen. One of the things that I argue is that this monopoly has been used to finance war and defense and things like that, but war and defense change. There's a huge difference between the world of the Middle Ages, where people are using bows and arrows and swords and things like that, to the world of cannons and muskets and rifles and machine guns. This dramatically changes those costs, and so you have got to adapt to those kinds of things.

Beckworth: Yes, so, if I look at the current literature, including the books I just mentioned, the articles that have been out there, they typically focus on the dominance part of the dollar, where we are today. So, the dollar dominates trade invoicing. It dominates foreign exchange markets. It dominates credit markets. It dominates foreign exchange reserves, and central banks, all of these metrics, and then we talk about [how] that's amazing. Then, we also talk about [how] there's path dependency, because they're there. It tends to continue to grow. This dollar network builds upon itself.

Beckworth: And what you do in this article, and correct me if I'm wrong, what you do is that you paint a meta-narrative of how we got to this place, and it's more than just path dependency, or market forces— and you're a markets guy. This is what's interesting. You're a market-friendly guy, but you're going to actually argue, [which] we'll come back to in a minute, that the state played an important role in getting to this dollar dominance. It wasn't just purely an emergent order, organically from the ground. It played a role, but the state played an important one. And the other way I would frame this is that you have a meta-narrative, and then part of that is that, like you mentioned, there's trial and error.

Beckworth: It's not as if these leaders of nations were intentionally aiming to do what the outcome turned out to be, but they were struggling to find ways to finance war and the changing nature of war. But they also— I think that the other key point in your paper is that they had to do it in a way that was sustainable. They couldn't just recklessly use their monopoly of money. They had to do it in a way that still anchored long-term, what we say today, inflation expectations, or long-term price stability, or what you say in your paper, long-term demand for these money assets. So, is that the executive summary, then, that there's this process of discovery, that nation-states have emerged, [and] they control the monopoly of money, and they're doing it for a particular end, but they have to be disciplined in their use of it?

The State’s Monopoly Over Money

Hendrickson: Yes, I guess the idea here is, why does the state want a monopoly over money? I mentioned this before, that people say, "Well, so they can pay for stuff,” or, "So they can generate revenue," but any state monopoly generates revenue. You can create a monopoly over anything. If the state has a monopoly over anything, they can earn monopoly profits, and that's their revenue. And so, the central point of the paper is that there must be something unique about money, because this desire for a monopoly over money persists throughout human history.

Hendrickson: So, there must be something that explains the durability of this desire. And so, what I argue is that what a monopoly over money allows you to do, is it allows you to do something that other monopolies don't, and that is that it allows you the ability to conduct emergency financing. If you need to raise a lot of revenue in a short period of time, only a monopoly on money is going to allow you to do that. That could come through the debasement of coins. It could come through printing money. In the modern world, [it could come through] just creating digital dollars, right? But the point is that you're able to generate a lot of revenue in a short period of time. The problem is that you face an economic constraint.

Hendrickson: So, if we think about seigniorage, in order to try to generate seigniorage— essentially, to do this effectively, to use this as a tool for emergency finance, you're not going to be just maximizing the seigniorage every single period. What you actually want to do is you want to create the biggest tax base possible. And so, when it comes to seigniorage, that means having the highest level of money demand possible. The way that you can do that is by committing to price stability during normal times. But then, when you go to war, or you have some national emergency or something like that, you need to spend a lot of money really quickly, then you can exploit that monopoly.

Hendrickson: And you exploit that monopoly while you have a large tax base. But, again, you've got to go back to that commitment to price stability afterwards, because otherwise, if people know that every time there's an emergency you're going to do this, then anytime that people anticipate there's an emergency, they're going to react. Then also, you're just going to reduce your tax base over time, because you're just going to have this record of always printing money, or always debasing the currency, or something like that, during times of war, and those effects are permanent. What you want to do is actually promise to reverse any of those effects that were experienced during the war once the war is over.

