The Dollar and National Security

The Monetary Component of Hard Power

Paul Viotti

• Publisher: Stanford Security Studies
• Year: 2014
• Print ISBN: 9780804792257, 9780804791137
• eBook ISBN: 9780804792301
• Edition: 1
• Topic: Politics & International Relations
• Subtopic: National Security
• Index: Politics & International Relations

Defense establishments and the armed forces they organize, train, equip, and deploy depend upon the security of capital and capital flows, mechanisms that have become increasingly globalized. Military capabilities are thus closely tied not only to the size of the economic base from which they are drawn, but also to the viability of global convertibility and exchange arrangements. Although the general public has a stake in these economic matters, the interests and interpretive understandings held by policy elites matter most—in particular those among the owners or managers of capital who focus on international finance and the international monetary regimes that sustain global commerce and their capital positions.

In The Dollar and National Security, Paul Viotti explores the links between global capital flows, these policy elites, and national security. After establishing the historical link between currency, gold, and security, he continues the monetary-security story by examining the instrumental role the dollar has played in American economic and national security over the past seven decades. He reveals how perceived individual and collective interests are the key drivers toward building the kind of durable consensus necessary to sustain the external financing of American foreign and national security policy, and addresses the future implications for national security as decision-makers in the BRICs and other countries position themselves to assume an even larger policy presence in global commercial, monetary, and security matters.

PART ONE

THE EUROPEAN CENTER

STERLING, THE DOLLAR, AND SECURITY BEFORE WORLD WAR I

1

Money, Empire, and Prewar Security

After 1870, France did not contest British financial leadership. On the contrary, on such occasions as the Baring crisis of 1890, it supported London with a gold loan from the Bank of France to the Bank of England.

—Charles P. Kindleberger

London became “an international discount market, an international market for shipping freights, an international insurance market and . . . an international capital market.”

—E. H. Carr

From the outset of the new millennium, European Union planners understood that a common currency and monetary policy required comparable fiscal policies. After much negotiation, the parties had agreed on goals relating to taxing, spending, and borrowing with limits set on budget deficits and national debt as a proportion of gross domestic product. As a practical matter, however, reconciling differences in fiscal policy was more easily said than done.

Indeed, serious questions arose a decade after the birth of the euro. Expansive national fiscal policies among Mediterranean members collided head on with the more conservative tax-and-spend policies of Germany and other northern European countries. Not surprisingly, these fiscal asymmetries challenged the viability of the common currency. Which eurozone country would opt out, returning to a separate national currency—or worse, bring the whole euro project down? Could it be Greece? Spain? Portugal? Cyprus? Could it even be Italy? What could (or must) be done to keep the eurozone intact? Economic and national security were at stake not just for one country, but for the European Union as a whole. Since no one country acting alone could resolve the issue, a multilateral, cooperative security approach with the European Central Bank at the center quickly became the order of the day.

Serving the economic and national security purposes of any one member state depends on this willingness to engage in collective action. Fortunately for projects like sustaining the eurozone, this propensity to multilateralism for dealing with any number of often contentious issues has become deeply embedded in the European fabric. This multilateral norm, constructed mostly in times of peace over several centuries, also stands as a reaction to, and a bulwark against, reverting to the scourge of armed conflict that Europeans have endured time and again.

International monetary collaboration is not new in the European experience. Maintaining British, French, Dutch, Belgian, German, and (what was left of) Portuguese (mostly in Africa) and Spanish empires in the late nineteenth and early twentieth centuries depended on the same international liquidity that states require today to cover trade deficits and other net capital outflows—enough gold and foreign currencies in national reserves and access, when needed, to loans or national lines of credit. Given differences in perspectives, the course to an agreed multilateral approach is by no means an easy one. Nevertheless, it is in this cooperative approach to economic and national security that eurozone members tend eventually to find common ground. The most influential player needed for sustaining the euro, of course, is Germany, which has had the region’s largest and strongest economy for more than six decades.

