Do states with reserve currency status hold the
upper hand when it comes to maintaining their military might? Rosella
Cappella believes so. To help illustrate her point – and what it might
mean for the United States – she looks at how Britain once used its
‘Sterling supremacy’ as a ‘power multiplier’.
Introduction
The dollar has been the dominant reserve currency since the end of World War II. However, recent events, notably the 2008 financial crisis, have caused the dollar’s dominance to come under question. In March 2009, the governor of China’s Central Bank, Zhou Xiaochuan, released a statement calling for the replacement of the dollar as the dominant currency and creating “an international reserve currency that is disconnected from individual nations.” [1] At the G20 summit meeting a month later, Russian President Medvedev echoed China’s statement, suggesting “the creation of strong regional currencies and to use them as the basis for a new reserve currency.”[2] In November 2011, Chinese President Hu Jintao again proposed a new regime based on an International Monetary Fund currency basket, “reform the SDR (Special Drawing Rights) currency basket, and build an international reserve currency system with stable value, rule-based issuance and manageable supply.” [3]
In addition to foreign states calling for an end to dollar supremacy, there has been a fear within the United States that the recent trend of dollar depreciation will result in decreased demand for the dollar as foreign states restructure their reserve holdings. [4] In a 2007 Congressional hearing, Brad Setser testified, “most foreign central banks have already concluded that they are saturated with their U.S. Treasury holdings and they are looking to find investments that offer higher yields.” [5]
Within the field of International Relations, realists, arguing that the distribution of power ultimately rests on an economic base, are concerned that a decline in reserve currency status will result in a decline in U.S. power.[6] Are these realists right? Should American policy makers be concerned and begin taking active steps to insure dollar supremacy? While policymakers and scholars have debated the economic implications of a decline in dollar supremacy, there has been little conversation regarding the effect of a decline on American ability to project military power. In order to understand this relationship, this article focuses on one form of military power, the ability to fight war. [7]
The few works that relate reserve currency status and military power suggest that reserve currency states are able to wage economic statecraft. [8] Few scholars, however, have systematically attempted to understand the relationship between currency reserves and the ability to fight war. Janet Kelly argues that ownership of monetary reserves means a state has “buying power,” which may be important in time of war.[9] Specifically, she argues that Organization of Petroleum Exporting Countries accumulation of ‘petrodollars’ allows them to purchase “off the shelf weapons and buy foreign trainers to teach their own armies how to fire them.” [10] Knorr and Kirshner argue that during wartime a weak reserve position may curtail a government’s capacity to fight a war when facing capital flight.[11] Kirshner also argues that a decline in the dollar’s reserve currency status will make borrowing to finance military expenditure more difficult and the American policymakers will have to make the difficult choice between raising taxes, cutting non-defense spending, and cutting defense spending.[12]
While these arguments are insightful and address the relationship of interest, they are not advanced beyond these assertions. In addition, aside from Kelly, they miss a vital element of war: the ability to purchase badly needed goods from abroad to maintain forward bases, supply troops, and supplement civilian consumption during wartime. States characterized by reserve currency status are afforded a unique ability to run a balance of payments deficit. This ability allows the state to purchase large amounts of goods from abroad that it would otherwise not have been able to do, providing a wartime advantage vis-à-vis an adversary. At the risk of surrendering their autonomy, states not characterized by this reserve currency status are forced to rely on allied aid to fight the war. It should be noted that while reserve currency states are relatively better able to fight wars than non reserve currency states, there exists substantial variation in the type of reserve status a state holds. States whose currency is held widely by a large proportion of countries will have more wartime advantages than states whose currency is held by a smaller proportion of countries. In sum, reserve currency status allows the state strategic flexibility, a crucial component of national power.
