Economists warn that the U.S. economy could be heading toward one of two catastrophes: the two-decade long stagnation that has befallen Japan, or the hyperinflation that struck Zimbabwe and the Weimar Republic. Such cautionary tales alert policymakers to the failed efforts of their predecessors. But the most relevant comparison is rarely cited – to Great Britain in the 1920s, as depicted in the highly popular PBS series Downton Abbey.
While Downton Abbey‘s plot focuses on the interpersonal relationships of the fictional Yorkshire country estate where the period drama is set, a subplot illustrates the crisis that Great Britain faced in the interwar period. Season three, which is currently airing, depicts the struggles of the agricultural workers whose labour economically supports the estate.
Great Britain entered the Great Depression in the 1920s, a decade before the rest of the world. The county faced high unemployment and depressed domestic consumption.
Sterling’s status as the reserve currency was the overarching cause of Britain’s economic problems. As I will illustrate, the parallels to the U.S. today and the dollar’s reserve-currency status are numerous and include high unemployment, slow economic growth and low interest rates.
The comparison between interwar Great Britain and the U.S. today was first explained to me in an interview with Columbia professor Bruce Greenwald. Greenwald and his co-author Judd Kahn elaborate on the analogy in their book, Globalization: The Irrational Fear that Someone in China will Take Your Job. Michael Pettis, a professor at Peking University, has a new book, The Great Rebalancing, which further explores the role of reserve currencies.
Let’s look first at the role reserve-currency status plays in a country’s economy. I’ll then turn to the comparison to Britain in the 1920s, and then to what this means for the U.S. today.
The exorbitant burden
Pundits and economists obsess over budget deficits, sequestration, the debt ceiling and quantitative easing. But, as Pettis explains, “the source of the global crisis through which we are living can be found in the great trade and capital flow imbalances of the past decade or two.”
The dollar’s status as the reserve currency has driven those imbalances. The dollar is the primary currency held by foreign central banks and institutions to settle international transactions.
Because dollars are so widely held, there is a persistent structural demand for them. This forces the value of the dollar higher relative to other currencies. Indeed, despite several rounds of quantitative easing – which many warned would weaken the dollar – its value relative to a trade-weighted basket of foreign currencies is the same as it was at the onset of the financial crisis.
This is because America’s trading partners – including China, Europe and Japan – have employed similar policies of quantitative easing, offsetting actions by the Fed that would have otherwise weakened the dollar. Those countries run trade surpluses, and as Greenwald and Kahn explained in their book, it is always the surplus countries that control global trade and currency values. To maintain reserve-currency status, the Fed must act cautiously and responsibly, whereas the surplus countries can devalue more aggressively.
Reserve currency status has been called an “exorbitant privilege” – a term coined in 1965 by Valery Giscard d’Estaing, then France’s minister of finance and economic affairs, according to Pettis. Giscard d’Estaing was referring to America’s ability to finance a high level of internal consumption with a seemingly limitless capacity to issue debt.
But Pettis argues that a more appropriate term would be an “exorbitant burden.” Because our trading partners are accumulating dollars, the U.S. must run a current-account deficit. U.S. demand exceeds production, with imports making up the difference. U.S. manufacturers are penalised by the overvaluation of the dollar, are forced to contract and unemployment rises.
Our large trade deficit flows directly from our reserve-currency status, as does our low savings rate and high levels of private and public debt.
“Consuming beyond your means, it seems, is not much of a blessing,” Pettis wrote. “And why should it be? Allowing excessive foreign purchases of its bonds requires often that the reserve currency choose between rising unemployment and rising debt.”
Like Britain in the 1920s, the U.S. today faces both burdens.
The Great Britain of Downton Abbey
Britain achieved reserve-currency status around 1870 as a result of its leadership in the Industrial Revolution. The nation’s economic downfall began after World War I. Let’s look at some of the key economic themes of Britain at the time and their parallels to the U.S. today.
Britain’s economy collapsed almost immediately after the end of the war. In a counterpart to the U.S. economy during the financial crisis, the British economy contracted from 1919 to 1921, with real GDP decreasing by 9.9%, 7.8% and 10.1% annually in those years.
Britain faced the same dilemma as rest of the world during the Great Depression. Productivity rose in its agricultural sector – Downton‘s farmers – due to the advances of the Industrial Revolution. Fewer workers could produce the same amount of goods. Today, the U.S. economy faces the same situation in its manufacturing sector, which has shrunk to 9% of its economy thanks to post-World War II productivity increases. Higher productivity naturally leads to higher unemployment.
Business Insider Emails & Alerts
Site highlights each day to your inbox.