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The latest reported monthly United States trade deficit is the third-highest on record; the German chancellor has complained about the newfound strength of the euro; and, at year-end 2002, the U.S. was a net debtor to the rest of the world in the impressive sum of $2.6 trillion.

Furthermore, the real, or inflation-adjusted,federal funds rate has swung to negative from positive; the federal budget deficit has flipped from a small surplus to a very large deficit; and the estimated monthly cost of the U.S. occupation of Iraq is now put at $3.9 billion (not $4 billion, but exactly $100 million less than $4 billion), up from $2 billion in April.

We all live in the era in which we are born. It’s the wisest course of action. Men and women of the world will accept the existing monetary arrangements for what they are. They will not waste precious time while the stock market is open trying to dream up improvements. However, practical people most of all will take a lively interest in the arc of monetary evolution. They will want to know where the existing system came from and where it might lead to. We believe we have the answers: The international gold standard (1870-1914) begat the gold exchange standard (1922-44), which begat the Bretton Woods demisemi gold standard (1944-71), which begat the dollar standard (1971 to date). The dollar standard will end in competitive devaluations, international recriminations and worldwide inflation. Timing, uncertain.

News of the upward revision in the cost of the Iraqi peacekeeping mission has put us in an evolutionary frame of mind. We are reminded that Iraq was once occupied by Britain, that the British pound was once the world’s reserve currency and that the Royal Navy once packed the world’s biggest punch. Iraq -- and Iran, too, as another point of information -- were once members in good standing of a monetary union called the sterling bloc. Now, it’s the U.S. that’s running Iraq and U.S. power that’s overawing the world. Like sterling at its zenith, the U.S. dollar is the world’s money.

At its peak, sterling was a global monetary asset that also functioned as a domestic currency. By contrast, the dollar is a domestic currency that also functions as a global monetary asset. To the growing constituency of overseas dollar holders, the stewards of the greenback customarily make not one concession. "The FOMC stands prepared to maintain a highly accommodative stance of policy for as long as needed to promote satisfactory economic performance," testified Alan Greenspan Tuesday morning. It was the United States’ economic performance to which he referred.

Not just any currency fills the bill of a reserve currency. A suitable candidate must be widely circulated, liquid and -- so its holders hope -- stable in value. Sterling was the reserve currency par excellence, and like some plucky mature brand of laundry detergent, it relinquished market share only grudgingly. As late as 1958, the chairman of Lloyd’s Bank was worrying about the place of the pound in the dollar-centric world. Sterling, at that late date, still financed about 40 percent of world trade, even though British monetary reserves were less than 4 percent of the world total and just half of Germany’s. The pound today is one referendum away from extinction (if Britain decided to join the European Union, it would exchange its pounds and pence for euros and cents). While it lasts, therefore, we should all make time to meditate on the lessons of its life cycle. Maybe some day, someone will pay the same courtesy to the dollar.

In preview, the rise and fall of the pound teaches that monetary ideas are cyclical, that monetary systems are impermanent and that war is bearish for currencies. It teaches that the dollar owes its commanding monetary market share to the world’s high opinion of America, not necessarily of American finance.

Sterling had its heyday in an era of free trade, low tax rates, fixed exchange rates, stable or falling prices, minimalist government and relatively small government debts. In the sterling era, Britain invested much more abroad than foreigners invested in Britain. For almost 100 years, the pound was everything the dollar has become, only more so. World War I knocked the pound off its pedestal, and the dollar supplanted it by degree. Now it’s the dollar’s heyday, but the dollar era looks nothing like the pound’s. The age of the greenback is characterized by less free trade, relatively high tax rates, floating (or manipulated) exchange rates, generally rising prices, interventionist government and burgeoning government debts. In the dollar era, Americans are investing much less abroad than foreigners are investing in America. One conclusion of the comparative monetary analysis to follow is that they don’t make reserve currencies like they used to. Admittedly, negative verdicts on the dollar as a reserve currency are seen most often in these pages (the subject is almost never broached elsewhere). However, we predict that, before long, we will have company. The arithmetic of the U.S. external financial position makes a persuasive argument.

