Is the US dollar at risk of losing its
position of international dominance? I have been seeing some breathless
speculation to that effect over the past few weeks; I will talk about the
sources of that speculation in a minute. But let me first note that this is not
a new question. Indeed, I wrote about it at length a few years back.
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And by a few years, I mean four decades. I
published a paper titled “The International Role of the Dollar: Theory and
Prospect” in 1984, in which I concluded that an end to dollar dominance was
possible but not probable and that it would not make much difference even if it
did happen.
Obviously, the world has changed immensely
since I wrote that paper, and there have also been some important advances in
the theory of international currencies. But both the logic behind the dollar’s
(continued) dominance and the reasons not to make a big deal out of that
dominance remain pretty much what they were all those years ago.
Why all the talk about a declining
dollar?
So where is the death-of-the-dollar buzz
coming from all of a sudden? Some of it is coming from the crypto cult.
Although cryptocurrencies have been around for many years and still have not
come to play any significant role in legitimate business — not to mention the
astonishing scale of the scandals that have plagued the industry — they are
still being hyped. Last week, Ted Cruz introduced a resolution that would
require vending machines in the Capitol to accept cryptocurrencies. And the
cult is still claiming that Bitcoin or one of its rivals will replace the
dollar any day now.
Money has to be a reasonably stable store of value — a place you can park your wealth for a while without much risk that it will suddenly lose most of its purchasing power.
Talk about an end to the dollar’s reign may
also reflect a widespread perception that the US “weaponized” the dollar to
impose financial sanctions on Russia after Vladimir Putin invaded Ukraine.
Without getting into the details, I think that is basically wrong; what we
really weaponized was the dominance of New York and London as financial
centers, which tends to make everything the business of their financial
regulators and rules. But in any case, the idea seems to be that some regimes
will turn away from the dollar to protect themselves against sanctions in the
event they do something America disapproves of.
And so we have reports that China is trying
to promote oil trade in yuan and Russia and Iran are considering creating a
gold-backed cryptocurrency. And for some reason, Brazil and Argentina are
talking about creating a common currency along the lines of the euro, which is
a really terrible idea.
What is a dollar, anyway?
To assess all of this, we need to talk
about what it means to say that the dollar is dominant. Basically, it means
that the dollar is to other national currencies as money in general is to other
assets.
Money is a medium of exchange. If you are a
carpenter who wants groceries, you do not try to find a supermarket that needs
its shelves repaired; you sell your services for dollars and use the dollars to
purchase eggs. Similarly, if you want to convert Indian rupees into Brazilian
reais, you do not try to find someone seeking the reverse trade; you convert
the rupees into dollars and use the dollars to buy reais.
Money is a unit of account. People normally
set prices and write contracts that specify payments in dollars rather than in
units of, say, Tesla stock. Similarly, many (although by no means all)
international prices and contracts are set in US dollars.
As the great Charles Kindleberger pointed out, the dollar’s role as an international currency is quite a lot like the role of English as an international language.
Finally, money has to be a reasonably
stable store of value — a place you can park your wealth for a while without
much risk that it will suddenly lose most of its purchasing power.
The dollar’s international role
What is somewhat distinctive about
international currencies is that they play these roles for governments — which
intervene in currency markets, sometimes peg the values of their currencies to
someone else’s money, and hold stocks of foreign exchange — as well as the
private sector.
To some extent, the dollar’s dominance is
locked in because these roles are self-reinforcing. It is easier to do
transactions in dollars than in other currencies because so many other people
use dollars, and the ease of transactions is one reason so many people use dollars.
As the great Charles Kindleberger pointed out, the dollar’s role as an
international currency is quite a lot like the role of English as an
international language.
So is there anything happening in the world
that would plausibly dethrone the dollar from its leading position? Bear in
mind that while the dollar’s dominance is partly caused by self-reinforcement,
it also rests on some fundamentals: America has a huge economy with a huge,
sophisticated capital market and usually does not have the kind of capital
controls that might leave people unable to access their funds at will.
The status of potential competitors
These fundamentals immediately rule out the
yuan as an alternative to the dollar, because China does have capital controls
and seems unlikely to give them up anytime soon. Furthermore, while it’s true
that dictators have some reason to fear that America might impound their assets
if they invade a neighbor or decide to kill a bunch of their subjects, private
investors have much more reason to fear arbitrary actions from an authoritarian
regime that doesn’t believe in the rule of law.
America has a huge economy with a huge, sophisticated capital market and usually does not have the kind of capital controls that might leave people unable to access their funds at will.
For a while, it looked as if the euro might
become a serious rival to the dollar; the euro area economy is comparable to
the US’ in size and sophistication. But since 2010, European capital markets
have been somewhat fragmented, with, for example, Italian bonds trading at a
discount to German bonds. So a euro challenge to the dollar has been postponed,
perhaps indefinitely.
What is true, as Barry Eichengreen and his
colleagues have pointed out, is that central banks have been diversifying their
currency holdings — not into potential dollar rivals but into smaller
currencies.
This is an interesting development, and it
would be worth trying to figure out why it is happening, but it is hardly
earth-shattering. Dollar dominance sounds important if you have not thought
about it much, but much less so if you have. In fact, in general, the more you
know about international currencies, the less important you think they are.
The bottom line
It is true that the dollar’s special role
probably lets America borrow a bit more cheaply than it could otherwise, and
Americans in effect get a zero-interest loan from the large quantity of US
paper currency — mainly $100 bills — held outside the country, much of it for
nefarious purposes. But these advantages are ultimately trivial for what is,
after all, a $26 trillion economy.
So, no, the dollar’s dominance is not under
threat. And even if it were, it would not be a big deal.
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