Theory 2 Action Podcast
Theory 2 Action Podcast
MM#377--The Rise and Fall of Global Reserve Currencies: Lessons from History and Modern Challenges
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Unlock the secrets of global economic power shifts and discover how the ebb and flow of reserve currencies have shaped the political and economic landscape over centuries.
Journey with us as we explore the historical narratives of influential nations, from the reign of Spain's silver-backed real to the strategic rise of the Dutch guilder.
With insights drawn from Ray Dalio's "Principles for a Changing World Order" and the scholarly exploration in "Power and Plenty" by Ronald Finley and Kevin O'Rourke, this episode promises a compelling examination of global economic history and its enduring lessons.
Join us as we unravel the fascinating rise of the Dutch Republic—a maritime marvel embodying innovation and strategic prowess and then ultimately its fall.
Key Points from the Episode:
- From the creation of the Dutch flute to the formation of the formidable Dutch East India Company, learn how the Dutch carved their place in the world economy.
- As we pivot to contemporary challenges, the episode delves into the threats facing the US dollar, including initiatives by BRICS nations and China's ambitious push for the renminbi.
- This discussion underscores the critical importance of maintaining reserve currency status for the US and highlights the necessity of forward-thinking fiscal policies to secure a stable economic future.
Other resources:
100 year marathon book review--LM#4--There Cannot Be Two Suns in the Sky
Chip War book review--MM#323--Tech Reliance and its Geopolitical Shockwaves: who needs red lines?
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Welcome to the Theory to Action podcast, where we examine the timeless treasures of wisdom from the great books in less time, to help you take action immediately and ultimately to create and lead a flourishing life. Now here's your host, david Kaiser, flourishing life.
Speaker 2:Now here's your host, david Kaiser. Hello, I am David and welcome back to another Mojo Minute. In our last Mojo Minute we talked all about sea power and how studying history and sea power will give us important understandings of world power, because there's all types of geopolitical realities and national strategies that are happening below the surface. Much like a river can appear calm on the surface, but below that surface there's all types of eddies and tides and current happenings, all not going in the same direction as the flow of the river. Now should we get caught up in analyzing each and every one of these little tides or currents? No, that wouldn't be prudential use of our time. But let me suggest that studying maybe the top two or three factors that are happening just below the surface would, in fact, be a good thing. It would be making yourself aware of possible changes in a rapidly changing world, such as in our 21st century. So the last time we talked all about sea power as one of those changing technologies happening beneath the surface, today we're going to go deep into history to understand reserve currencies. Yes, I know it's a total nerd question and it's going to be a nerd episode, but stay with me here because I think you're going to find this episode quite beneficial, as we're going to connect some dots. Now, what I want you to keep in the back of your mind is that, as we transition from one reserve currency to another in history, that's, that's a big thing, that's a big, significant shift in global economic power power and then downstream to the political power and fortunes of the oncoming and issuing nation. That's a big deal. We got to watch that Now for some context. What are we really speaking about here?
Speaker 2:Well, in Ray Dalio's book Principles for a Changing World Order, we learn this. Principles for a Changing World Order. We learn this China was dominant for centuries, consistently outcompeting Europe economically and otherwise, though it entered a steep decline. Starting in the 1800s, the Netherlands, a relatively small country, became the world's reserve currency empire. In the 1600s, the UK followed a very similar path, peaking in the 1800s. Finally, the United States rose to become the world's superpower. Over the last just 150 years, though, particularly during and after World War II, the United States is now in relative decline while China is rising again. And that is Dalio's main thesis of his book that the US is now in a relative decline while China is rising again. And he is saying that all three, all four of these rise in the superpowers, especially in economic power, has been repeated over history and we need to study that so we can see that the status of the global reserve currency does greatly impact economic power. It allows nations to trade and influence trade. It allows the reserve currency nation or group of nations to shape monetary policies and obviously they enjoy much lower borrowing cost. Lower borrowing cost.
Speaker 2:Now, historically, countries like China, the Netherlands, the UK and then us, the United States, have benefited from holding that position. As these shifts occur, understanding the stakes is crucial and understanding the history behind it is even more crucial, especially as decisions made today will shape economies and geopolitics for the future. Now, just for context, we did some checking on Dalio's history and he has China outpacing the Spanish before the Dutch guilder takes precedent in the 16th century, so we'll have to check on that later. But to us, before the Dutch guilder rose to prominence as a reserve currency in the 17th century so we'll have to check on that later. But to us, before the Dutch guild arose to prominence as a reserve currency in the 17th century, the Spanish silver dollar, also known as the Spanish real or the piece of eight held the position of a very dominant global reserve currency.