With justice, a monetary critic could say that the millennial dollar is a greater achievement than the Victorian pound, because although sterling was convertible into bullion at a fixed and certain rate, the greenback circulates on faith. The dollar is supported by the U.S. economy, the U.S. financial system and U.S. geopolitical power. However, we believe, what chiefly sustains the dollar is the idea of America. The Bank of England had a bullion reserve (not very large against the outstanding liabilities), whereas America has the Statue of Liberty, Microsoft, Hollywood, Coca-Cola, the Nasdaq, the institution of consumer credit and the Third Infantry Division. Britain, to be sure, had its queen and its navy as well as its bank, but there was net emigration from the home islands even during sterling’s high noon. America is a net importer of people. It’s the world’s destination. Still, not one American institution warrants the value of the dollar. The greenback is a faith-based currency. It falls to every dollar holder to decide if that faith is warranted. And if it was warranted at a 6 percent overnight money-market rate, is it equally justifiable at a 1 percent rate?

"[T]here are few things upon which mankind are so much the slaves of habit, or so suspicious of change as in regard to the money which they are accustomed to handle in their daily transactions." So wrote a correspondent of The Times of London in 1891, hitting the nail on the head. Yet lightning does strike and cycles do turn. (Amazingly, the Germans agreed to trade in their beloved DM for the euro before there even was a euro.) Over time, the sterling bloc was absorbed into the worldwide dollar bloc. But the United States is a highly leveraged enterprise that requires rising volumes of funding from offshore creditors. It is written in the stars that the dollar will one day go the way of every preceding currency. It is written in Grant’s that there are forces at work to cut short the dollar’s reign as the unchallenged reserve asset.

The proven force of monetary inertia weighs against near-term change. Up until the post-2000 time of troubles, the dollar was a pleasure to have and to hold. From the mid-1990s, its exchange rate appreciated, the U.S. economy expanded and U.S. securities prices rose (and rose). Former Treasury Secretary Robert Rubin soothingly repeated the words "a strong dollar is in the U.S. national interest." However, all the while, the current account deficit expanded and the net international investment position deteriorated.

If not the dollar, what? The euro, peut etre? The dollar bear here confronts a problem, as the monetary alternatives are limited. The euro and the yen each labor under the handicap of the expressed view of a ranking politician (the heads of Germany and Japan, respectively) that their exchange rates ought to depreciate, notably against the dollar. In the global game of money, a strong currency is the Old Maid, and not even the Swiss want her. The euro was presented to the world as the currency supported by a "growth and stability pact," but now comes a plea to tolerate bigger budget deficits. The call was made July 14 -- Bastille Day -- by none other than French President Jacques Chirac. To its credit, France is leading by example. Its budget deficit this fiscal year is pointing toward 3.6 percent of GDP, 60 basis points higher than the EU’s supposed outside limit of 3 percent.

It can’t be said that the Continent’s fiscal problems significantly eroded confidence in the management of the euro, because confidence came, or should have come, pre-eroded. Wim Duisenberg’s scheduled retirement from the presidency of the European Central Bank was planned with the understanding that his successor would be French. Or, as Christopher Fildes, financial columnist of The Spectator, London, put it, Duisenberg’s successor would be No. 1, French, and No. 2, not in jail. With his acquittal last month on charges of having assisted in the wrecking of Credit Lyonnais a decade ago, Jean-Claude Trichet perfectly qualifies. He is expected to slide into Duisenberg’s empty chair on November 1.

The dollar, the yen and the euro all have different macroeconomic characteristics, but each is an "IOU-Nothing," to use the phrase coined by gold investor John Exter, a former vice president of the New York Federal Reserve. Unless stamped "legal tender," or words to that effect, each currency would circulate for the intrinsic value of the paper and printing. No one under the age of 31 has drawn a breath while the dollar was anything more than an IOU-Nothing (the right of foreign central banks to exchange their dollars for gold at the rate of $35 an ounce was repealed by President Nixon on Aug. 15, 1971). To the world’s youth, the phrase "fiat currency" is a redundancy.

An epochal monetary drama is unfolding, in the opinion of your fossilized editor. If others don’t see it, we admit, it could be because it isn’t there. On the other hand, so slow is the action and so bland are the spoken lines that it’s easy to mistake the late afternoon of the dollar for The Wall Street Journal’s daily currency story. A shortcut to understanding is to reflect on the age of the pound.