CONSTRUCTING AND SUSTAINING THE EURO

Bringing the euro to birth—a decade-long gestation period—came to fruition with the beginning of the twenty-first century.¹ The collaborative process that brought this about had deep historical antecedents that we begin exploring in this chapter. Not just an economic-security issue, those policy elites committed to the project saw constructing a viable euro as essential to keeping Europe competitively in the front rank globally alongside the United States and other powers. Support came from many among European capital owners and managers in both government and the private sector and, more broadly, from attentive publics across the Continent.

Dissenting voices among policy elites were particularly strong in EU member states that ultimately opted out of the euro project—the UK and Denmark. Critics observed how acceptance of a monetary exception (for the first time allowing some to opt out so that others might proceed) had transformed the European process into integration à la carte. Previously members had moved together in tandem to ever deeper forms of integration from coal and steel community (1953) at the outset to customs union (the goal set in 1958, finally achieved by 1967), and common market (the goal set in 1987, finally achieved by 1992).

European Union policy-makers opting into the eurozone discussed the linkage between monetary and fiscal policies and took steps to avoid (or at least minimize) asymmetries between the two. They sought a common, middle ground between expansionary, growth-oriented policies preferred by some and the more fiscally and monetarily conservative approach preferred by others, particularly Germany and other capital-rich countries. Guidelines on national budgetary deficits and debt limits were needed to meet the challenge of sustaining a common monetary policy while, at the same time, allowing separate fiscal (taxing, spending, and borrowing) policies among the seventeen eurozone members.

This shared understanding among policy elites of what was needed to make a eurozone work ultimately led seventeen EU countries to: (1) set aside their national currencies and adopt the euro; (2) participate in a new European Central Bank (ECB) they established in Frankfurt; (3) agree to a common monetary policy—setting money supply and interest rate targets with fiscal limits on the national budget deficit (3 percent of GDP) and debt (60 percent of GDP);² (4) manage the euro’s value and exchange rate in relation to the dollar, sterling, yen, and other currencies; and (5) reach out to the UK, U.S., Japan, China, and other noneurozone countries to facilitate the cooperative relations essential to maintaining international liquidity not just regionally but also globally.

In spite of extraordinary efforts to keep differences in fiscal policy within narrow limits, asymmetries persisted—the Achilles’ heel of the euro, common-currency project. By the end of the decade, finance ministers, bankers, and even prime ministers were in crisis mode, scrambling to avert financial default by Greece, Spain, and other countries in the European Union. It was an old European story—the capital-rich north confronting the fiscally challenged south, which we treat in greater detail below in this and in subsequent chapters.

Greater austerity was the price demanded by Germany and others in the north for the capital transfers needed to sustain the eurozone and the viability of the EU as a whole. Although the language used was technical and formally diplomatic, the underlying message had a puritanical ring—as if it were “penance” yet again for alleged profligacy in Mediterranean Europe. Budget deficits add to sovereign debt—finance ministries or central banks borrowing in financial markets the difference between expenditures and revenues, often at higher interest rates than more creditworthy countries pay.

If that were not enough, falsified and inaccurate reporting of economic data in Greece and elsewhere angered many, particularly in Germany and elsewhere in northern Europe. To them, governments that continually spend substantially more than the revenues they take in are the cause of the problem. They “deserve” the consequences of such policies so long as such actions do not undermine the whole set of monetary arrangements—putting the euro project and the EU itself in jeopardy.

By contrast, in the southern European view it was the anti-inflationary austerity of capital-rich countries in the north that was the real cause of the problem. Their tight money and fiscally austere policies resulted in reduced imports from the south and less investment there than otherwise might have been the case. Put another way, policies pursued in both camps have had negative externalities—adverse policy implications for each other.