Beckworth: Now, going back to this meta-narrative, as I like to frame it, the reason we have a global dollar system— or prior to that, the pound sterling system was the global reserve currency. The reason these emerge is to have this emergency financing power. That's your argument, right? And the tax base is this global dollar system. It's a wide base. It's established around the world. And we saw during the pandemic that the US government was fighting a war of sorts, a public health war. It had to really quickly fund that helicopter drop, and that's what it was, [and then] World War II and, similarly, World War I. That's the point you're making, right? This global dollar system, even though, maybe, we didn't get here with well-thought out plans and steps, we did get here, though, for a certain purpose.

Hendrickson: I wouldn't necessarily reject the idea that there's path dependence. But what I would say is that, what's explaining the path is this desire for emergency finance. But the nature of emergency finance changes over time, right? And so, the modern world is much different than the ancient world in the sense that, if you go back to ancient Greece or something like that, you would have all of these areas where people effectively have their own little monopolies. It's not like there's one dominant power. Now, there are certain times, under, like, the Persian empire, the Roman empire, things like that, where there is some level of dominance. Fpr the most part, it's the same motivation that's guiding us through time, but it's the changing circumstances of the world that ultimately end up leading us to wherever we are. 

Beckworth: So, define for me the Treasury Standard.

Hendrickson: Basically, the idea behind the Treasury Standard is just that we live in a world where the global reserve currency is the dollar and the global reserve asset is the US Treasury security. I call it the Treasury Standard, because we've essentially replaced gold, as this world reserve asset, with Treasuries.

Beckworth: And we'll circle back to this and its implications and what it means for central banks and the path going forward. Again, the big takeaway I get from this is that this really paints the bigger picture for why we have dollar dominance and the broader picture for why the Fed does what it does in terms of supporting the broader US objectives. Let's go back, though, and start at a very basic level, because in your paper, you say, "Okay, what would a market do for money?" Then, you introduce the second option, "What would a state do for money?" That's a good starting place, because it helps us understand how your theory unfolds in terms of the role the state played in generating this dollar dominance.

What Would a State Do for Money?

Hendrickson: There's always two competing narratives about money that I see in the literature, especially when it gets into the historical stuff, or why money exists, or what gives money value. There's a market pay story that's like, this is just a spontaneous emergence of particular types of assets that become money, and that there are just problems inherent to trade, problems inherent to exchange. You can't have a world entirely based on credit if people are anonymous. You can't have a world entirely based on barter, because it would be incredibly costly. And so, money is that third alternative for trade.

Hendrickson: And the market-based idea is just that, yes, what's happening is that people have this desire to trade, but trading with other people is costly, and you want to look for the least costly way to engage in these trades. You want to minimize your transaction costs. And in minimizing your transaction costs, what's going to happen over time is that there's just going to be some asset like gold or silver or something like that that emerges as this thing that you can use on one side of every exchange. Then, that just gets adopted as money, but then there's this natural evolution.

Hendrickson: Because it's like, "Well, it's still costly to trade those things." With gold and silver, you have got to weigh them, you have got to make sure it's actually gold, you have got to make sure that it's not just a gold-coated rock or something like that. You've got to do all these things. That leads to standardization through coins. And so, then, you've got coinage going on, and so now people have these standard units of value, but then people don't want to necessarily carry a bunch of coins around with them all the time, and so maybe they start depositing these things. Then, that leads us into a world of banking, and then it leads us into a world of fractional reserve banking, and then banknotes, and then into the modern world.

Hendrickson: So, you could trace this market-based story all the way from ancient societies to now by thinking about the nature of trade and things like that. So, that's one narrative that exists. Then, the other narrative that exists is that people point out that states have been involved the whole time, and it's actually, really, just states that determine what money is, and it's states that determine whether money has value or something like that. You have these two competing narratives. And I think the problem is that I think that the market-based argument does a really good job of explaining the economic issues of exchange, why money would be desirable, why you would have to use money.