The pound’s glory years we’ll call the Warm Beer Era. They date from 1821 (when gold convertibility was restored following the Napoleonic wars) to World War I. In the succeeding Cold Beer Era, 1944 to date, the world has put its faith in the dollar -- most of the time. (Cool beer characterized the transition phase between the reserve roles of the British and American currencies.)

The confidence lodged in the pound was confidence in the Bank of England to discharge a specific and well-defined obligation: to exchange a troy ounce of gold for £3 17s 101/2d, and to maintain the pound’s dollar parity at $4.86. By contrast, the confidence reposed in the post-1971 dollar is confidence in the United States government to do the right thing.

Doing the right thing is a subjective mandate that usually happens to coincide with the interests of the United States. Strict adherence to the lawful sterling exchange rate aligned the interests of the sterling community, holders and issuer alike. No such stricture applies to the dollar, and the interests of the national issuer and the foreign holders are sometimes at odds. One of those times is now. The United States is a net debtor to the rest of the world. Its citizens are in hock at home. Its political brain remembers the Great Depression as if it were yesterday. For these reasons and many more, the Federal Reserve tries to make dollars cheaper. It will be said that dollars continue to find a foreign home, the foregoing facts notwithstanding. But it can be said right back that more and more dollars find a home on the balance sheet of a foreign central bank, rather than in the portfolio of a profit-seeking investor (Grant’s, June 20).

Doing the right thing is a mandate that exactly suits the chairman of the Federal Reserve Board. It affords him maximum scope for ad hoc action and intuitive judgment: At one and the same time, he can be the nation’s guardian against inflation, deflation, recession, bear stock markets, hedgefund panics and crises of the computer clocks (the latter occurring at the millennium only). "Price stability," long the Fed’s North Star, is the guide for monetary policy no longer. It is explained that stable prices are at risk of falling, which would produce deflation and consequences too terrible to discuss, especially, as the Fed does not forthrightly admit, in an economy as leveraged as the American one. In the Warm Beer Era, deflation was that portion of the monetary cycle in which creditors got back some of their own for the losses they bore in the preceding inflation (or would suffer in the succeeding inflation).

In his semiannual monetary report, delivered Tuesday, Greenspan emphatically reaffirmed that the 19th century is over. "With the economy operating below its potential for much of the past two years and productivity growth proceeding apace," he stated, "measures of core consumer prices have decelerated noticeably. Allowing for known measurement biases, these inflation indexes have been in the neighborhood that corresponds to effective price stability -- a long-held goal assigned to the Federal Reserve by the Congress. But we can pause at this achievement only for a moment, mindful that we face new challenges in maintaining price stability, specifically to prevent inflation from falling too low."

Too low? So saying, the chairman has ordered short rations for bondholders, as he might say, "for the foreseeable future." The persistence of generationally low interest rates can be read as a vote of no confidence in the will or capacity of the Fed to restore a decent minimum of price inflation. It’s a vote we continue to dissent from.

Sterling’s golden years coincided with the towering prestige of the City of London. Yet the world wasn’t asked to accept the pound on faith. Her Majesty’s Government put up collateral. Easy exchangeability of paper into bullion was a system grounded in the historically observed tendency of governments to crank the presses too fast. Fans of the Cold Beer Era would say that, in the dollar system, too, there are checks and balances, but ones suited to the computer age. Thus, free and well-informed capital markets keep watch on central banks, heads of state and secretaries of the Treasury. However, there is this rub: The capital markets are staffed by excitable and suggestible human beings. They are the same kind of people, in fact, who staff the central banks. By contrast, the statutory sterling conversion rate was impassive and (until the guns of August 1914) unshakable. Has evolution produced a better kind of central banker or a less discerning class of creditor? It has certainly produced a faster gait of credit creation and a more explosive derivatives market.

Picking up a Victorian newspaper dated late in the 19th century, any Grant’s reader could follow the story line. Deflation was in the news -- in the last two decades of the century, prices were given to sinking. Leaders of the Bank of England worried that London’s fast-growing banking system was becoming too big and too complex to supervise. Interest rates were falling, globalization was proceeding and technological change was hurtling.