Speaker 2:The Spanish real emerged as that global reserve currency during the 16th century. It coincided with the height of the Spanish empire's power and influence. Now this currency's prominence was due to several factors the fact that it had a vast colonial empire. Spain had extensive territories all the way from the Americas, from the bottom of America to the top of the Americas, south America and North America. That provided a strong economic foundation. I mean, I think they had the whole Western hemisphere. So in terms of Dalio's research, was China controlling the whole eastern hemisphere at the time? Not sure we're going to check on Dalio's research about that, but there was other such factors of why Spain and the Spanish empire was so powerful. They had silver abundance. Most certainly the discovery and the exploitation of significant silver deposits in Spanish America, especially in the regions like Potsi, modern-day Bolivia, fueled the production of the Spanish silver coin. Now it had wide acceptance. The Spanish Real gained widespread acceptance across different cultures and civilizations, which helped facilitate trade. And then it was really the first time we had a standardization across much of the Western hemisphere. Certainly in the Roman empire there was a standardization of coin and weight and purity. But finally, coming back in the 15th century, we had that same standardization in the Spanish real, just as a medium of exchange, a reliable medium of exchange. So for us, in the 21st century, that transition from the Spanish Real to the Dutch Gilder as the dominant reserve currency occur gradually, reflecting the shift of the global economic power from Spain to the Dutch Republic during the 17th century.
Speaker 2:Which brings all of us to our book of the day Power and Plenty Trade and War in the World Economy in the Second Millennium, by Ronald Finley and Kevin O'Rourke. Now, at 546 pages, this is a beast of a book, but then again, it's examining the global economic history spanning some thousand years. Now, what do I like in the book? Well, I will have to confess I haven't read all the book, but the book that I portion of the book that I have read offers a very good but nuanced analysis of the interplay between trade and war and economic development across all these different regions of the world. And what I especially liked is I wanted to answer this question what did the Dutch exactly do to help them gain the world reserve currency status at the time? So let us begin to answer that question. Let's read from Power and Plenty Go on to the book.
Speaker 2:The last decade of the 16th century saw the emergence of the Dutch as a major actor in the world economy, displacing the Portuguese and the Spanish within a few decades and holding their primacy well into the 18th century before eventually losing it to the British. The seven northern provinces of the 17 comprising the Spanish possessions in the Netherlands had revolted against what was felt to be an oppressive rule of Philip II at the end of the 1560s. They formed the Union of Untrich as a sort of defensive alliance in 1579 and declared their independence from Habsburg Spain in 1581. The southern provinces, including the highly developed Flanders in Barbant, roughly corresponding to what is now Belgium, were brought back within the Spanish and Catholic fold, but only after considerable emigration of wealthy and skilled dissenters to the north. Antwerp in Barbant, which had been the major emporium in that part of Europe from before the 15th century, was largely ruined by the hostilities and the prolonged blockade of the Schandt by the Dutch and was soon overtaken by Amsterdam and Holland, by far the most populous and wealthiest of the seven United Provinces. The population of Amsterdam rose from about 50,000 in 1600 to double that in 1620 and 200,000 by 1650. Okay, so we can see we have a revolt of the seven northern provinces against the 17 in total. And so there we have that interplay of trade, war and economic development. And speaking of economic development, let's go back to our next paragraph and learn more.
Speaker 2:The Dutch Republic was a merchant oligarchy, somewhat like Venice, but much more than a mere city-state, with a population between one and two million, about the same as Portugal, and with a diverse and productive hinterland. Executive leadership in the new state largely came from the House of Orange, descendants of William the Silent, who died in 1584, regarded as the father of the nation. They held the office of Stadtholder in Holland, zeeland and Utrecht and also commanded the Dutch armed forces. The main federal institution was the States General that met at the Hague. The main asset of the upstart republic was listen, its economic system, certainly the most productive and efficient in Europe at the time, with Italy having passed its peak in the preceding century. Agriculture was concentrated on high value added activities such as livestock and dairy farming, rather than tillage, releasing a high proportion of the labor force for industry and services.