Hendrickson: I think it does a really good job of that, but it leaves out the role of the state, and the state seems to have played a big role. On the other side, you've got this state theory, but the state theory is weak, because state theory can't really explain these examples of a spontaneous emergence that can't explain some of the innovations and things like that that come along. Nonetheless, I don't want to throw out the state stuff, because all of that stuff that the state is doing seems important. I just think that focusing on the state as providing value to money or focusing on the state as being like the source of money's creation, or something like that, I just think that's not where the focus should be when we're thinking about the role of the state with money.

Hendrickson: Then, that leads me to ask, "Well, then why does the state get involved, and how can we relate these kinds of things?" So, the way that I'm thinking about it is, if you take this spontaneous emergence story, and you just think about that, that can explain why things evolve, in an economic sense, over time. Then, as that is taking place, states are intervening over and over again, and that's altering this evolution, that's altering how these systems evolve. But it calls out for some kind of theory of why the state wants to do any of this in the first place. My idea is kind of like, let's take this spontaneous emergence story, and then have a theory of why the state gets involved, and weave those things together to explain what the state's trying to do, and how the state's role has evolved alongside these private sector sources of evolution as well.

Beckworth: So, you are taking seriously the Carl Menger story of money that emerges naturally, organically through the market process, but you're not taking as seriously the hard state theory. You're taking a little bit of the state theory. You're not at all endorsing a chartalist view of the world, but you are saying, "Yes, the state can intervene and shape the direction of where that organic market path goes." So, let me draw on the example of the dollar, since I started this off with dollar dominance, and the role that government institutions have played. We'll come back to some other histories that you have in your article.

Beckworth: But, in preparing for the show, I went back and was reviewing how the dollar did become dominant, and I read a number of articles, and I went back and skimmed some books that I had on this. Some of them I mentioned earlier in the program. And one of the things that, really, was fascinating is the introduction of the Federal Reserve in 1913, the Federal Reserve Act. It wasn't just the introduction of the Fed itself, but laws that changed what it could do and what banks could do. National banks could now have foreign branches. They could also buy and sell trade acceptances, bills that would be used to facilitate international trade, and secondary markets emerged. The Federal Reserve in the 1920s could buy and sell it as well.

Beckworth: They could discount those notes. And that created this very liquid, deep market, the creation of a central bank, changing the laws of what banks can do. Barry Eichengreen has this chart, and it shows that by the mid '20s, the US dollar actually was the number one reserve currency in the world in terms of shares. Now, it falls in the 1930s, and it's not really until after World War II [when] it becomes permanently dominant. But by the 1920s, there was enough traction, from what the Federal Reserve was doing and changes in laws, that the dollar was already getting a foothold.

Beckworth: Then, after World War II, we get Bretton Woods, which we'll talk about shortly, and the emergence of the Eurodollar market, and all of these things continue to add momentum. But these are all policy choices, I think is what you're saying. These are decisions. In fact, I've had guests on the show who are critical of what the Fed did in allowing the Eurodollar market to emerge. They look at that as the beginnings of shadow banking and unregulated offshore activity. But these were policy choices that ultimately contributed to this path dependency for the dollar to become dominant, and your argument is that that was allowed, or maybe even pushed [and] motivated by this desire to have this emergency financing potential should it ever arise.

The Path to Dollar Dominance

Hendrickson: I think every state has that desire. I think that the United States benefited from a couple of things. One of the things that significantly benefited the United States— it was not necessarily a policy design related to emergency finance, it was just the delayed involvement in World War I. So, the United States stayed out of World War I for a good period of time. They never left the gold standard, and when they're on the gold standard, they're not accepting payment in anything but gold, right? So, there's a lot of gold inflows that occur, such that at the end of World War I, the United States is now in this position of power, but this also gives people the willingness to hold more dollars in reserve, because they know that the United States has massive gold reserves.

