A brief history of reserve currencies - their rise and decline

Having set out in the previous paper ('Reserve Currencies must provide an anchor in a sea of uncertainty') the framework for considering the importance of alliances to anchor networks it is useful to briefly look at the history of the rise and fall of reserve currencies. The particular focus will be on the breakdown of the ability of the issuing nation to maintain effective alliances as a contributing factor to its decline as a reserve currency.

13th – 15th Centuries: Venetian Ducat

Rise : Originating in Italy, the Venetian ducat were the first highly trusted, gold-based currencies. They served as the primary bridge between European and Middle Eastern trade.

While possessing the dominant navy in the Mediterranean, Venice as the centre of trade connecting Middle East with Europe used its wealth and position to form shifting alliances to maintain stability.

Decline of Alliance Network - Capacity to Impact Outcomes : Venice’s role as an anchor to the network was undermined as trade shifted from the Mediterranean to the Atlantic. Not only did it reduce the relative wealth flowing to Venice but also the importance of its alliance network to determine global affairs. While Venice may have still been relevant for regional affairs the significance of the region on global affairs was reduced over time.

16th -17th Centuries: Spanish Silver Dollar

Rise : Driven by abundant gold and silver supplies from Spanish territories in the Americas, this became the first true global reserve currency. It was widely circulated and accepted across Europe, Asia, and the Americas.

The wealth from the New World positioned Spain as the defender of the Catholic faith facilitating alliances to maintain stability within Europe. In the 16th century, Spain built a global empire through strategic alliances. Most notably within Europe, the Spanish Habsburgs allied with the Austrian Habsburgs to encircle rival powers and defend Catholicism.

Decline of Alliance Network - Convergence of Interests : This position as ‘global policemen’ was undermined by the Reformation which split Europe between Catholic and Protestant nations. The most notable Protestant nations being the growing naval and trading nations of England and the Dutch Republic. Seeking to maintaining its position as defender of the Catholic faith meant that not only could it no longer cooperate with the newly Protestant countries but it increasingly took on the role of a revisionist state as it sought to re-establish Catholicism within Europe through a series of prolonged and costly wars. The convergence of interests which had sustained the network with Spain as the anchor unravelled as Spain sought to maintain a socio economic system which was becoming relevant to fewer stakeholders. Exacerbating the situation was the extended transport lines to the New World’s gold and silver reserves which proved exceedingly vulnerable to the rising naval power of the Protestant states of England and the Dutch Republic.

17th Century: Dutch Guilder

Rise : Issued by the Dutch Republic, the guilder emerged during the Dutch Golden Age. The newly formed Dutch Republic established a central position in trade in Europe given its colonies and financial innovation such as joint stock companies public debt markets etc. Backed by the immense trading and financial power of the Dutch East India Company and the Bank of Amsterdam, the Dutch Gilder became a cornerstone of early European capital markets and the first fiat reserve currency.

During the 17th-century Golden Age, the Dutch Republic formed key defensive and diplomatic alliances to secure independence from Spain and counter the expansionist ambitions of France. By utilizing a decentralized federal system, the Republic dynamically shifted its allegiances to protect its lucrative global trade networks and maintain European power balances.

Decline of Alliance Network - Convergence of Interests : The key alliances between the Protestant nations of England and the Dutch Republic were undermined as the rising power of England, on the back of a naval build up and ongoing colonial expansion, brought it inevitably into conflict with the Dutch Republic. This rivalry between the two main trading nations within the network resulted in a divergence in interests which would prove irreconcilable. After a series of mainly naval conflicts spanning 1652-1784 England not only seized most Dutch overseas possessions but largely eliminated the Dutch navy as a viable military force. With this the ability of the Dutch Republic to play a material role in alliances its position as anchor to the network was seriously weakened.

19th – Early 20th Centuries: British Pound Sterling

Rise : Backed by the Industrial Revolution and the expansive reach of the British Empire, the pound sterling was the undisputed global reserve in the 1800s and early 1900s. It was deeply integrated with the gold standard.

During the 18th century, Britain's "Golden Age" of expansion was driven by a practical balance-of-power strategy. To protect her commercial interests and counter the hegemonic ambitions of France and Spain, Britain utilized a revolving, flexible system of European alliances (often called the "stately quadrille").

Decline of Alliance Network - Desire to Impact Outcomes : The decline of the Britain was driven by many factors most notably the (a) weakened financial position after World War I (‘WWI’) and (b) rise of USA as a financial and trade centre. US disengagement from global affairs post WWI thrust Britain back into a central role but its position was weakened with the shadow of the US looming as the key, albeit reluctant, power to be courted. Further the cost of WWI in terms of money and manpower had exhausted Britain and it could be argued that the changing geopolitical environment meant that the commitment to act as ‘global policemen’ had weakened.

What resulted was a shift from Britain being a ‘global policeman’ (focus on utilisation of ‘hard power’ to achieve goals) to being a ‘global watchdog’ (focus on utilisation of ‘soft power’ to achieve goals). The alliance structure also became ‘locked in place’ with the focus being on enforcement of post war Treaties. With this the alliance system shifted from one of proactive enforcement to being more focussed on defensive arrangements. Britain’s weakened position was best highlighted by (a) disastrous attempt to reestablish stability in the pound by returning in 1925 to the gold standard at pre WWI parity and (b) failure to proactively engage through alliances to confront threats to the status quo from the revisionist countries such as National Socialist Germany. With Britain lacking the desire to impact outcomes it could be argued that one of the key issues creating the instability in the period between WWI and World War II (‘WWII’) was the lack of an effective anchor to the network.

Mid-20th Century to Present: United States Dollar

Rise : With the end of WWII the US became the global and financial powerhouse as Europe grappled to rebuild after the devastation of WWII. Importantly the USA created the economic and financial systems which would define the post war world with itself as the anchor. With these developments US dollar (USD) overtook the pound sterling as the world's leading reserve currency. Cemented by the Bretton Woods Conference in 1944, USD dominance continues today, backed by the size of the US economy, deep financial markets and the projection of both ‘hard’ and ‘soft power’ through a global alliance network.

With the USA taking on the mantle of anchor country the alliance system also shifted given the development of nuclear weapons made operation as a ‘global policemen’ more difficult. The result was a hybrid system where defensive alliances would be used to project ‘soft power’ against developed/nuclear armed nations while ‘hard power’ was projected via a series of proxy wars.

Decline of Alliance System - Consistency of Behaviour? : Does the ‘Make American Great Again’ movement and the increasing inconsistency created by the US’s focus on ad-hoc transactional relationships permanently undermine its position as the undisputed anchor to the existing trade and financial network?