In addition, previous theories only explore a linear relationship: reserve currency status amplifies a state’s ability to project power. I find an endogenous relationship between a state’s currency status and war exists under certain conditions. When a state is fighting a high intensity war with a heavy reliance on inputs for the war purchased abroad, not only will the benefits of reserve currency status diminish but the actions taken by the state to supply the war effort will cause a decline in the state’s currency status. Essentially, in order to secure a high volume of inputs from abroad, the state will have to procure currency by engaging in large foreign loans or the selling of foreign assets. The ability to engage in foreign loans has an upper bound as private markets become saturated and are no longer able to absorb the state’s debt. Once this occurs, the state will have to look elsewhere, either procure loans from the supplier state or sell its foreign assets. These actions result in financial overextension, affecting the stability and convertibility of the reserve currency after the war is over, critical components to maintaining reserve currency status. [13] In sum, during wartime, reserve currency status is an accelerant. It is either a power multiplier if a state has a strong reserve currency status or a power decelerator if a state’s currency status is in decline.
To test my argument, I compare British financing of its various interstate wars between the height of the sterling’s prominence in the 1850s to its demise in the 1950s.[14] Specifically, I look at the effect of sterling supremacy on Britain’s ability to fight the Crimean War, World War I, World War II, and the Korean War.[15] While the sterling’s status yielded Britain clear advantages in the Crimean War and the first half of World War I, the size and intensity of World War I and the need to purchase goods from the United States ultimately resulted in the sterling’s decline, affecting Britain’s ability to fight World War II. Unfortunately for Britain, the intensity and duration of World War II and the repeated need to procure goods from the United States placed further pressure on the sterling. By the time of the Korean War, the sterling’s status crippled the country’s ability to project military power abroad and its war fighting effort on the Korean Peninsula.
This article advances our knowledge of the effect of reserve currency on the ability to finance war by providing the first empirical assessment of the claims made by the scholars discussed above. More importantly, by building upon their assertions, incorporating the role of balance of payments problems, and addressing the variation in reserve currency status, I provide the first cohesive theory of reserve currency and the ability to fight war, allowing scholars to understand under what conditions and to what extent reserve currency status affects a state’s military power. In addition, by moving beyond the linear relationship between currency status and war, this article also contributes to our understanding of the effect of war on economic rise and decline.
The rest of this article proceeds in three parts. First, I discuss the military benefits of reserve currency status and the effect of high intensity protracted wars on reserve currency decline. I follow this discussion with an in-depth look at the ability of the British Government to wage war during different periods of sterling supremacy. While the variation in sterling supremacy is helpful in shedding light on the relationship of reserve currency status and the ability to fight war, there are a myriad of differences between the international monetary system of the nineteenth and twentieth century and the present. Thus, I conclude with a discussion of the effects of the declining dollar has on the United States’ ability to fight war. In brief, the dollar currently enjoys even more prominence than the sterling due to the end of the gold standard and the pricing of many commodities in dollars. These differences have afforded the United States an even larger advantage in the post World War II era than its predecessor. That said, the dollar has come under periods of decline and is vulnerable to the same pressures that faced the sterling.
Read the full article.