Hendrickson: And so, they don't really have to worry about a run on the dollar or something like that, or they don't have to worry about a devaluation. Part of it is that, occasionally, it's just circumstance. I would not argue that there was any policy design. I don't think Woodrow Wilson or something was sitting around saying, "Well, we need to delay World War I for dollar dominance." I don't think that was going on. I think that the fact that the US had delayed involvement meant that it got all of these gold inflows, and that substantially strengthened the dollar internationally. 

Hendrickson: And so, I think that the story of dollar dominance is probably twofold, [and] it’s that, in the early years, where the dollar is developing some level of dominance, where we look back now, and we say, "Oh, that's when things really started." A lot of those things were just circumstance. A lot of those things were just [that] the United States benefited from entering World War I late by accumulating all of this gold. They also benefited from the fact that, after World War I, the Bank of England just screwed things up. And so, those kinds of things were not deliberate US policy decisions. But I think that by the time you get past World War II, now the United States is ready to assert its dominance, and they're ready to claim their place as the dominant global currency.

Beckworth: There were a number of developments that you outline in your paper that lead to this, or contributed to this. The Bretton Woods arrangement, you spent a lot of time on that, how it was developed, how it ultimately collapsed and led to the Treasury Standard. But, again, your point is that, sometimes, these weren't intentional policy choices. Woodrow Wilson wasn't thinking [about] dollar dominance, but they were, maybe, intentional choices in terms of US foreign policy and goals for US dominance, maybe politically, in the world, which then shape how finances and money policy is therefore executed.

Hendrickson: Starting in the 1960s, the United States really had to think carefully about the international monetary system, because it was clear that the Bretton Woods system couldn't hold. It was clear, very early on in the 60s, that this system couldn't hold, because there were too many dollars that were flowing overseas. Early in the 60s, foreign central banks were threatening to redeem those dollars for gold and things like that. But by the time you get to the mid-60s, they're not saying they're going to do it, they're doing it.

Hendrickson: So, the United States had to really think about what kind of system it wanted, how this was going to play out, or what was really happening. I spend a lot of time talking about the lead up to the closing of the gold window, but I think that what that lead up does is, it just shows how the United States was just very, very-- policymakers across political parties were very focused on keeping the dollar dominant, and not only keeping the dollar dominant, but in ways where people would look at them and say--

Hendrickson: You had foreign countries saying to the United States, "You're running up too much debt, you have too many dollars flowing overseas, you have too loose of monetary policy," and they kept saying, "You've got to change these policies." And the deliberate policy interventions that were made, from Kennedy, to Johnson, to Nixon, to Ford, and to Carter, is that there was this consistent pattern of, "Well, we're actually not going to change any of our policies, we're not going to change anything that we're doing, you guys need to adapt to us."

Hendrickson: In some sense, that sounds ridiculous, but they used a little bit of political power. They used a little bit of their control over institutions, like the IMF. They used a lot of soft political power, with West Germany and Japan, who were still indebted to the United States for the Marshall Plan, and for the military protection that the United States was promising to provide them. And so, there's these deliberate attempts where the US is very clearly like, "No, we're not adjusting our policy, you adjust to us, and otherwise, we'll do this, this, or this," and it was all political or geopolitical threats that they were making, but it was very deliberate that they were not going to give up the policies they were pursuing, and that the rest of the world needed to adapt to what the United States was doing.

Beckworth: So, always, it's our foreign policy, our goals for the world, that's driving our decisions, and early on, we may not have made the connections, explicitly, between those and international monetary issues, but by the 1960s, we were, is what you're saying. By that point, we realized, "Okay, there is this linkage, and we need to make sure the rest of the world understands it and adapts to what we want to do." Give some examples.

Historical Examples of Dollar Dominance

Hendrickson: In this intervening period, that begins with the Nixon administration, people were looking for alternatives. They were looking for ways to handle all of these international imbalances on these accounts. There's a lot of dollars flowing overseas, and then there's a question of, "Well, what do you do with these dollars?" People wanted to redeem them for gold. The United States didn't want to let them redeem them for gold. They kept saying, "Well, how about instead of redeeming them for gold, you can redeem them for these Treasury securities? They have a yield on them, and so you can earn a yield on this, and you're not going to earn a yield on gold, so you can earn a yield on these Treasuries.” Some countries went along with that, some protested. Some negotiated things with the United States so that they would agree to hold them.