This asymmetry among fiscal policies—relatively austere in the north and expansionary in the south—is the crux of the monetary challenge. Unlike the United States, which at the federal level has a single fiscal policy alongside its monetary policy set by central bankers on the Federal Reserve Board, each of the seventeen eurozone countries has its own fiscal policy—bound only by promises to keep within specified national deficit and debt limits.

To keep Greece within the eurozone and, more broadly, to sustain the EU’s common-currency project were motivations for the initial €110 billion “bailout” loan agreed in May 2010, capital coming from the International Monetary Fund (IMF), Germany, and other eurozone participants working through ECB facilities. Worsening conditions in Greece necessitated transfer of additional capital—€130 billion being the amount finally ratified in February 2012. Severe austerity measures designed to raise government revenues, curb deficit spending, and privatize government-run enterprises were the price imposed on Greece for these loans. Complying with demands for greater austerity became the condition for actually receiving funds.

Labor strikes and domestic turmoil were the not unexpected outcome of these austerity measures. When people and businesses are adversely affected by increased taxes and reduced government spending remedies, the highly charged political climate typically leads to calls for changes in governing authorities. Notwithstanding substantial political opposition, Greek policy elites committed to keeping Greece in the eurozone prevailed in these debt-negotiation rounds.

Greece was not alone. To sustain their eurozone commitments, loans or lines of credit were extended Hungary (€20 billion, 2008), Latvia (€7.5 billion, 2008), Romania (€20.6 billion and €5.1 billion, 2009 and 2011, respectively), Ireland (€67.5 billion, 2010), Portugal (€78 billion, 2011), and Spain (€41.4 billion, 2012). Responding to the Greek and other challenges, a consensus gradually formed among politically connected European policy elites to strengthen the ECB’s capability—the resources it needed to maintain international liquidity among eurozone members.

Creation in 2010 of the European Financial Stability Facility (EFSF) and the European Financial Stability Mechanism (EFSM) was followed by calls for greater multilateral institutionalization and provision of greater capital resources for eurozone participants. The result was consolidating the EFSF and EFSM in a new €700 billion European Stability Mechanism (ESM) organizationally located in Luxembourg.

Maintaining international liquidity—access to, or reserves of, foreign currencies needed for currency exchange—within the region and globally is not just an economic challenge but also at the core of national (and international) security concerns. Financial failure in Europe, the United States, and elsewhere obviously has global ramifications, the exchange of money essential not just for economic security (sustaining trade, investment, and other forms of commerce upon which businesses and people depend for their livelihoods) but also for financing the outlays made by governments for foreign and national security purposes. Although policy-makers in the United States and other capital-rich states typically have a louder voice in collective deliberations, not even they can achieve economic and national security strictly through unilateral measures. Indeed, sustaining the international monetary regime—maintaining international liquidity—is a security objective in want of a multilateral approach.

Economic security of state- and private-sector interests, the conduct of foreign policy, and the deployment of armed forces abroad require day-to-day finance—the ready acceptance as payment in a given country’s currency. Trade, investment, and other forms of commerce conducted by both state and nonstate actors drive the daily capital flows that require the exchange of currencies which, in turn, depend on each country’s liquidity—its access to the currencies of other countries held in its national reserves or available by purchase or loan in financial markets or from the national holdings in other states.

Multilateralism matters. European, American, or other monetary challenges are recurring phenomena worth studying historically if, even for no other reason, than to underscore that the collective remedy to liquidity problems, though often elusive, requires an ongoing willingness to work with others. Cooperative security is not just a matter of finding ways to avoid armed conflict but also the enlightened self-interest in the minds of policy elites that results in a propensity to consult, coordinate, and construct...

Table of contents

• Cover
• Copyright
• Title Page
• Dedication
• Contents
• Acknowledgments
• Preface
• Introduction. Money and Security
• Part One. The European Center: Sterling, the Dollar, and Security Before World War II
• Part Two. The United States Moves to the Center: Dollar Primacy and American National Security
• Notes
• Bibliography
• Index