How crisis became opportunity for dollar's supremacy

Business booksThis readable history tells how one man rescued the US from monetary crisis at the outbreak the first World War and made the dollar the dominant currency, writes Richard Keatinge

When I first picked up this book , I wondered whether it described events so long ago that they were irrelevant today and whether it would be written in such an academic fashion as to be turgid and unreadable for the ordinary mortal interested in business and a good read.

Well, I was wrong on both counts. As a history it explains the origin of the financial system we have today, although many of the events described (most notably the closure of the New York Stock Exchange (NYSE) for 4½ months) simply would not happen today thanks to electronic trading and the globalisation of share dealing.

As a story, it manages to tread the fine line between financial thriller and academic treatise. The quality of the academic background gives credibility to the tale, but the way it is told - tight, succinct and to the point - gives it pace and makes it an eminently readable piece of financial history.

In essence this is the story of how one man - US treasury secretary William G McAdoo - almost single-handedly succeeded in ensuring that the US dollar survived a potential run caused by the outbreak of the first World War and laid the foundations for that currency becoming the dominant medium of international exchange for the rest of the 20th century.

"William G McAdoo paved the way for the dollar to dislodge sterling as the world's currency by remaining true to gold."

How he did so is well summarised in the introduction, a quick read of which will tell you whether this book is for you.

In August 1914 McAdoo - only a year in office - presided over an economy in which the dollar had a fixed exchange rate with gold into which it was freely convertible. Sterling likewise was linked to gold and, by virtue of its strict adherence to this link and the fact the British banking system under the supervision of the Bank of England had avoided the crises that had periodically engulfed the American system, was recognised at the outbreak of the war as the main international trading currency.

Moreover, unlike Britain, McAdoo had no central bank to influence the market and control the activities of commercial banks, although the creation of a federal reserve board had been much debated in congress.

In the absence of such an entity, McAdoo, as the book explains, had to improvise. His strategy had five main elements. Firstly, he suspended dealings on the New York Stock Exchange, which meant that foreign investors could not sell their US stock and exchange the proceeds for gold. "The British could not drain American gold without the dollar proceeds from sales of US stocks and bonds."

Secondly, as ordinary bank customers feared a repeat of the 1907 collapse of the US banking system, he flooded the system with paper currency to ensure the banks had adequate liquidity, just as Alan Greenspan did after the 1987 stock market crash.

Thirdly, he orchestrated the financial bale-out of New York city, thereby ensuring foreign investors in the city's bonds were repaid. Fourthly, he promoted the acceleration of US agricultural exports to earn the foreign exchange reserves needed to offset the outflow of gold to Europe. And finally, in November 1914 he set up the Federal Reserve board despite the heated opposition of several experienced bankers. (In the midst of all this, incidentally, he found the time to marry president Woodrow Wilson's daughter.)

Gradually, the financial world came to believe that the US would not abandon the gold standard, and by early 1915 foreign governments began to issue substantial quantities of dollar-denominated bonds for the first time. Since then, the dollar went from strength to strength.

Along the way, a few interesting precedents were set. For instance, the bale-out of New York city was the first example of the idea that some entities are just "too big to fail" if the banking system is to survive. As recently as 1998 we saw this again with the bale-out of Long-Term Capital Management orchestrated by the Fed, so brilliantly described in Roger Lowenstein's book, When Genius Failed.

One precedent was short-lived. McAdoo was adamant that he should be a member of the Federal Reserve board and that its members should be compatible with him - a bit like Brian Cowen being chairman of the Central Bank and picking his follow board members. But since 1932 this has no longer been the case, as a result of which people like Paul Volcker and Greenspan have been able to pursue a sound money strategy irrespective of political considerations.

What, if any, relevance does all this have today? Perhaps not a lot in terms of markets. Flexible exchange rates mean that nowadays the problem of maintaining a gold standard simply does not exist, and electronic trading and the globalisation of stock exchanges mean closing the NYSE as a means of stopping a currency crisis is irrelevant.

However, at least two broader lessons seem to be relevant.

Firstly, strong, credible monetary authorities that can materially influence the broad economic parameters have become essential to our financial well-being, and McAdoo saw this. Secondly, at times of crisis, it is courage, decisiveness and leadership that count. McAdoo was no academic but he understood markets and had the guts to take unpopular decisions to achieve his objective.

He was some operator.

• When Washington Shut Down Wall Street  By William L Silber,  Published by Princeton University Press £17.75 (€26.30)