currency and monetary system, and the important thing is to tell the difference between systemically beneficial
devaluations and systemically destructive ones.
What do these devaluations have in common?
In the major cases we looked at, all of the economies experienced a classic “run” dynamic, as there were more
claims on the central banks than there was hard currency available to satisfy the claims on that money, which
was typically gold, though it was US dollars for the UK reserve currency decline because at that time the
British pound was linked to the US dollar.
Net central bank reserves start falling prior to the actual devaluation, in some cases starting years ahead of the
devaluation. It’s also worth noting that in several cases countries suspended convertibility ahead of the actual
devaluation of the exchange rate, such as with the UK in 1947 ahead of the 1949 devaluation, or for the US in
1971.
The run on the currency and the devaluations typically came alongside significant debt problems, often
related to wartime spending (the Fourth Anglo-Dutch War for the Dutch, the world wars for the UK, Vietnam
for the US under Bretton Woods), which put pressure on the central bank to print. The worst situations were
when countries lost their wars; that typically led to the total collapse and restructuring of their currencies and
their economies. However, winners of wars that ended up with debts that were much larger than their assets
and reduced competitiveness (e.g., Great Britain) also lost their reserve currency status, though more
gradually.
Typically central banks respond initially by not increasing the supply of money so that when their currency
and debt are being sold they let short-term rates rise to forestall the devaluation, but that is too economically
painful, so they quickly capitulate and devalue. Then, after the devaluation, they typically cut rates.
After devaluation, the outcomes diverge significantly across the cases, with a key variable being how much
economic and military power the country retained at the time of the devaluation, which impacted how willing
savers were to continue holding their money there.
More specifically for the major reserve currencies:
For the Dutch, the collapse of the guilder was massive and relatively quick in taking place over less than a
decade, with the actual circulation of guilders falling swiftly by the end of the Fourth Anglo-Dutch War. This
collapse came as the Netherlands entered a steep decline as a world power, first losing a major war against the
British and subsequently facing invasion on the continent from France.
For the British, the decline was more gradual: it took two devaluations before it fully lost its reserve currency
status, though it experienced periodic balance of payments strains over the intervening period. Many of those
who continued to hold reserves in pounds did so due to political pressures and their assets significantly
underperformed US assets during the same time.
In the case of the US, there were two big abrupt devaluations (in 1933 and 1971) and more gradual
devaluations against gold since 2000, but they haven’t cost the US its reserve currency status.
Typically leading up to a country losing its reserve currency position 1) there is an already established loss of
economic and political primacy to a rising rival that creates a vulnerability (e.g., the Dutch falling behind the
UK or the UK falling behind the US) and 2) there are large and growing debts that are monetized by the
central bank printing money and buying government debt, leading to 3) a weakening of the currency in a self-
reinforcing run from the currency that can’t be stopped because the fiscal and balance of payments deficits are
too great for cutbacks to close.
As this appendix is getting long, I have decided to cut it here and to follow in a few days with the rest, which
consists of brief explanations of the decline phases of the Dutch guilder and British pound and their empires.