From Dollar Gap to Dollar Glut

This shift from dollar scarcity to dollar glut was the consequence of several factors, but at its base it was a consequence of official and private capital flows out of the United States. In 1958, the major European economies returned their currencies to external convertibility for current-account transactions, meaning that for trade purposes the currencies were now freely tradable with other foreign exchange. This was soon followed by the relaxation of exchange controls and the explosion of the offshore "eurodollar” market in London.[1] Together, these changes created conditions where short-term international capital transfers increased in size and frequency. In the words of Susan Strange, "Between 1958 and 1961 it is no exaggeration to say that there had taken place a major renascence of international financial and money markets ... . [This] united Western Europe and North America for the first time since the war into a single international market for foreign exchange.”[2] Capital movements were driven by interest-rate differentials as well as expected changes in par values.[3]

Bretton Woods was getting its first taste of speculative capital flows. Private capital outflows rose throughout the 1950s, reaching nearly $4 billion in 1960. Meanwhile, even after the Marshall Plan ended, US overseas military spending and foreign aid continued to increase by almost $2 billion annually over 1952 levels.

All the while, Europe’s economy had recovered. By 1954, industrial production in most European countries reached levels 50 percent above those prior to World War II. World trade had also recovered. The total volume of international trade was about 65 percent larger than it had been before the war. As European countries exported more, they sought to increase their own foreign exchange reserve stock as insurance against trade shocks. Due to the inconvertibility of their own currencies, an increase in reserves meant an increase in dollar holdings. By the latter half of the 1950s, a number of onetime trade deficit countries—including Belgium, France, the Federal Republic of Germany, Italy, and Japan—were all running trade surpluses and rapidly stockpiling dollars.7 The combination of overseas US government spending, a transformed international financial system increasingly characterized by private, liquid capital flows from the United States to Europe, and growth in European governments’ foreign exchange reserves resulted in a growing supply of dollars pooling outside of US borders. The rapidly changing international financial system generated two new threats to the US economy.

  • [1] For an excellent historical account of the development of the euro-dollar market and therole that states played in its creation, see chapter 4 in Helleiner 1994.
  • [2] Strange 1976, p. 58. Emphasis added. The integration Strange speaks of was primarilythrough the offshore deposit or "euro-dollar” market, which started in London around 1958and took off in the 1960s. Direct integration of national financial markets only came later(see Cohen 1986).
  • [3] The economic boom taking place in Europe caused those countries to raise interestrates. On the contrary, with the United States in recession, the Federal Reserve preferredlower rates to stimulate the US economy. This led to the interest-rate differentials that were,in part, driving liquid capital flows. For example, the spread between UK and US Treasury
 
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