March 5, 2013
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 labor 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.
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