Reforming Global Finance

A Brief History of Global Anchor Currencies

How can dominant economic powers of their time use their currencies to gain cheap financing from abroad?

Credit: Feng Yu/


  • Spain spent its wealth on expensive wars in the Netherlands and elsewhere. As a result, it constantly ran trade deficits.
  • War, colonization and drug-running were key ingredients in managing the international monetary system.
  • Gold discoveries in California, Australia and South Africa allowed the world's gold supplies to expand roughly in line with economic activity.
  • By November 1923, a kilogram of bread cost 428 billion marks, a newspaper 200 billion marks and a tram ticket 150 billion marks.
  • Modern central banks are willing to hold U.S. dollars -- despite its indebtedness and political wrangling -- just as ancient Indians were willing to accept Roman gold.

One of the common characteristics of international monetary systems throughout history is the willingness of a major economy — usually the pre-eminent power of its time — to trade its credibility to provide the world with a monetary anchor.

This leads to a symbiotic relationship between the anchor country and the rest of the world: The anchor country gets cheap financing and the rest of the world gets the monetary liquidity needed to lubricate economic activity.

During the Roman times, for instance, the world economic system was underpinned by booming trade between the Roman Empire and India, the export champion of the ancient world. Merchant ships sailed down the Red Sea or the Persian Gulf and then took advantage of the monsoon winds to cross the Arabian Sea to India.

The problem with Indo-Roman trade, however, was that India ran a large trade surplus with the empire. As Pliny (23-79 AD) wrote: “Not a year passed in which India did not take fifty million sesterces away from Rome.”

The trade deficit meant that there was a continuous drain in gold and silver coins that, in turn, created shortages of these metals in Rome. Expressed in modern terms, this meant that the Romans were constantly facing a monetary squeeze.

Matters were made worse by the fact that the empire frequently ran fiscal deficits due to external and internal wars. Roman emperors tried to deal with the twin deficits in various ways. Emperor Vespasian tried unsuccessfully to impose restrictions on imports from India in the 1st century AD.

However, the more common response to the problem was the debasement of imperial coins by reducing the gold/silver content (the ancient equivalent of printing money). Not surprisingly, the real value of the coins declined and the Romans experienced inflation.

It is estimated that the price of a military uniform rose 166 times between 138 and 301 AD. The price of wheat rose more than 200-fold during this period. This should dispel another common belief that inflation is a modern invention.

The Romans tried many things to stabilize prices, including Emperor Diocletian’s famous edict to fix prices. None of these efforts worked in the face of a continuous trade deficit with India, persistent fiscal deficits and the consequent debasement of coinage. (Interestingly, the Indians continued to accept the debased coins for centuries, although probably at a steadily falling exchange rate).

Ultimately, inflation led to serious distortions in the economy. It is said that soldiers’ pay was so diminished in real worth that a full year’s pay could barely buy eight week’s worth of bread. This was one of the pressures that eventually eroded Roman credibility even as the empire went into terminal decline.

Pieces of eight

For a thousand years after the decline of Rome, Europe played a relatively small role in the global economy even as trade boomed between the Arabs, Indians, Chinese and the kingdoms of South East Asia.

Columbus’ discovery of the Americas and Vasco da Gama’s discovery of the sea route to India changed this. Spain now became a superpower and its financial strength was bolstered by its access to silver from New World.

Between 1501 and 1600, 17 million kilograms of pure silver and 181,000 kilograms of pure gold flowed to Spain. However, Spain spent its wealth on expensive wars in the Netherlands and elsewhere.

As a result, it constantly ran trade deficits with the rest of Europe and paid for it in silver coins. This injection of monetary liquidity, in turn, caused an economic boom in the rest of Europe and helped spread the spirit of the Renaissance.

Nonetheless, the increase in the supply of precious metals also caused a sustained bout of inflation. Prices rose at least four-fold in Spain over the course of the 16th century. Despite its access to New World silver, Spain became increasingly unable to service its war debts.

Spain’s supplies of gold and silver were often pledged years in advance to Genoese bankers. Eventually, Spain repeatedly defaulted on sovereign debts (in 1607, 1627 and 1649) and went into geopolitical decline. Many bankers, such as Germany’s Fuggers dynasty, were ruined by the defaults.

