2 hypotheses came about:

Structuralist Rationale, the deficit {was due to} inherent world forces that could not be manipulated to restore payments equilibrium for the United States,

and

the International Financial Intermediary Hypothesis (IFIH), which sought to explain away the deficit as merely a statistical anomaly.

The Structuralist Rationale held that the United States occupied a unique position in the world economy because, as Robert Roosa said, the United States had “undertaken external commitments, both military and economic.”

The price non-Communist countries had to pay in exchange for the U.S. protective umbrella was to absorb this deficit.

Specifically how, well:

Foreign nations must either provide the U.S. Treasury with the requisite funds directly, by holding their international reserves in U.S. Treasury securities or “Roosa Loans” negotiated with the Federal Reserve System or, by expanding their imports from the United States and limiting their exports, must permit the U.S. private sector to run a surplus of whatever magnitude was needed to balance the government outflow.

This Structuralist Rationale went a step further by recognizing that the payments outflow on government account could not be compensated by surpluses on private transactions, contrary to what had been believed possible in the early 1960s. A study made by Hendrik Houthakker of the Council of Economic Advisers and Stephen Magee indicated that U.S. economic growth tended to be accompanied by imports rising more rapidly than exports

There seemed to be little America could do to alter these built-in structural relationships, The Houthakker–Magee study concluded. Indeed, "prospective deterioration in the United States trade balance will probably be especially marked vis-à-vis Japan and Canada, unless these countries maintain much higher rates of growth and inflation than the United States."8

U.S. deficits, it was implied, were the byproduct of America remaining a thriving market for foreign output,

It seemed, the U.S officials argued, that unless the world follows the plan of financing U.S deficits in such manner, well

The alternative would be for the U.S. economy to stop growing {and for the US dollar hegemony to bring the world economy down with them, I suppose}

**Such reasoning led to what was termed the International Financial Intermediary (IFI) hypothesis, which asserted that the U.S. payments deficit was just a statistical illusion.9 **The U.S. economy, it was argued, functioned much like a savings bank or a savings and loan association, which are called financial intermediaries because they borrow short-term savings and reinvest them in long-term assets, mainly mortgages.

Plus, what about that sweet interest? Surely that’ll bring some trust

Also, foreign central banks chose to invest their dollar surpluses in interest-bearing U.S. Treasury securities instead of in gold, as the latter earned no interest. U.S. international banks turned around and lent their Eurodollars to U.S. international corporations wishing to finance their foreign investment activities, including the buy-out of foreign companies

And soon the U.S officials tried to justify the deficits as an imbedded part of the system

By definition, the theory stated, " – The existence of a positive foreign net demand for liquid dollar assets and gold combined implies, in the absence of an increase in world monetary gold stocks, that a U.S. deficit on the liquidity definition is not only consistent with equilibrium in the foreign exchange market but is a necessary condition of it…"

Just one thing, however

But its depiction of the lines of causality at work was wholly imaginary. Throughout the 1960s it had been U.S. entities, both private and governmental, that had initiated the build-up of international liquid assets, or hot money as it was termed by the popular press. U.S. companies bought up foreign firms while the U.S. Government spent funds abroad to finance military and related operations.

These activities put dollars into the hands of foreigners in excess of their demand for U.S. goods and services. It was then up to foreigners to respond, headed by the central banks in which the surplus dollars built up. At this point, what the Americans represented as a matter of economic choice became a product of political and diplomatic coercion.

Oof, also the savings bank analogy doesn’t rlly work

A savings institution first receives funds from depositors, and then relends them long in the form of real estate mortgages. Matters would be different if it were to begin financing mortgages by printing its own bank notes and afterwards obliging the person to whom it lent this mortgage money—or to whom that borrower in turn paid the money—to redeposit the private savings bank’s notes in the same institution that had issued them.

Professor Triffin was one leading economist who criticized the analogy

And returning back to the “voluntary nature” of the deal

A more realistic interpretation would have been that Europe and Japan accepted this option reluctantly, partly out of sympathy with U.S. war aims to be sure, and partly to avert a world political showdown and monetary collapse. The important point was that foreign central banks held their liquid claims on the U.S. Treasury not because that was their first preference, but simply because they feared to do otherwise,** because they feared bringing about a breakdown in international finance and trade.**

As Arthur Laffer summarized the issue: "In their now classic article, Despres, Kindleberger and Salant set forth an altogether novel framework for analyzing the U.S. balance of payments. If correct, their analysis points out (i) that U.S. deficits, within some limits, do not represent a disequilibrium position, but, in fact, are necessary for a healthy world economy; (ii) any lack of confidence in the dollar is brought about by a failure to understand the role of the dollar; and (iii) unless there are a myriad of controls the normal macro-economic tools are likely to fail in controlling the deficit."13

Going back to the Vietnam War issue, in this context, it means

(i) the Vietnam War and its associated payments deficits were necessary to provide international reserves to insure a healthy world economy; (ii) people who do not understand this fail to understand both the ineffable benefits of slaughter and the financial mechanisms at work, and (iii) there is nothing to be done about the U.S. deficit short of transforming the nature of American and foreign political society, which is precisely what the American strategy was designed to prevent.

About the IFI

Logically speaking, the IFI hypothesis applied only to the private sector’s investment and payments transactions. It maintained the fictions that government finance capital played no role in the world economy, and that some investment alternative was always available to foreign dollar holders. However, because the parameters of international transactions in real life are manipulated by political policy and not by free market forces, any general equilibrium theory is inapplicable to modern balance-of-payments analysis.

The hypothesized voluntariness of most private transactions therefore must be replaced by an analysis of economic behavior taking government diplomacy into account.

Now, going back on the Gold

In the final analysis the United States remained liquid only by imposing a de facto embargo on its gold sales, and in August 1971 an outright embargo. Foreign desires to purchase U.S. gold with their surplus dollars were denied, pending some resolution of the U.S. monetary dilemma.

The most serious defect of the IFI hypothesis was its attempt to divert attention from analysis of how the world inflation actually was being transmitted and where its origins lay.

It interpreted the politically inspired U.S. payments deficit, which stemmed from government actions and transactions designed to maintain U.S. hegemony, as an interest-rate responsive exercise in liquidity preference between long- and short-term investments. It did not ask what was responsible for creating the capital funds that comprised the reserve assets of the world’s central banks.

What the seperation of political economy into politics and economics does to a brain

Finally, let’s talk about some economic manipulation shenanigans

During the 1960s the payments deficit was redefined from a measure of net economic imbalance in U.S. international transactions to a more nebulous category, which the Department of Commerce termed “transactions in U.S. monetary assets.” One effect of this was to treat foreign, mainly British, drawings on U.S. swap agreements as adding to U.S. reserves rather than as part of the deficit.

Consult the graph again…

In other words, whatever situation might exist in the U.S. balance of payments, whether surplus or deficit, whether short-term or long-term, was to be defined as equilibrium ipso facto.

To rational minds, economics itself was becoming incomprehensible and devoid of scientific analytic process.

To be sure, the proposed measure is asymmetrical in the sense that foreign central banks properly count increases in their dollar balances held in this country as surpluses (other things being the same), while under the proposed measure the United States would not consider these increases to show a deficit. This asymmetry appears to be appropriate, for it corresponds to an asymmetry in the real world. It is a shortcoming of the currently published official measures that they fail to take of this asymmetry.

Henceforth, it was suggested, America’s unique debtor position was to be recognized and institutionalized, not constrained or curtailed.