Hendrickson: But, essentially, the interesting thing about this is that the IMF tried to develop programs where they could actually help solve the problem, and the idea was that— So, this was especially after the gold window was closed and after oil prices started to spike, there was a huge problem with the spike in oil prices, because you had all of these dollars flowing into these oil exporting countries. And there was a question of, "What are they going to do with these dollars, and how are they going to handle this?"

Hendrickson: But, also, [with] all of the importer countries, there's a net outflow, of either their currency or of dollars, to buy the oil. There are, basically, these global imbalances in where the currencies are flowing, and there was a question of, "How do we handle this?" So, the IMF tried to deal with this. The IMF tried to develop tools to resolve these things, and the IMF was set up for this very purpose. The point of the IMF, initially, was to just handle payment imbalances and things like that, but the US saw the IMF as a threat to its role in the global financial system.

Hendrickson: So, if the IMF suddenly started taking on this power, it might give people the ability to diversify away from dollars and things like that. So, in response to these high oil prices and these global imbalances, the IMF was like, "Let's create a facility,” and oil-producing countries that are running balance of payment surpluses, they can lend this surplus to the IMF, and then the IMF can turn around and it can lend money to countries that need the foreign currency to deal with their own balance of payment deficits.

Hendrickson: The US was very opposed to this, because what the US wanted them to do is, the US wanted these oil exporting countries to take all of their dollars and buy US Treasuries. So, if the IMF was going to provide this service, this was going to be a threat to the United States, because this meant that those oil exporters might lend their money to the IMF instead of lending their money to the United States government. And so, the United States had this unique ability because of their veto rights at the IMF, that they prevented this from ever getting off of the ground. Not only that, but China and Saudi Arabia, they were trying to get into the IMF, and if they had gotten into the IMF— and all of the quotas, the original quotas of the IMF stayed the same— this, actually, would've eroded the veto power of the United States.

Hendrickson: So, the United States actually does these little side negotiations to keep their veto power, so that they can prevent this from happening. And so, the net effect of this is that the IMF kind of gets a program, but the way that the IMF program is set up is that the rate that the IMF could pay on these loans was less than the yield on a Treasury. And so, anybody who was holding a bunch of dollar balances would much rather just buy the Treasury than lend to the IMF, because they can get a higher yield.

Hendrickson: And so, they manipulated this system so that people would have the incentive to buy Treasuries and not lend excess dollars to the IMF. Then, with regards to Saudi Arabia, we now know that one of the things that happened is that the United States government actually just made secret agreements with the Saudis in the 1970s, where they essentially said, "Hey, if you take the surplus dollars that you have coming in, and you buy US Treasuries, we will sell you weapons, we'll provide you with some level of defense in your region,” all of these kinds of things.

Hendrickson: So, there was a deal made. Now, the reason that it's secret, and the reason that we didn't find out about it until later on, is that both parties had an incentive to not reveal this information to the public. The United States had an incentive to keep the secret, because they were telling Europeans, "Don't go to the Saudis, don't go to these oil exporters and try to get them to take their surpluses and invest in your bonds or into your country. Don't do that. We need a global solution."

Hendrickson: But, secretly, behind the scenes, they're going to the Saudis and saying, "Hey, yes, just take those dollars and buy Treasuries." But then, the Saudis also wanted to keep this secret, and the Saudis wanted to keep this secret because of the conflict between some of their allies in the region and the State of Israel. And so, because the United States had been supportive of the State of Israel, Saudi Arabia did not want to be seen lending money to the United States government, and then the United States government using some of that money to support Israel.

Hendrickson: And so, this would basically make it appear as though the Saudis were financing Israeli defenses or something like that. They had a desire to keep this quiet, because they knew that their allies would be upset. And so, this remained secret for a long time, but this is a huge critical role, because what this did was, not only did Saudi Arabia agree to take their excess dollars and buy Treasuries, but they agreed to continue to price oil in dollars in perpetuity.

