Abstract
This paper provides new evidence on the rise of the dollar as an international currency, focusing on its role in the conduct of trade and the provision of trade credit. We show that the shift to the dollar occurred much earlier than conventionally supposed: during and immediately after World War I. Not just market forces but also policy support—the Fed in its role as market maker—was important for the dollar’s overtaking of sterling as the leading international currency. On balance, this experience challenges the popular notion of international currency status as being determined mainly by market size. It suggests that the popular image of strongly increasing returns and pervasive network externalities leaving room for only one monetary technology is misleading.
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Notes
On the evidence, see Hausmann and Panizza (2010).
Something that has obvious implications for thinking about the future. The recent work in question is Eichengreen and Flandreau (2009).
Or why other currencies could not eventually join them.
With some exaggeration, Alexander Noyes, financial editor of the New York Times, argued that the replacement of London by New York and of sterling by the dollar occurred “almost immediately” with the outbreak of World War I (Silber 2007, p.168).
See Flandreau and Jobst (2009), who document the influence of trade and geography on currency internationalization before World War I.
That is to say, it flowed in the directions and proportions suggested by the gravity model of international trade.
See Rothbard (1963), pp.117–123.
As contemporaries such as Jacobs (1910) recognized.
And also private, joint stock and colonial institutions with international reach.
Over time, the large commercial banks with their substantial international branch networks joined them.
See King (1936).
They could also secure advances from the central bank against the parcels.
This narrative was prominent in the debates surrounding the creation of the Federal Reserve System. In a pamphlet written for National Monetary Commission, for example, Jacobs (1910, p. 13) deplored a state of affairs in which U.S. bankers were forced to transact via London, observing how this “adds to the importance of London and militates against the development of New York as a financial center.” John J. Arnold, First Vice-President of the First National Bank of Chicago, similarly argued that the “three cornered arrangement” whereby London banks financed American foreign trade could “and should be eliminated” so that a “direct dollar exchange market” be created between the US and South America and the Orient so as to deny London “the undue advantage which this center has had in the past” (Parrini 1969, p. 105). U.S. business and policy leaders supporting the internationalization of New York and the U.S. dollar referred to the amount paid annually to British banks in acceptance fees as the “tribute” (see e.g. Warburg 1910). Of course the metaphor was flawed: British bankers financed American trade more cheaply than New York bankers would have (Phelps 1927, p. 102; Parrini 1969, p. 103). The actual amount involved was a small fraction of U.S. trade or GDP. In 1927, when U.S. banks had secured a large share of the global market for acceptances, the Acceptance Bulletin estimated the annual saving to have been a “material” $5 million. Even this figure is an upper bound, since it does not subtract the resource cost for U.S. banks to supply the acceptances. For a related discussion, see Broz (1997).
Trust companies could branch abroad, but few did, and those which set up foreign offices did so mainly in order to gather information on foreign bonds, which were attractive assets to add to their portfolios since these matched the maturity of their liabilities to their trustees. Some state charters also allowed state banks to branch abroad, although few if any ever did. There was one specialized institution, the International Banking Corporation, set up by the Remington Arms Company to assist it in its foreign sales, that operated foreign branches but was prohibited from engaging in domestic banking.
Actually the relevant legislation only lacked provisions explicitly authorizing banks to engage in this business, but the courts, channeling long-standing American suspicion of concentrated financial power, repeatedly ruled against their efforts to do so. While other forms of short term credit emerged, they were less liquid than European style acceptances. One form of short-term negotiable security that came to existence and played some domestic role was the so-called single name “commercial paper.” Commercial paper was issued by industrial and commercial enterprises of substantial standing and traded in organized markets. But while commercial paper paid with “clockwork regularity,” it was relatively illiquid (James 1995, p. 224, drawing on Foulke 1931, pp.80, 84–6).
Flandreau and Jobst (2005) show that bills denominated in sterling, francs and marks had the widest foreign circulation. Those in sterling were traded everywhere, those in francs in 80% of foreign markets, those in German marks in 59%.