Speaker 2:The strongest initial comparative advantage of the Dutch economy was in shipping, particularly to the Baltic, the so-called mother trade from which all the others sprang. Much of the grain exported from the Baltic the so-called mother trade, from which all the others sprang, much of the grain exported from the Baltic regions was carried in Dutch ships to Amsterdam and re-exported from there to other parts of Europe, including the Mediterranean. The herring fisheries of the North Sea were another great staple of the Dutch, were another great staple of the Dutch, using the large vessel known as the herring bus, a sort of floating factory in which the catch was gutted, salted and packed. So now we learn about the Dutch and how they were mainly a trading republic, and trade is where they make their mark. They essentially don't have to use all their labor force for tillage, but they can use it, they can re-acclimate it for industry and services and they certainly got very smart on providing that herring bus, the sort of floating factory in which the catch was gutted, salted and packed. That was a development. That's simply just outsmarting your competition. Let's learn about their technology, because technology plays a huge, important role in how Ray Dalio in his book says that there's a rise of the world powers, and technology is a critical aspect of that. Let's do a deep dive into the Dutch and their technology strides.
Speaker 2:Going back to the book, considerable strides were also made in manufacturing, partly at the expense of older, more established centers in Flanders and other parts of the Spanish Netherlands. Thus, hans Schutt had been the major producer of the new draperies. Quote-unquote lighter woolen cloth made from a long staple wool. The conflict with Spain sent thousands of skilled workers and entrepreneurs from this town to Leiden in Holland, which doubled its population from 1580 to 1600 and more than doubled its output of these textiles over the same period. By 1664, leiden was producing 144,000 pieces of a year, and Van Hout, this other author, states that at the time Leaden was the most outstanding manufacturing center for wool in Europe and perhaps in the world. These Dutch cloths were soon being exported to the Baltic as well as to the Mediterranean markets. Flemish refugees also established Haarlem as an important linen producer.
Speaker 2:Shipbuilding to replace depreciation of the huge fleet and also for export was another major component of the industrial sector, with 250 to 300 ships a year produced around 1650. Here's an important part. The notable nautical innovation was the Dutch flute, a vessel designed to maximize cargo capacity and minimize labor costs at the expense of speed. It was these vessels introduced in the 1590s and built in the shipyards of Horn, which kept Dutch freight rates so low in the bulk carrying trades as to drive most competitors out of the market. Very important point right there. One reason why the flutes could economize on labor was that they were unarmed or very lightly armed. This meant, however, that they required naval escorts when sailing in dangerous waters. A nice example of the dependency of plenty on power. During this period, In contrast to this Dutch division of labor between civilian and military shipping, english and other merchant ships continued to be heavily and expensively armed. Another important point According to George Downing, another author whom we will encounter in the next chapter, if their merchantmen have constant convoy and the English merchantmen must be both merchant and man-of-war and that last quote was from a person from the time period.
Speaker 2:So that's why we have the jumbled type of quote, as they were not very styled back in the day. They simply just said what they said. And we are here in the 21st century picking up what they said in the late 16th and early 17th century. So you can see technology played a huge, important role in the Dutch moment from the wool that they were able to do that with the Dutch flute, which they designed themselves and which they were able to build 250 to 350 ships a year. Can you imagine those shipping manufacturing ports that were just a bustle of activity.
Speaker 2:And here enters the famous Dutch East India Company, known formally as the VOC, which are the initials of the Dutch name, which is super long and I'm not even going to attempt to try and say it because I will just butcher the name. But the Dutch East India Company was created in 1602, and it was done so for several key reasons, and it was the first of its kind in all the world and that would make a difference. First, it was created for economic reasons. It had to break into the lucrative spice trade which was primarily controlled by the Portuguese empire at the time. In the Far East. It wanted to gain a monopoly on valuable spices such as nutmeg, mace and cloves, which were in high demand in Europe for flavoring food, in the use of medicines, and it also wanted to establish a profitable trading network in Asia, particularly with the Mongol India where most of Europe's cotton and silk was originating.
Speaker 2:On the political front and strategic front, for that there was six small Dutch trading companies that were competing with each other and they wanted to combine all that into a single powerful entity that could then challenge the Portuguese dominance in the East Indies, and they wanted to get their money together to provide a fund to fight for Dutch independence during the 80 Years' War against Spain from 1568 to 1648, which we read about earlier. Now they also just wanted to strengthen the newly re-established Dutch Republic against foreign control by drawing wealth from outside its borders. Now, the most important and creative point for the Dutch in this establishment of the VOC was that it was the world's first joint stock company which allowed citizens of the United Provinces to purchase shares in this company, shares in this company. This structure helped manage the high risks associated with a long distance trade expeditions by pulling their resources and spreading that risk among all the investors, and the Dutch government was responsive to that. They granted the VOC a 21 year monopoly on the spice trade with the South Asian countries, and then the company was given quasi-governmental powers the ability to wage war, to imprison and execute convicts, negotiate treaties and strike its own coins, and then, in the very end, to establish colonies. Now why all this was important about the VOC was the creation of the Dutch East India Company represented a strategic merger of economic interest, followed by national ambitions, and it set the stage for the Dutch moment, the Dutch dominance in global trade during most of the 17th century.