Hendrickson: They were not going to start pricing oil in any other currency, and so, if you wanted to buy oil, you had to use dollars. That was really key, especially at this time, when oil prices are high, when Saudi Arabia actually has some political leverage over these kinds of things. But this solidifies the dollar's global role in the aftermath of the breakdown of the Bretton Woods system, because now, there's this key commodity, where you have to use dollars if you want to buy it.

Hendrickson: Then, because Saudi Arabia is a net exporter, they're going to have this surplus of dollars, which they're then going to turn around, and they're going to use to buy US Treasuries. And so, that would allow the United States to continue the policies that they were on, and that would prevent them from facing the fiscal constraints of the deficits that they had been running for the past two decades.

Beckworth: Yes, and those stories were really interesting to read, to see the US government forcefully making these other countries invest in Treasury securities, because today, you don't see that, or we don't know about it, at least. Today, I don't think they have to. I'd like to get your view on this, but, back then, maybe it was important, because Bretton Woods was coming apart, and the US government really did need these other countries to make a first step and invest in Treasuries. Whereas, today, there is this path dependency, this lock-in effect. The dollar market is so big, [and] there isn't really a viable alternative. Do you think that's a fair assessment, that it's somewhat easier today for the US government to keep playing this role without having to put its thumb on the scales and encourage these countries to buy Treasury securities?

Hendrickson: Yes. I think the way to think about it is that the breakdown of the Bretton Woods system— the threat was that this would undermine the network effect of the dollar in international markets; that people would diversify, or people would pick a different sovereign currency. And so, the thing was that these early policies were designed to reinforce the network effects that were already in place, so that there wouldn't be an alternative. But once you established that network effect, then the network effect can be durable outside of some significant shock.

Beckworth: Yes, so, it's really fascinating to see this history, particularly this secret history, with places like Saudi Arabia. So, let's come to the present. One observation I want to make and get your response to is, if we look at the size of the global dollar market— so, we look at, for example, all of the dollar assets, not just Treasuries, but private dollar assets, corporate bonds, repo, commercial paper, bank accounts. If you look at, for example, what we see in terms of the net international investment position, look at the liabilities that we owe to the rest of the world, or alternatively, the assets that they hold, the claims on us. They hold about $20 trillion-plus in what we might call safe assets, so highly liquid money, like bonds, securities, stuff like that. 

Beckworth: Only $8 trillion of that, though, is Treasury debt. So, yes, we have foreigners holding our Treasury securities, but they're holding a lot more other dollar-denominated, relatively safe assets. Then, the BIS tells us that there's close to 13 trillion in dollar assets and liabilities created outside the US. So, we have this big dollar market around the world, and only a portion of it is actually US Treasury securities. How do you see that playing into the story that you're telling?

The Significance of the Global Dollar Market’s Magnitude

Hendrickson: Essentially, the reason that I focus on Treasuries is that Treasuries are where I see the major trade-offs for this system. And so, what I mean by that is that the fact that so many countries are willing to hold Treasuries as a reserve asset implies that we have lower borrowing costs than we would in a world where the dollar wasn't as dominant, which likely means that we have more debt than we would have in a world where the dollar wasn't dominant. But that's just the story of exorbitant privilege. This is this idea that, because the dollar is a reserve currency, we have these advantages that other places don't. We can run larger deficits, we can run up more debt, we can borrow at lower costs, all because of this reserve asset. 