The dollar has been the dominant reserve currency since the end of World War II. However, recent events, notably the 2008 financial crisis, have caused the dollar’s dominance to come under question. In March 2009, the governor of China’s Central Bank, Zhou Xiaochuan, released a statement calling for the replacement of the dollar as the dominant currency and creating “an international reserve currency that is disconnected from individual nations.” [1] At the G20 summit meeting a month later, Russian President Medvedev echoed China’s statement, suggesting “the creation of strong regional currencies and to use them as the basis for a new reserve currency.”[2] In November 2011, Chinese President Hu Jintao again proposed a new regime based on an International Monetary Fund currency basket, “reform the SDR (Special Drawing Rights) currency basket, and build an international reserve currency system with stable value, rule-based issuance and manageable supply.” [3]
In addition to foreign states calling for an end to dollar supremacy, there has been a fear within the United States that the recent trend of dollar depreciation will result in decreased demand for the dollar as foreign states restructure their reserve holdings. [4] In a 2007 Congressional hearing, Brad Setser testified, “most foreign central banks have already concluded that they are saturated with their U.S. Treasury holdings and they are looking to find investments that offer higher yields.” [5]
Within the field of International Relations, realists, arguing that the distribution of power ultimately rests on an economic base, are concerned that a decline in reserve currency status will result in a decline in U.S. power.[6] Are these realists right? Should American policy makers be concerned and begin taking active steps to insure dollar supremacy? While policymakers and scholars have debated the economic implications of a decline in dollar supremacy, there has been little conversation regarding the effect of a decline on American ability to project military power. In order to understand this relationship, this article focuses on one form of military power, the ability to fight war. [7]
The few works that relate reserve currency status and military power suggest that reserve currency states are able to wage economic statecraft. [8] Few scholars, however, have systematically attempted to understand the relationship between currency reserves and the ability to fight war. Janet Kelly argues that ownership of monetary reserves means a state has “buying power,” which may be important in time of war.[9] Specifically, she argues that Organization of Petroleum Exporting Countries accumulation of ‘petrodollars’ allows them to purchase “off the shelf weapons and buy foreign trainers to teach their own armies how to fire them.” [10] Knorr and Kirshner argue that during wartime a weak reserve position may curtail a government’s capacity to fight a war when facing capital flight.[11] Kirshner also argues that a decline in the dollar’s reserve currency status will make borrowing to finance military expenditure more difficult and the American policymakers will have to make the difficult choice between raising taxes, cutting non-defense spending, and cutting defense spending.[12]
While these arguments are insightful and address the relationship of interest, they are not advanced beyond these assertions. In addition, aside from Kelly, they miss a vital element of war: the ability to purchase badly needed goods from abroad to maintain forward bases, supply troops, and supplement civilian consumption during wartime. States characterized by reserve currency status are afforded a unique ability to run a balance of payments deficit. This ability allows the state to purchase large amounts of goods from abroad that it would otherwise not have been able to do, providing a wartime advantage vis-à-vis an adversary. At the risk of surrendering their autonomy, states not characterized by this reserve currency status are forced to rely on allied aid to fight the war. It should be noted that while reserve currency states are relatively better able to fight wars than non reserve currency states, there exists substantial variation in the type of reserve status a state holds. States whose currency is held widely by a large proportion of countries will have more wartime advantages than states whose currency is held by a smaller proportion of countries. In sum, reserve currency status allows the state strategic flexibility, a crucial component of national power.
In addition, previous theories only explore a linear relationship: reserve currency status amplifies a state’s ability to project power. I find an endogenous relationship between a state’s currency status and war exists under certain conditions. When a state is fighting a high intensity war with a heavy reliance on inputs for the war purchased abroad, not only will the benefits of reserve currency status diminish but the actions taken by the state to supply the war effort will cause a decline in the state’s currency status. Essentially, in order to secure a high volume of inputs from abroad, the state will have to procure currency by engaging in large foreign loans or the selling of foreign assets. The ability to engage in foreign loans has an upper bound as private markets become saturated and are no longer able to absorb the state’s debt. Once this occurs, the state will have to look elsewhere, either procure loans from the supplier state or sell its foreign assets. These actions result in financial overextension, affecting the stability and convertibility of the reserve currency after the war is over, critical components to maintaining reserve currency status. [13] In sum, during wartime, reserve currency status is an accelerant. It is either a power multiplier if a state has a strong reserve currency status or a power decelerator if a state’s currency status is in decline.