However, great chunks of coverage that fill today’s economics columns were absent. The welfare state was uninvented, and the art of macroeconomic management was in its infancy. The Bank of England focused on the exchange rate and the gold reserve. It would intervene to stop a panic, as it did in 1890 during the first Barings pileup. However, if the weakening of the sterling exchange rate happened to coincide with a soft patch in business activity, up would go the bank rate. It was first things first, and the exchange rate above all else.

Every monetary system has its contradictions. One of sterling’s centered on the dual personality of the Old Lady of Threadneedle Street. Investors, not the government, owned the Bank of England. They expected their bank to pay a dividend, and the nation expected its bank to hold an adequate store of non-interest-bearing gold. So the bank economized on bullion, as did the British banking system as a whole.

The pound, writes Nicholas Mayhew in his Sterling: The Rise and Fall of a Currency, "was securely founded on the government’s promise to redeem its notes in gold. ... Nevertheless, the sterling balances accumulating in British and foreign bank accounts actually far outnumbered the amount of gold in circulation, and if the public had suddenly chosen to redeem their notes and bank deposits in gold a very serious crisis would have developed. This was why the Bank had to husband its reserves, and raise the bank rate at the first sign of increased demand for gold."

For the most part, Mayhew points out, the world was a happy holder of sterling, but it wanted gold in times of trouble. "The Franco-Prussian War, for example, raised the demand for gold on the continent, and brought the bank rate quickly up to 6 percent in England," he goes on. "A drain of gold abroad could also occur if sterling became too plentiful, leading to a fall in the sterling exchange rate. If this happened, it could be worth a man’s while to convert his sterling bills to gold, which retained its value against foreign currencies. But these circumstances would also be answered by a rise in the bank rate, for as loans and discounts became more expensive, the supply or sterling would tighten, improving the sterling exchange rate, and so reducing the incentive to withdraw gold."

By chaining the pound to gold, the British also, at rare geologic intervals, chained their economy to mine production. As a rule, the aboveground supply of gold grows slowly, but it jumped with the big turn-of-the-20th-century discoveries in the African Rand. A faster pace of mining led to a faster rate of expansion in the monetary base, which led to a rising price level and the start of what proved to be a generational bear bond market. Close your eyes and imagine the chairman of the Federal Reserve Board ceding control of the money supply to geologists (or Congress letting him).

But the Cold Beer Era is also rich in contradictions, even if, to the uncritical eye, they still resemble business as usual. First and foremost is a mighty contradiction between the international role of the dollar and the international financial position of the United States. If Britain was the world’s workshop, the U.S. (as colleague Gert von der Linde has poetically observed) is the world’s mouth. We consume more than we produce, and we pay the bill with dollars. The money winds up in the vaults of the countries that consume less than they produce. This traffic in dollars is measured in the current account of the balance of payments. The current account encompasses international trade in goods and services as well as earnings on investments. The current account today is in deficit at an annual rate of $510 billion, representing 5.3 percent of estimated 2003 United States GDP. A current account deficit is not necessarily an economic indictment, nor is a current account surplus necessarily an economic badge of honor (Japan is in surplus). You may ask: What about the U.S. international investment position? Surely, like Britain at its financial apex, the millennial United States is laying up vast net wealth abroad. Actually, no. As previously noted, foreigners own many more claims on U.S. assets than Americans do on foreign ones: $2.6 trillion more at year-end 2002, measured at estimated market value. The number was last positive -- by just $10 billion -- in 1988. Around the time of inflection in America’s status from national net creditor to national net debtor, Thomas Gale Moore, a member of the president’s Council of Economic Advisers, tried to offer reassurances: "We can pay off anybody by running a printing press, frankly, so it’s not clear to me how bad that is." In 1913, as sterling reached its highest point in the heavens, Britain’s net foreign investment as a percentage of British GDP was 9.1 percent; in 2002, America’s net foreign investment as a percentage of American GDP was minus 24.9 percent.

World War I killed the $4.86, goldexchangeable pound, but sterling was a marked currency even before the hostilities began. Manufacturers had begun to complain about the lack of tariff protection and about the intermittent high bank rates by which the value of the pound was maintained. Social reformers spoke up for the hungry and destitute and for those who could not compete in the world labor market. "Some of us," Earl Russell told the House of Lords, "felt that a slight disturbance in the temples of high finance is worthwhile if something is done to alleviate the lot of those unfortunate people, and to bring stability and enjoyment of life to a larger portion of the population of this country."