According to Lindert (1969), sterling accounted for 51% of identified reserves in 1913, the franc 33%, the mark 16%.
One motive for the act was precisely to create a market in trade acceptances in New York, the belief being that a market in securities backed by receivables would be more stable than one dominated by speculative stock market transactions—this having been a popular explanation for the 1907 financial crisis.
This is essentially the QWERTY story of strong lock-in (David 1985). This presumption is found in some recent historical literature in which it is argued that sterling remained the leading international currency until after World War II as well as in accounts by economists. Modern accounts assert that, once established, London’s first-mover advantage was difficult, even impossible to overturn. For example, Roberts and Kynaston (2000, p.192) argue that “the lesson of history is that—once established—leading financial centers retain their primacy until toppled by an external shock.” Michie (2007, p. 78) similarly argues that World War I was a major shock for London’s supremacy, but was “insufficient to destroy the strong position it had established in the years before 1914.” Others like Aliber (1966) and, more recently, Chinn and Frankel (2008), have echoed Triffin (1960) in suggesting that dollar only overtook sterling after World War II.
Previous students of strategic externalities (Liebowitz and Margolis 1990) have argued that the strong lock-in suggested by the QWERTY hypothesis is unlikely. In the conventional tale, large players are able to subsidize adoption of the new standard and, once it is adopted, agents coordinate on it and the subsidy is no longer needed. In our context, these players would be central banks or possibly public-private partnership of banks and policy makers. In this spirit, Ferderer (2003, p.666) argues that “Federal Reserve Banks played a key role by reducing the risk borne by private dealers and propelling the [dollar acceptances] market to a high-liquidity equilibrium.” Silber (2007, p.168) praises the steps taken by Treasury Secretary McAdoo at the onset of World War I to keep the dollar on gold, persuading markets of its credibility. Had this policy not been implemented, he concludes, “Britain could have easily remained the undisputed, if somewhat battered, champion of international finance until the Second World War. It almost happened.”
While the first effect was permanent, the second was more transient, the Fed withdrawing from the market after the summer of 1931.
This makes the interest differential a fair approximation of the relative cost of financing a shipment in the alternative centers and currencies. See Vigreux (1932), p. 121.
This is an appropriate comparison, since commercial paper benefited in similar fashion from the new arrangements. The Federal Reserve Act was intended to promote the commercial paper market, and Federal Reserve rediscount rates on commercial paper were close to, if slightly higher than, the rate on acceptances. As recalled by James (1995, p. 227), the Federal Reserve Act was defined as “An Act to provide for the Establishment of Federal Reserve Banks … and to afford means of rediscounting commercial paper.” As for information on dollar acceptances, the editors of the Acceptance Bulletin constructed monthly series from material submitted by reporting banks. The resulting series is available January 1917 to April 1936 (the Bulletin having been discontinued at that point). From 1917 onward, the Bulletin also distinguished acceptances created to finance exports, imports, shipments and goods stored in foreign countries, domestic shipments, domestic warehouse credits and dollar exchange Federal Reserve reports and bulletins then provide information on acceptances between 1936 and 1939.
From Federal Reserve statistics and the Acceptance Bulletin.
It complains, however, the acceptances it originated failed to find ready buyers, forcing it to hold its own paper (Guaranty Trust 1919).
See the Federal Reserve Board’s Annual Report for 1915.
The report also mentions that 7 additional banks in the area had moved into the acceptance business (Federal Reserve System, Annual Report for 1915, p. 136).
A body created in 1923 to monitor Fed’s investment and money market policy and operations.
Federal Reserve Archival System for Economic Research, Federal Reserve Open Market Investment Committee (Open Market Policy Conference), Excerpts, 1923 to 1928. Quote taken from “Excerpts of the Federal Open Market Investment Committee during 1923”, p. 5.