To test my argument, I compare British financing of its various interstate wars between the height of the sterling’s prominence in the 1850s to its demise in the 1950s.[14] Specifically, I look at the effect of sterling supremacy on Britain’s ability to fight the Crimean War, World War I, World War II, and the Korean War.[15] While the sterling’s status yielded Britain clear advantages in the Crimean War and the first half of World War I, the size and intensity of World War I and the need to purchase goods from the United States ultimately resulted in the sterling’s decline, affecting Britain’s ability to fight World War II. Unfortunately for Britain, the intensity and duration of World War II and the repeated need to procure goods from the United States placed further pressure on the sterling. By the time of the Korean War, the sterling’s status crippled the country’s ability to project military power abroad and its war fighting effort on the Korean Peninsula.
This article advances our knowledge of the effect of reserve currency on the ability to finance war by providing the first empirical assessment of the claims made by the scholars discussed above. More importantly, by building upon their assertions, incorporating the role of balance of payments problems, and addressing the variation in reserve currency status, I provide the first cohesive theory of reserve currency and the ability to fight war, allowing scholars to understand under what conditions and to what extent reserve currency status affects a state’s military power. In addition, by moving beyond the linear relationship between currency status and war, this article also contributes to our understanding of the effect of war on economic rise and decline.
The rest of this article proceeds in three parts. First, I discuss the military benefits of reserve currency status and the effect of high intensity protracted wars on reserve currency decline. I follow this discussion with an in-depth look at the ability of the British Government to wage war during different periods of sterling supremacy. While the variation in sterling supremacy is helpful in shedding light on the relationship of reserve currency status and the ability to fight war, there are a myriad of differences between the international monetary system of the nineteenth and twentieth century and the present. Thus, I conclude with a discussion of the effects of the declining dollar has on the United States’ ability to fight war. In brief, the dollar currently enjoys even more prominence than the sterling due to the end of the gold standard and the pricing of many commodities in dollars. These differences have afforded the United States an even larger advantage in the post World War II era than its predecessor. That said, the dollar has come under periods of decline and is vulnerable to the same pressures that faced the sterling.
Read the full article.
[1] Zhou Ziauchuan, Statement on Reforming the International Monetary System, 2009 (Washington D.C.: Council on Foreign Affairs).
[2] Helene. Cooper, “Medvedev Resurrects Idea of Replacing Dollar as Reserve Currency,” The New York Times, April 2, 2009.
[3]
Rebecca Christie & Zijing Wu, “China to Commit on Currency
Flexibility at G-20, Treasury’s Brainard Says,” Bloomberg, November 2,
2011. These claims by Asian leaders are consistent with Benjamin Cohen’s
prediction that there will be no single challenger currency to the
dollar. Rather what will emerge is a fragmented monetary system with
several currencies in contention and none clearly in the lead. Benjamin
Cohen, “Towards a Leaderless Currency System,” in Eric Helleiner and
Jonathan Kirshner (eds.), The Future of the Dollar (Ithaca: Cornell
University Press, 2009), p. 143.
[4]
Craig K. Elwell, The Depreciating Dollar: Economic Effects and Policy
Response, 2012 (Washington, D.C.: Congressional Research Service). It
should also be noted that not all scholars fear that dollar depreciation
will result in a decline in dollar supremacy. Drezner (2010) in
particular argues that it is unlikely that China and other actors in the
Pacific Rim will challenge the dollar’s status in order to gain a
strategic geopolitical advantage. Daniel W. Drezner "Will Currency
Follow the Flag?" International Relations of the Asia-Pacific, Vol. 10,
No. 3 (2010). See also Eichengreen, “The Rise and Fall of the Dollar.”
Helleiner and Kirshner’s (2009) edited volume The Future of the Dollar
provides an excellent discussion of whether or not the dollar will
retain its reserve currency status. Eric Helleiner & Jonathan
Kirshner (eds). The Future of the Dollar. Ithaca: Cornell University
Press, 2009.
[5] Brad Sester, Foreign Holdings of U.S. Debt: Is Our Economy Vulnerable, 110th Cong., 1st sess., 2007.
[6]
Robert Gilpin, War and Change in World Politics (Cambridge: Cambridge
University Press, 1981), p. 67. Recent works that link American power
and dollar supremacy include: Stephen G. Brooks and William C.