Speaker 2:Now let's go back to the book. Plenty of Power, our book of the day, or Power and Plenty, rather, power and Plenty, our book of the day, by Ronald Findlay and Kevin O'Rourke, because this is the point where we're going to pull it all together. Let's go back to the book for one last quote. As we have seen in the previous sections, trade in the Indian Ocean and the Pacific had settled into a stable pattern by the early 1600s. The Portuguese held Goa, hormuz, malacca and Macau, and the Spanish held Manila as fortified bases and harbors, but with more spices going overland to Europe than around the Cape. At this time, there could be no question of any monopoly held by the Astondo D India in these commodities. And here we go.
Speaker 2:The acutely penetrating geostrategic mind of the young Cohen this is the fourth director of the VOC a guy named Cohen saw this situation as clearly ripe for a takeover bid of global proportions. His native country had fought the Iberian superpower to a standstill on its own soil and was building up sufficient naval resources to break into the ring of fortified trading posts from Hormuz to Manila by seizing them directly or establishing competitors that would divert their trade. Furthermore, instead of passively waiting for supplies to appear, a more forward policy could extract spices at the source from the native growers at lower prices if rival native and foreign buyers could be kept away by force and exported to Europe at relatively low volumes but high margins of profit. Judiciously selected Dutch settlers could be set up for businesses at various locations in Asia, engaging in the huge volume of the intra-Asian carrying trade. Trade to turn over without the expensive necessity of obtaining silver bullion or specie in Europe from the Spanish or their Italian creditors and that last point is so crucial that they did not the profits from which could provide the annual working capital for the trade to turn over without the expensive necessity of obtaining silver bullion or specie in Europe from their Spanish or Italian creditors.
Speaker 2:Folks, that's the challenge to the reserve currency, and that is big time. Why is it big time? Because, again, like we said before, the transition from one reserve currency to another reflects dramatic shifts in global economic power. Each currency's rise and fall is closely tied to the economic and political fortunes of the issuing or upcoming nation. Again, real quick, let's go over at a very high level, let's say a 50,000 foot level.
Speaker 2:What Dalio's book talks about? The history of the last three major reserve currencies the Dutch guilder, the British pound and the US dollar. They span several centuries and they reflect the representative of the shifting dynamics of global economic power. So let's connect some more dots. The Dutch guilder it emerges as a prominent reserve currency during the 17th century and it coincides ironically with the Dutch golden age. Its peak is reached during the mid to late 17th century. It begins to decline as power dynamics in Europe shift and it rapidly falls due to war spending. Remember that. Why does decline in world reserve currencies happen? World reserve currencies happen primarily because to war spending and in this case, in the Dutch, primarily after the Fourth Anglo-Dutch War. The war led to the collapse of the Dutch debt, its equities and the reserve currency. Then we have the rise of the British pound. The British pound succeeds the Dutch guilder as the dominant reserve currency, maintains that status for nearly two centuries.
Speaker 2:Key milestones along the way In 1717, the UK defined sterling's value in terms of gold. In the 1800s the official gold standard adopted, encouraging was adopted and encouraged mass international trade. Again we're seeing that same standardization, just like the Spanish Real to the Dutch Gilder and now to the British Pound, as if the whole world community is saying we don't care what the reserve currency is. You tell me what it should be, and as long as it's providing the value that I want, I will be glad to trade in it. By 1914, in the British pound sterling example, we have the gold standard suspended to support ore efforts.
Speaker 2:Sounds like it's on the decline, doesn't it? In 1931, sterling came off the gold standard, leading to a significant drop in value. The British were coming out of World War I, they had huge debts. And then, we know, in the 1930s it was a lead up to World War II. World War II, the British economy was hemorrhaging under mounds and mounds of debt. And by 1944, bretton Woods Agreement established the US dollar as the primary reserve currency. And then there's a gradual decline post-World War, in the British pound sterling.
Speaker 2:So then we get to the US dollar. It becomes the primary reserve currency. Like we said in the mid 20th century Bretton Woods, really the first time ever that we dropped the dollar against gold. So we've now transitioned as a world economy to floating exchange rates. Now, despite these challenges, the dollar still has maintained its status as the primary reserve currency and, as of right now, most central banks are holding about 58% of their allocated reserves in US dollars.
Speaker 2:Okay, you might be saying, david, what's the big deal? Well, the US dollar being dominant is the big deal, but its dominance as the world reserve currency is facing many, many challenges on several fronts. Probably have not heard about this, but primarily, it's led. These challenges are led by what they call the BRICS nations, b-r-i-c-s nations and China. So let's continue to connect some dots.