The political and economic center of gravity now shifted north to Holland, France and Britain. They would by turns come to dominate world trade in the 17th, 18th and 19th centuries.

Despite this shift, Spanish silver coins (known as “pieces of eight” or Spanish dollars) continued to be the key currency used in world trade right up to the American Revolutionary War. In fact, they remained legal tender in the United States till 1857 — long after Spain itself had ceased to be a major power.

The opium trade

It was only in the 19th century, following the defeat of Napoleon, that Britain was finally able to impose a system that affirmed its role as the world’s anchor economy.

This system is known to historians as “triangular trade” between Britain, India and China. Under this arrangement, the British sold manufactured goods to the Indians and purchased raw cotton and opium. The opium was then sold to the Chinese in exchange for goods such as tea and porcelain. These were then sold back in Europe to fund the manufacture of exports to India.

In this way, Britain did not bleed gold in order to keep the system flowing. Note that this global trade system functioned because the East India Company was militarily able to impose its will. The imports of British-made industrial goods devastated India’s large artisan-based manufacturing sector.

At the same time, Chinese attempts to close down the opium trade resulted in the Opium Wars of 1839-42 and 1856-60. In other words, war, colonization and drug-running were key ingredients in managing the international monetary system.

By the middle of the 19th century, the world was functioning on a bimetallic system based on gold and silver. However, following the British example, most major countries shifted to a gold standard by the 1870s.

The Bank of England stood ready to convert a pound sterling into an ounce of (11/122 fine) gold on demand. The U.S. Treasury was similarly committed to convert an ounce of gold at $4.86. This, in turn, locked the dollar-pound exchange rate.

This underlying monetary system anchored a great age of expansion in global trade and economic activity. Nevertheless, its success was underpinned by a lucky coincidence — a succession of gold discoveries in California, Australia and South Africa that allowed the world’s gold supplies to expand roughly in line with economic activity. It helped that many of these discoveries were conveniently in British control.

Even then, it was not an age without problems. There were periods of inflation as well as periods of deflation. A succession of “panics” affected the global financial system. There were worries that excessive gold supplies would lead to sustained inflation.

The system was finally disrupted by World War I, but by this time Britain had long ceased to be the world’s most powerful economy. Britain was overtaken by the United States around 1890 and then by Germany in the 1900s.

After the war, harsh terms were imposed on Germany by the victorious allies. With no other resources available, the German authorities resorted to printing ever greater amounts of paper money till the process spiraled out of control.

By November 1923, a kilogram of bread cost 428 billion marks, a kilogram of butter 5,600 billion marks, a newspaper 200 billion marks and a tram ticket 150 billion marks. This experience with hyperinflation remains imprinted in German memory.

Meanwhile, the British tried to reestablish the pre-war global order by going back to a gold standard in 1925. There were also attempts to create a mercantile system of “Imperial Preference” within the British Empire that would have served the same purpose as had triangular trade in the19th century.

The world had changed, however, and Britain’s position was no longer credible. With the Great Depression taking hold, the Bank of England was forced to choose between providing liquidity to the banks and honoring the gold peg. It opted for the former on September 20, 1931.

The economics of persistent imbalance

The current economic crisis, variously named the “Great Contraction” or the “Great Recession,” is often interpreted as a crisis of the world monetary system triggered by indebtedness and a loss of credibility.

Many experts have argued for “reform” of the global monetary system. There have been many suggestions ranging from a return to gold, a greater role for the IMF’s Statutory Drawings Rights (SDR) or a completely new world currency.

What most people are little aware of is how old a problem this really is. Ancient Indians were willing to accept debased Roman coins just as modern central banks and economic participants are willing to hold U.S. dollars — despite its private and public indebtedness, its political wrangling and even a sovereign ratings downgrade.

Then as now, this is not because nations cannot see the problem of an asymmetric arrangement, but due to their willingness to pay a price for keeping the world economic system liquid.

Editor’s note: This article was adapted from “Are We Entering a Post-Dollar World?” from the Wide Angle series published by Deutsche Bank.

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About Sanjeev Sanyal

Sanjeev Sanyal serves as Deutsche Bank’s Global Strategist in Singapore.

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