Holdings are measured here as total holdings, i.e. holdings for its own account and for the account of foreign customers, mostly central banks.
Again, either on its own account or on that of foreign central banks holding deposits with it.
See Sayers (1968) for a discussion of the conflicts created by the multiplicity of policy objectives during the 1920s and the partial remedies found to deal with it.
Parrini argues that U.S. declaration of war and Wilson’s sponsoring of the League of Nation were direct responses to this challenge. They led Britain to revise earlier plans and offer the U.S. “co-chairmanship” of the global trading and financial system (Parrini 1969).
Parrini (1969), p.129.
The Deutsche Bank, the Discontogesellschaft, or the Dresdner Bank. Such arrangements were not specific to Latin America. The Deutsche-Asiatische Bank for instance was active in China.
And of German origin and with a strong German information base
Inflation played a role in the reduction in the capital base but geopolitical dislocations were decisive. Had shareholders of German overseas banks felt that recapitalization would bring revenues they would have supplied the needed resources.
There is no British equivalent of the Acceptance Bulletin (no central body collected relevant information). The figures we report are for the sub-period 1927–1937. Truptil (1936, p. 159 ff) used material from the Committee on Finance and Industry (1931) together with assumptions about stability of various types of banks’ proportions in totals to impute missing information. Baster (1937) then extended Truptil’s estimates. We have also drawn on unpublished estimates by the Bank of England. Starting in the 1930s the Bank provided estimates of the volume of acceptances (Bank of England Archive EID4/86). We thank Olivier Accominotti for this material.
This seems to be the best way to go: because domestic trade could also be financed by domestic drafts, trying to disentangle domestic and foreign drafts is hopeless. Statisticians of British acceptances typically attempt to identify acceptances from banks’ balances-sheets, as the publishers of the Acceptance Bulletin did for the United States.
This is only half surprising of course since central bank foreign exchange reserves mostly comprised bills (or acceptances), deposits and government bonds. In the Fed’s case foreign deposits were reinvested on acceptaces, thus establishing a direct link between demand and supply.
On the surface previous estimates differ, although on closer inspection discrepancies can be explained away. This we did by constructing our own estimates from the Bankers’ Almanac. Phelps provides a table with number branches by bank at some benchmark years (1913, 1920, 1926) and another one with banks by region in 1926 (Phelps (1927, pp.211--2)). Lewis (1938) expands Phelps’ table for branching to 1919, 1924, 1929, 1933, and 1935. Parrini (1969, p.116) offers a decomposition of branching in 1920 by country and banking “family” (the National City-International Banking Corporation conglomerate vs. the Morgan affiliates). Cleveland and Huertas (1985, pp.324–5 provide a table describing National City Bank/Citigroup per region. Finally Stallings (1987 p.70) tracks U.S. branches in Latin America between 1914 and 1930. The Bankers' Almanac gives for each city a list of institutions in operation. This being a British source, it may however have undercounted U.S. banks.. Where Phelps and Lewis list 57 National City Company branches in 1920 when Cleveland and Huertas have 81. As shown in the table, Cleveland and Huertas must be considering all the branches of the National City complex.
This is assembled from the Acceptance Bulletin’s league tables for the value of acceptances originated.
Acceptance Bulletin (January 1928), pp. 3–4.
The Federal Reserve Act authorized national banks to purchase or discount acceptances up to 50% of capital. The ceiling was raised to 100% subsequently.
They come from the Baker Library at Harvard, Columbia’s Online Digital Collection, the British Library and the Graduate Institute collection of banks balance-sheets. See appendix.
Real-life situations tend to be more complex. Occasionally, acceptances on the liability side are mixed with related securities like credit lines. It was generally possible to get fairly reliable numbers, which were checked against the rankings in The Acceptance Bulletin’s league tables.
We abstract from reverse causation. It could be, of course, that branching does not add more acceptances, but that banks that did a number of things had more acceptances and had then to branch in order to meet customers’ needs. However, considering this would weaken the case for branches, and given our later finding, this is not essential for us as it would only strengthen our conclusions.
