Since World War II the U.S. has abused the status of the dollar as the world currency to live beyond its means. It has forced others to finance its wars by exporting inflation. This was done after the Vietnam war and today the U.S. is trying to do it again and to let the world pay for its War on Iraq.

As a defensive measure against abuses like after Vietnam european countries established their common currency. Today, as the U.S. tries to repeat its old trick, the defense gets tested and it seems to be working fine.

After World War II and the decline of the British Empire the U.S. became the leading economic power of the world. The Bretton Woods
agreement fixed world currencies to the U.S. dollar and the U.S. dollar
to gold. But soon the U.S. economy declined relatively to the western
European and the Japanese economies.

President Johnson decided not to increase taxes to pay for the
Vietnam War and his Great Society program. Instead the Fed printed more
dollars. The war led to an outflow of these dollars, high inflation and
a deterioration of the U.S. balance of trade position. The peg of the
dollar to gold at $35/once became untenable.

In 1971 Nixon broke the Bretton Woods agreement and took the dollar
off the gold standard. The important international currencies went into
free float and the dollar declined. The OPEC oil cartel, which sold its
product in dollars, replied to this loss of revenue with hefty price
increases. This ‘oil shock’ increased the already rampant inflation
while the U.S. went into a recession.  Despite the high inflation the
Fed reduced interest rates to revive the U.S. economy.

European and the Japanese economies depended on exports into a
dollar denominated world market. With their currencies rising against
the dollar their export products became more expensive. At the same
time the higher inflation due to oil prices demanded an interest rate
increase.

But with interest rates lower in the U.S. than in most European
countries money flowed into their currencies and the dollar threatened
to decline further. Their export economies were in danger of collapse.
They had to follow the Fed and also decrease their interest rates. As a
consequence stagflation set in on both sides of the Atlantic.

As an answer to this effective export of U.S. stagflation to their
economies the European Community decided in 1975 to launch the European
Currency Unit ECU. This was the birth of the Euro.

Paul Volker’s harsh interest increases, lower demand for oil and
increased supply of OPEC independent energy sources killed off
inflation (and cost Carter a second term). Reagan’s debt financed tax
stimulus revived the U.S. economy.

President Bush decided not to increase taxes to pay for the War on Iraq and his other programs. Instead the Fed printed more
dollars. The war led to an outflow of these dollars, high inflation and
a deterioration of the U.S. balance of trade position.

The important international currencies were in free float and the dollar declined. The
OPEC oil cartel, which sells its product in dollars, replied to this loss of revenue with hefty
price increases. The ‘oil shock’ increased the already rampant inflation
while the U.S. went into a recession. Despite the inflation the Fed
reduced interest rates to revive the U.S. economy.

But one thing has changed between the 1970s and 2000: There is now an alternative to the dollar as world exchange medium.

Most of Europeans exports are no longer denominated in U.S. dollar
but in euros. Many countries have diversified their reserves away from
the dollar and into euros and yen. The dependence of world trade on the
U.S. dollar has declined. At the same time U.S. dependency on imports
has increased.

While the U.S. in the 1970s could effordless export its inflation
and recession to Europe and Japan it is now meeting hard resistance.

Bernanke would like to lower interest rates further to get the U.S.
out of the recession and to inflate away the nation’s debt. But he can
not do so because this time the Europeans will not follow him but will
increase their interest rates and fight inflation.

As Wolfgang Münchau explained in the Financial Times:

By
moving in the opposite direction from the Fed, the ECB is providing a
much more appropriate domestic policy response than what would have
been possible under a national currency regime. The ability to do this
constitutes quite possibly one of the biggest economic benefits of the
euro.
  It has not only domestic but global implications. In particular, it
limits the Fed’s own room for manoeuvre, something that would have been
unthinkable only a few years ago. If the Europeans had followed the
Americans again, the Fed would probably have been in a position to cut
interest rates further. The dollar would not have fallen as much and
Ben Bernanke, Fed chairman, would not have needed to revert to verbal
intervention to prop up the dollar as he did last week.
This suggests that in terms of global monetary policy, we are in the
middle of a shift from a unipolar to a bipolar world.

…
As
US inflation rises, more and more countries may unpeg from the dollar
to avoid imported inflation. If this trend persisted, the US would risk
losing its exorbitant privilege – the ability to live beyond its means
thanks to a globally domineering currency.

The leading country of the world can not lead anymore.
We may now also see the end of the Anglo-Saxon financial model:

Continental Europe should take the lead in devising new rules for financial markets because the Anglo-Saxon model of regulation has failed, Angela Merkel has told the Financial Times.
…
The chancellor praised the euro as having allowed the economy of the EU
to partially decouple from the US, at least in the industrial goods
area if not in financial markets, and reaffirmed her support for the
independence of the European Central Bank.

The
euro-countries are now able to withstand U.S. inflation export. But the
devaluation of the dollar still exports U.S. inflation to those
economies that are still pegged to the dollar. As less they are pegged
and more independent they are from the dollar, the better is their
control over imported inflation.

The Gulf States, pegged to the U.S. dollar, now all have between 15 and
25% inflation. China is using drastic measures, increasing mandatory
bank reserves to 17.5%, to reign in double digit inflation. Smaller
currencies with a dollar peg like the Ukraine’s hryvnia are inflating
at a 30% rate.

The U.S. is making these countries pay for its war on Iraq by exporting
inflation to them. The euro model shows that alternatives are possible.

This success of the euro will reinforce the moves towards currency unions in Asia,
South America and the Gulf region. The ASEAN+3 group is developing an Asian Currency Unit which replicates the ECU model. The Gulf countries are in talks of launching a common currency of their own by 2010. The Bank of the South is working on a similar model for Latin America.

The future world will be multipolar with five to six currency blocks
which will have about equal weight. When those currency blocks are
established, the U.S. dollar will have lost its special position. With
that the U.S. will have lost its special place in the world and the
luxury to let others pay for its wars and consumption.