Between 1914 and 1919, the British national debt exploded to £7.4 billion from £650 million. In 1920, the silver content of coins was reduced (gold coins had stopped circulating in 1914); the pound was quoted at $3.20. In 1925, the chancellor of the exchequer, Winston Churchill, presided over the restoration of the prewar exchange rate, but it was a forlorn and eviscerated gold standard that Britain famously abandoned in 1930. Deliverance! "The stimulating effects of cheap money for the domestic economy were soon evident," Mayhew chronicles. "As interest rates fell, shares rose, doubling in value between 1932 and 1936. The housing market responded, too. ..."

World War II was fought at a sterling-dollar exchange rate of $4.03. The Bank of England was nationalized in 1946 (no more contradictions in monetary policy on the point of central-bank ownership). Sterling was devalued in 1949, to $2.80, and again in 1967, to $2.40. In August 1975, retail inflation achieved an annualized monthly rate of rise of 26.9 percent. In 1976, Nigeria announced that it would no longer hold sterling as a reserve asset. In 1985, the pound briefly fetched $1.04. Britain joined the European Rate Mechanism in October 1990 but withdrew (to the sound of George Soros cheering) in September 1992. "A significant decline in sterling after 1945 was inevitable," writes Mayhew, "given the decline in Britain’s international status." No such decline is apparent for America, but international status doesn’t come for free. As a point of distant historical comparison, it cost the British treasury £2.7 million a month to pacify Iraq in 1919. Eighty-four years later, it is costing the U.S. Treasury $3.9 billion a month to pacify the same country. Tuesday’s Financial Times featured an essay in which Niall Ferguson and Laurence Kotlikoff contended that it won’t be the cost of empire that lays the dollar low, but rather the cost of unfunded Social Security and Medicare benefits.

We don’t deny that there’s a lot of ruin in a currency (as there is in a country, observed Adam Smith). However, we are not for that reason complacent. We now have open in front of us a 1964 monograph from The Quarterly Journal of Economics, published by MIT. Written by Robert Z. Aliber, it is titled, "The Costs and Benefits of the U.S. Role as a Reserve Currency Country," and it might as well be preserved on a clay tablet. None of the points of monetary reference matter-of-factly advanced by Aliber in 1964 would seem familiar or useful or true to a millennial central banker. The U.S. was then beginning to chafe at the constrictions imposed by its role as the issuer of the one major currency that remained convertible into gold (such was the foundation of the Bretton Woods scheme). Inflation had been latent since the late 1950s, but the Vietnam war was about to make it manifest. "The constraint on expansive economic policies imposed by persistent, large U.S. payments deficits and the consequent weakening of the U.S. international reserve position, when domestic unemployment has ranged between 5 percent and 6 percent," wrote Aliber, "has raised concern about the costs and benefits of the U.S. reserve currency role."

In other words, the privilege of issuing a currency that would be held as another nation’s store of value imposed certain responsibilities on the issuer. It must have seemed obvious to Aliber, as it did to Aliber’s readers, that foreign countries would not absorb limitless volumes of dollars merely because it was expedient for the U.S. to strike them off on a press. Has the world so changed that, 40 years later, there is no effective limit? But the greatest threat to the Cold Beer Era in money, we believe, is not the cost of war, or of looming federal social outlays, or even of the arrogance of a unilateral U.S. interest-rate policy. It is rather the conceit that a paper currency can be managed by the seat of the pants of a committee of government employees. While chancellor of the exchequeur, Denis Healey lost patience with the economists who would lead the nation with forecasts. He described their method, records Mayhew, as "extrapolation from a partially known past, through an unknown present, to an unknowable future according to theories about causal relationships between certain economic variables which are hotly disputed by academic economists, and may in fact change from country to country or from decade to decade."

The world’s foreign central banks and international financial institutions, as of July 9, owned U.S. Treasury and agency securities in the sum of $945.6 billion. According to the back page of the current Economist, China has amassed foreign reserves (much of them presumably held in dollars) of $320.9 billion. Dollar-wise, we would call the world very long and very, very trusting.