Speaker 2:What is this BRICS group all about? What's this alliance? Well, brics is an acronym originally consisting of Brazil, russia, india, china and South Africa. It's recently expanded to include Egypt, ethiopia, iran and the UAE, with Saudi Arabia considering joining the group. The alliance is actively working to reduce dependence on the US dollar. They are promoting the use of national currencies in trade and transactions.
Speaker 2:Efforts to reduce reliance on the US dollar are gaining some momentum. There's an initiative like the Alternative Payment System. It's called the BRICS Cross-Border Payment Initiative and it could be potentially a new reserve currency. And China also. In addition to promoting this chaos among the BRICS group, they're actively promoting their own renminbi, that's the Chinese currency. They're expanding its payment system, its currency swaps and what they call the panda bond market. Now, countries like Russia, india and Turkey are also expanding and exploring dollar alternatives and trade, while projects like Enbridge focus on cross-border digital currencies. Projects like Enbridge focus on cross-border digital currencies. Now, despite all these moves, the US dollar still remains dominant. Like I said, 58% of global reserves are held by most federal reserve banks worldwide and currently 90% of currency trading is still done in the dollar, still traded. All the key commodities are still trading the dollar, but experts note that replacing the dollar could have vital and hemorrhaging effects all over the place.
Speaker 2:So in today's Mojo Minute, our book of the day is Power and Plenty and, like we said before with CPower, it's not just a history book. It helps us to understand that maintaining the US dollar status as the world's reserve currency is vital and crucial for providing the United States its dominant superpower advantage. Now the United States, with necessary time and economic advantages right now, should begin to address under President Trump President-elect Trump, they should aggressively address the debt challenges the United States is facing. We are way over leveraged and burdened by 35 trillion in debt Because we hold the world's reserve currency. This has huge advantages. Like we said before, it offers us lower borrowing costs, increased financial and fiscal flexibility and global economic stability. However, it's essential that we recognize that this status is not guaranteed. It's not guaranteed indefinitely. The US must use this exorbitant privilege wisely by implementing responsible fiscal policies to reduce its debt to GDP ratio. By doing so, it will ensure long-term economic stability.
Speaker 2:If not, we just learned the history. We just learned we will go the way of the Dutch and the English before us. Despite whatever Dalio's research on China being far more powerful than the Spanish in the 15th and 16th centuries, we will still go the way of the Dutch and the English before us. Why? Because they were overburdened by debt, among many other things. But that was one primary warning that we are hearing loud and clear from history and, frankly, dalio is warning us about that today. He still says and we believe he's closer to the truth than his research on the earlier times so he's saying the debt is the huge problem, it's the elephant in the room Now. Furthermore, that transition from the Dutch to the English reserve currency, that was gradual over some 50 to 100 years. The transition from the English to the US dollar in 1944 at Brentwoods was gradual over the course of some 40 years, and it was kind of in and out at World War I and then by World War II it was accelerating. Now do we think, do we have the hubris to think, that if the Chinese challenge the US dollar and ultimately overtake it, do you think that transfer would be gradual? I think not. Do you think it'd be less than 25 years? Nope, if we have any indication, any leading indicator, we could look to China's takeover of Hong Kong. I think it's the canary in the coal mine, if you will. That is a topic we have to keep an eye on because it can impact very quickly how we live and who we live under. We should do our homework now to understand what is happening.
Speaker 2:Last time we talked about two books and we want to reference those again Chip War by Chris Miller and the 100-Year Marathon by Michael Pillsbury Two books you've got to check out if you're curious about how global politics and technology collide, especially when you throw in these world currency crises. We've touched on both these topics before. These reads even go deeper than what we've done here today. Chip Orr if you've ever thought about how semiconductors became the backbone of the modern global power, chip Orr tells a fascinating story about that semiconductor industry and how it's shaped politics and economics on a massive scale.
Speaker 2:And then the 100-year marathon. What if China indeed had a secret long-term strategy to overtake the United States without firing a shot as the world's top superpower? The 100-year marathon explores that very idea and gives us a peek into China's alleged plan. Does it involve overtaking and changing the world reserve currency to the Chinese currency? Curious, we got links in the show notes to take a deep look into these eye-opening insights. So with that, we appreciate you listening and, as always, let's keep fighting the good fight listening and, as always, let's keep fighting the good fight.
Speaker 1:Thank you for joining us. We hope you enjoyed this Theory to Action podcast. Be sure to check out our show page at teammojoacademycom, where we have everything we discussed in this podcast, as well as other great resources. Until next time, keep getting your mojo on.