Wohlforth, World Out of Balance: International Relations and the
Challenge of American Primacy (Princeton: Princeton University Press,
2008), p. 124-129; Jonathan Kirshner, “Dollar Primacy and American
Power: What’s at Stake,” Review of International Political Economy, Vol.
15, No. 3 (2008); Michael Mastanduno, “System Maker and Privilege
Taker,” World Politics, Vol. 61, No. 1 (2009); Carla Norrlof, America’s
Global Advantage: U.S. Hegemony and International Cooperation
(Cambridge: Cambridge University Press, 2010); Joseph S. Nye, Jr., “The
Future of American Power: Dominance and Decline in Perspective,” Foreign
Affairs, November/December 2010; and Robert A. Pape, “Soft Balancing
Against the United States,” International Security, Vol. 30, No. 1
(2005).
[7]
While this article addresses the ability to fight all interstate wars,
reserve currency status is particularly important for long costly wars
where the ability to procure a high volume of inputs to fight an
adversary is critical to the war effort.
[8]
David Baldwin, Economic Statecraft (Princeton: Princeton University
Press, 1985). Klaus Knorr, The Power of Nations: The Political Economy
of International Relations (New York: Basic Books, 1975). Jonathan
Kirshner, Currency and Coercion: The Political Economy of International
Monetary Power (Princeton: Princeton University Press, 1995). David M.
Andrews, “Monetary Power and Monetary Statecraft,” in D.M Andrews, ed.,
International Monetary Power (Ithaca: Cornell University Press, 2006).
[9]
Janet Kelly, “International Monetary Systems and National Security,” in
K. Knorr and F.M. Trager, eds., Economic Issues and National Security
(New York: National Security Education Program by the Regents Press of
Kansas, 1977).
[10] Ibid., p. 236.
[11]
Klaus Knorr, The Power of Nations: The Political Economy of
International Relations (New York: Basic Books, 1975. Jonathan Kirshner,
Currency and Coercion: The Political Economy of International Monetary
Power (Princeton: Princeton University Press, 1995).
[12] Kirshner, “Currency and Coercion.”
[13]
It should be noted that reserve currency decline often covaries with
other aspects of economic decline caused by war such as decrease in
trade, loss of capital assets, or financial flight. This article will
demonstrate that despite other negative economic externalities caused by
war, reserve currency status is uniquely affected by the inability to
run a balance of payments deficit when procuring goods from abroad to
fight the war. In other words, while war can have a disastrous effect on
a state’s economy these effects are not necessarily sufficient
conditions to cause a decline in a state’s currency status whereas the
inability to run a balance of payments deficit is.
[14]
I focus on interstate wars for two reasons. First, the Indian Army, of
which the British Treasury only financed a fraction of the cost, fought
most of British colonial wars. Second, the policy for financing colonial
wars not fought by the Indian Army was to supply and pay forces
locally. The Sudan, for example, was conquered in 1888 at the cost of
£2,354,000 at the expense mainly of the Egyptian Exchequer. The extra
finance required from the British Treasury was only £500,000, not enough
to put up income tax from 8d. in the pound. Susan Strange, Sterling and
British Policy: A Political Study of an International Currency in
Decline (London: Oxford University Press, 1971), p. 182.
[15]
Excluded from this study is the Second Boer War, fought from October
1899 to May 1902, as it is not considered an interstate war by the
Correlates of War Project. For a superb discussion of supplying the war
effort, in which inputs for the war effort were shipped from Britain and
purchased locally, as well as army pay, and how these expenses were
met, see (Report of His Majesty's Commissioners Appointed to Inquire
into the Military Preparations and Other Matters Connected With the War
in South Africa, 1903).
Rosella Cappella is an Assistant Professor of Political Science at Boston University and a former fellow at the Dickey Center for International Understanding at Dartmouth College.
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