Hendrickson: But the reason that I focus on this is that another characteristic of the state's monopoly on money, one of the things that's consistent throughout history-- The reason you wanted to prevent others from owning a mint is that, if somebody else owned a mint, they also could, conceivably, have access to emergency financing, and they could potentially have a revolution against you. One of the things I talked about, with regards to the Bank of England in the paper, is that the fact that the Bank of England was holding sovereign debt meant that the Bank of England had this implicit poison pill. Whereas, if you were a revolutionary, and you tried to repudiate the debt, you could just destroy the financial system and lose your ability to provide emergency finance. And so, I guess what I'm saying is that this demand for emergency financing also went along with actual foreign policy. And so, we see this in how the United States is behaving. You mentioned Dan McDowell’s book, and he talks about this a lot. The United States is using the dollar as a tool of foreign policy.

Hendrickson: You do something that we don't like, we can freeze your assets, and things like that. We can prevent people from transacting with you. We can impose sanctions on your behavior. And so, in a sense, what I've described— this exorbitant privilege and this tool of foreign policy— these are benefits to the United States, but I'm an economist, so there are no solutions, there are only trade-offs. And so, if these things provide benefits, they also entail costs. And so, the costs of using the dollar as a tool of foreign policy is that people might diversify away from the dollar. The cost of the US Treasury security being the global reserve asset is that, as the world economy grows, what happens to the demand for reserve assets? Well, it grows along with that growth in the world economy, and so, if the United States doesn't provide that, if they don't provide a sufficient amount of Treasuries, then yields are going to go down.

Hendrickson: That tends to incentivize governments to borrow more. "Look, we're running these massive deficits, and it's not affecting our interest rates. Maybe we should run bigger deficits." The thing is, there are lessons from the literature on the international monetary system that essentially say that when you control the supply of this global reserve asset, and this asset is a debt instrument, well, you run into a problem, because the more and more debt that you run up— at a certain point, people are going to become concerned that you won't be able to pay back that debt without resorting to devaluation. But the thing is, is that the devaluation doesn't actually have to come first, right? All that has to happen is that people start to worry about devaluation, and they start acting on it. 

Hendrickson: They start selling their dollar-denominated assets, and then you have turmoil in international markets, and maybe the Federal Reserve has to intervene and buy some of these assets or settle down the Treasury market, which leads to expanding their balance sheet and leads to higher prices. And so, the point is that the system has substantial benefits. As long as the level of debt that the US has is sufficiently low, the benefits dramatically exceed the costs, at least for policymakers. We can debate some of the other secondary effects on the actual people of the United States, [but] for policymakers, as long as the debt level is low enough, they can sustain this indefinitely.

Hendrickson: The problem becomes, if debt gets sufficiently high, now the system becomes potentially, very fragile, and it becomes subject to self-fulfilling runs, and once it gets there, then we're talking [about] very costly consequences. And so, what I'm encouraging people to think about is that, yes, this foreign policy tool that we have might help us to impose sanctions. It might help us to do things— to harm people without actually having to engage in military conflict, but there are costs people might diversify away. Yes, having the global reserve asset might give the United States policymakers the ability to do all of the things that they want to do, but it's also potentially fragile, if debt levels get too high. So, there are always costs and benefits, and policymakers need to think about those things.

Beckworth: I think that you can see some of those costs this past year, when interest rates went up, Treasury values went down. There's been a huge loss in the Treasury market, in terms of market value versus par value. And so, people have already borne some of that. Another way of saying that is that they took a loss because of the inflation, and the rates went up as a result of that. But I guess that I would come back and say, well, what's the alternative?

Beckworth: Again, going back to those big numbers I threw out, if you want to get away from the dollar, the entire dollar system— so, Treasuries, as well as these private dollar-denominated assets— there really isn't much of an alternative out there. The scale is so much larger, and, again, going back to that point I raised just a few minutes ago, could it be that you have so much debt, that there isn't much of an alternative? They're locked in this path dependency. They're stuck with dollar-denominated assets.

The Path Dependency of the Dollar System

Hendrickson: Thinking about the international monetary system, and thinking about this debt instrument as the reserve asset of the world, is that the models that we have of this suggest that how stable the system is depends on how much debt we have. Yes, there's no obvious alternative right now, but if we were to have some sort of crisis, people might go looking for an alternative.