Introducing capital and total assets together creates a problem of multicollinearity, as one would expect.
Although, again, multicollinearity is an issue.
In this table and the one that follows we continue to cluster the standard errors.
As explained by the industry’s advocate, the American Acceptance Council, the investor “would have to be educated, first as to the nature of a bankers’ acceptance, second as to its attractiveness as an investment, and third, owing to its quality as a doubly secured risk [that it was guaranteed both by the original issuer and the accepting bank], that it would be offered at a lower rate than he had been accustomed to, when buying the best single name commercial paper.” American Acceptance Council (1931), p.17.
China has already begun moving in this direction by encouraging limited use of the renminbi for trade settlements. It is negotiating arrangements with Brazil whereby the two countries can use their own currency in bilateral transactions. It has allowed select banks to issue renminbi-denominated bonds in Hong Kong and done a sovereign bond issue in renminbi there itself. It has allowed the multilaterals to issue renminbi-denominated securities in Shanghai.
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This paper received funding from the National Science Foundation and the Fondation Banque de France pour la Recherche whose generous support is gratefully acknowledged. Many thanks to Olivier Accominotti, Gopalan Balachandran, Stefano Battilossi, Peter Ferderer, John James and Mathilde Maurel for their generosity in sharing with us data and insights. They are of course absolved from shortcomings that can only be ours. We are grateful to Hassan Malik, Riad Rezzik, Trevin Stratton, Pierre Turgeon for assisting with the data collection. Many thanks also to Sara and Théa Bertin for their friendly help with spotting material in the New York Public Library. This paper benefited comments from participants to 8th Journées of the Foundation Banque de France, 21–22 June 2010, and to the BIS annual research conference, Lucerne, 24–25 June 2010. Comments and suggestions by our discussant and from Philip Lane are gratefully acknowledged.
Appendix
Appendix
Data Sources for Regression Analysis
US Banks data:
Extracted from 31st December balance-sheet (or closest available date). Balance-sheets were collected from Baker Library (Harvard), Columbia University Library, British Library (London) and Graduate Institute Library (Geneva). The banks in the sample are as follows (periods for which we have data are indicated).
American Exchange Irving Trust 1927–1928
Bank of New York and Trust Company 1922–1938
Bank of the Manhattan Company 1924–1935 (missing years)
Bankers Trust Company 1915–1935
Central Hanover Bank and Trust Company 1930–1935
Chase Bank 1915–1938 (missing years)
Chemical Bank and Trust Company 1929–1935
Commercial National Bank and Trust Cy of NY 1929–1939
Continental Illinois National Bank and Trust Company 1932–1935
First National Bank of Boston 1915–1935
First National Bank of Chicago 1915–1935
Guaranty Trust 1914–1937
International Accpetance Bank 1929
Irving Bank-Columbia Trust Company 1920–1926
Manufacturers Trust Company 1924–1935
Marine Midland 1929–1935
National City Bank of new york 1915–1935
National Bank of Commerce in New York 1923–1928
Old Colony Trust Company 1919–1929 (missing years)
New York Trust Company 1920–1935
Philadelphia National Bank 1926–1935 (missing years)
Wells Fargo 1921–1935
Heavy Branching dummies:
Dummy equals 1 for Chase, First National Bank of Boston, Guaranty Trust, National City Bank
Total Acceptances Outstanding:
December totals from Acceptances Bulletin and Federal Reserve, as described in Text.
Federal Reserve Holdings of Acceptances (own and foreign accounts).
December observation from Federal Reserve Publications
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Eichengreen, B., Flandreau, M. The Federal Reserve, the Bank of England, and the Rise of the Dollar as an International Currency, 1914–1939. Open Econ Rev 23, 57–87 (2012). https://doi.org/10.1007/s11079-011-9217-1
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DOI: https://doi.org/10.1007/s11079-011-9217-1