Hendrickson: But even besides that, I think that the issue is that we have this really weird situation— and this is part of the reason that I wrote this paper, also, is that we find ourselves in a really weird situation— because for the entirety of human history, and I'm overgeneralizing, obviously, but for the entirety, what you had as a reserve asset was a neutral asset. Nobody controls the supply of gold, not one individual, not one country. They don't control the supply of gold.

Hendrickson: There's no one single entity that controls the supply of silver. But there is one single entity that controls the supply of US Treasury securities, and so, we find ourselves in this weird world now, that conveys a bunch of benefits to policymakers. It allows them to do all of the things that they want to do at a lower cost than they would be able to do otherwise, or perhaps not be able to do at a higher cost. But, I think that the reason that the United States is so protective of this and why policymakers don't want to see this eroded whatsoever is that I think that they think that the only alternative is that there's going to be another sovereign country whose debt could become the reserve asset, or something like that. To me, that is one possibility, but I'm not necessarily sure that that is what would happen.

Hendrickson: In fact, if the United States ever decided that it didn't like the system or that it wanted to slowly get out of this system, they would be better off promoting some kind of neutral asset as the new reserve rather than allowing some other country to come in and take the exorbitant privilege for themselves. But, of course, policymakers don't really have that incentive. The only thing that's going to provide them with that incentive is a crisis; a crisis that reveals that, maybe, this can't continue.

Hendrickson: The other thing about this is-- I'm fully aware, and I believe that I say this explicitly in the conclusion— I'm not making any predictions about what happens in the future. I'm not making any predictions about what happens in the future, because when I was researching this paper, I could just keep going back further and further and further, and you would just find these people saying, "This system is unsustainable. It can't last. It's not going to survive."

Hendrickson: You see that 10 years ago, you see that 20 years ago, 30 years ago, 40 years ago. You see the same general pattern of people. Some of them are identifying some of the same costs that I'm identifying. Some of them just had a lot less belief that the system could persist, given what we've learned later on, but the consistent pattern is that people say that this isn't sustainable. I'm not going to say it's not sustainable. What I'm going to say is that it's not sustainable under certain circumstances, and we don't want to ever find ourselves in that certain circumstance.

Hendrickson: Policymakers need to be cognizant of that, and they need to be especially cognizant of that when they're thinking about deficits and when they're thinking about debt, because there is a point at which you can have too much debt, and then it becomes unsustainable. You don't want to find yourself in that position, but also, in terms of the secondary effects, it's not at all clear that this is beneficial to the United States as a whole.

Hendrickson: It's definitely beneficial to policymakers, because they get to do the things that they want to do, but we might not want them to do those things. There are a lot of people who are opposed to fighting wars in Iraq and Afghanistan, and one reason why we were able to fight those wars and fight them for so long is because we have this Treasury Standard. And so, you're able to borrow substantially more money than you would have to otherwise so taxpayers didn't suffer the way that they would from a prolonged war in the past and things like that. So, we have to think about all of the consequences, and policymakers are going to think about it one way, but then voters and the American people need to think about what the costs and benefits are to them, independent of what the costs and benefits are to policymakers.

Hendrickson: That's kind of where I was just trying to go with this paper and with this argument, is pushing people to think more about what's really going on here, what the consequences are, and how we can think about these things, because the dollar might be the global reserve currency long after I'm gone, but it might not. But even if it is long after I'm gone, I have children, [and], hopefully, my children have children. I care about my children. I care about my yet to be born grandchildren, and their children, and et cetera, et cetera. And so, you have to think for the future, and you have to think about what the consequences are, and what the possible paths are for the United States, with this system.

Beckworth: Okay, well, with that, our time is up. Our guest today has been Josh Hendrickson. His paper is titled, *The Treasury Standard: Causes and Consequences.* Josh, thank you for coming on the program.

Hendrickson: Thanks for having me.

About Macro Musings

Hosted by Senior Research Fellow David Beckworth, the Macro Musings podcast pulls back the curtain on the important macroeconomic issues of the past, present, and future.