THE DOLLAR’S central role in world financial markets reflects both faith in American leadership and the absence of reasonable alternatives. Currency dominance has also been a linchpin in America’s efforts to shape a global order around free markets and democracy while serving as a foundation for the sustained growth of a more integrated global economy. These roles now face rising risks. Both Republicans and Democrats question the benefits of an open and integrated economic order that seems to drain good jobs and demand repeated bailouts of bad banks and corrupt foreign governments. Meanwhile, allies and rivals alike raise doubts about the durability of U.S. leadership and the wisdom of depending so heavily on one dominant power.
Such talk hardly portends imminent financial collapse or reconfiguration of the global order. America’s military and political strength remain paramount and investors still retreat to dollars whenever risks mount—even when those risks originate in the United States itself. Nevertheless, signs of an unravelling consensus are unmistakable. They lie not in the declining percentages of U.S. currency held in sovereign reserves, but rather the weakening faith in America’s ability to hold the system together. The clues are in the early elements of financial plumbing that bypass dollar markets, international financial institutions without active U.S. participation and increasingly rudderless economic gatherings of finance ministers. The risks for the existing global order are not that another power will displace Washington on these issues, but that there will be no leadership in areas that have become increasingly important to global commerce. Worse, the response to the next financial crisis will be uncoordinated and disastrous.
The U.S. midterm elections have triggered some renewed debate about America’s global agenda, yet there have been few voices to remind voters that international financial leadership benefits Americans and not just America’s banks. In fact, global dependence on access to the dollar gives Washington leverage to coordinate battles against terrorism and cybercrime, to shape rules against corruption and tax avoidance, and to protect privacy through the regulation of global data flows that will drive the next decades of economic innovation. Meanwhile, the United States must also build on summit communiques to make concrete progress in these areas with skeptical allies and rivals. For all its fits and starts, U.S. leadership continues to provide a crucial global framework for strong, sustainable and balanced growth. Yet faith in the dollar will only endure with a sense that the United States’ role has evolved from chief executive to managing partner that champions the integrity of a global financial system along with its own interests.
THE FUNDAMENTAL choice to transact, invest or save in dollars reflects a judgement that they are most useful for those purposes. These judgements are slow and cumulative, but the choices can shift surprisingly and decisively. In many ways, the dollar emerged later than it should have, but perhaps sooner than expected. The U.S. economy surpassed Britain’s in the 1870s and was a larger exporter by the First World War. Yet the dollar first gained preeminence in bond markets by 1929, only to cede leadership back to sterling with the Great Depression. The end of the Second World War left the United States paramount with victorious armed forces, an unmatched economy and a network of global interests. In the decades since then, however, the dollar has endured the end of gold convertibility, inflationary fevers, expanding trade gaps, ballooning fiscal deficits, intermittent government shutdowns, a global financial crisis and even the loss of the U.S. Triple-A bond rating.
Foreign firms use dollars because their customers, suppliers and competitors do. In one survey by Harvard economics professor Gita Gopinath, now the International Monetary Fund’s (IMF) chief economist, the share of global trade invoiced in dollars is more than three times the U.S. share of global exports. Foreign governments accumulate dollars in reserves because they like to manage their own exchange rate against the world’s major trading currency. According to the IMF, the dollar still represents roughly 62 percent of all sovereign reserves, with the euro at 20 percent and the renminbi still accounting for less than 2 percent even though its share in global trade and finance is rising. Finally, investors favor dollars in part because firms and governments do, but also because the dollar markets are the deepest and most sophisticated, which makes them likely to be less expensive to tap for loans and more likely to deliver a reliable return.
The economic tradeoffs for the United States are clear. Issuing the world’s reserve currency offers the prospect to literally print money everyone accepts to buy guns without giving up butter. The dollar’s dominance also allows the United States to delay or shift any costs of global adjustment to other countries. Another benefit, the United States pockets the “seigniorage” income from what are effectively no-interest loans from the foreigners who hold two-thirds of the $100 bills in circulation. Among the costs, America’s easy access to low-cost credit may contribute to a stronger exchange rate that hurts exports and makes fiscal and trade deficits larger. Washington also bears responsibility to provide dollars and safe assets in a crisis.
Some of the dollar’s durability comes from the absence of viable alternatives. Europe’s common currency was a political project to bind the continent after centuries of war, although a clear aspiration of some European leaders has been to create a counterweight to dollar dominance. Yet the European financial crisis fragmented its financial markets and triggered questions about the viability of the European project itself. Postwar Japan deliberately protected the yen from an international role so that domestic capital could be directed for domestic purposes and the exchange rate could be managed. More recently, Japanese economic woes and competition from China have proscribed any real role for the yen, which remains at roughly 4.5 percent of international reserves. Chinese officials have a clear aim to expand the role of the renminbi in global trade, finance and sovereign reserves. For example, foreign governments have issued debt and central banks have established swap lines in Chinese currency. Even the likes of Germany and Chile have added it to the mix of their global reserves. Yet for now the reach of China’s currency remains restricted. Even if there is no economic crisis that interrupts more than two decades of blistering growth and reforms open the capital account and exchange rate, China’s domestic financial markets are not deep or liquid enough to absorb vast global flows. Ultimately, these require fundamental reforms in corporate governance, regulatory transparency and a system of checks and balances that a government can trust. Even the nineteenth century Rothschilds preferred lending money to constitutional monarchs, whom they considered better credit risks than unconstrained absolute monarchs.
“Great powers have great currencies,” wrote the Nobel Laureate Robert Mundell, and it seems uncontroversial that global influence and global money are intertwined. Indeed, if the military strength and economic wealth of the United States underpin the dollar’s central role, America’s global influence is enhanced because its currency dominates trade, finance and sovereign reserves. In the extreme, the United States has been known to leverage its military strength on behalf of economic interests—and indeed, the dollar itself. At different times, for example, Japan, Germany and Saudi Arabia have been reminded that U.S. security guarantees warranted their financial support when the dollar came under strain. Alternatively, during the Suez Crisis, the dollar’s dominance allowed the United States to force a British military withdrawal under threat of triggering a run on sterling.
Yet much of the dollar’s influence stems directly from the prestige of America’s institutions and trust in its intentions. Military and economic power support the dollar’s dominant share of trade and investment, but faith in U.S. political institutions has bolstered its role as both a reserve currency and a safe haven. In a world of imperfect choices, other countries have come to rely on the U.S. record of building rules-based financial institutions, proposing agendas for policy coordination and shaping progress toward open markets. This has been the story of the postwar Bretton Woods institutions, U.S. engagement in debt relief negotiations and the response to financial crises.
Meanwhile, currency power ultimately depends on trust in the intentions of the issuer. The issuer’s interests may naturally come first, but its usage will grow if these interests are essentially aligned with shared goals of global growth and stability. The most important economic conferences of the twentieth century convened military and political allies for difficult negotiations around monetary and financial policy. How much more difficult will these discussions become with strategic rivals around the table? How eager will China or Russia be to cooperate when the G20 leaders next convene to address a global crisis? The United States put its own interests first long before the Trump administration, but it has generally interpreted this to include the construction of global financial rules and institutions that apply to all. The growing concerns among allies and rivals are the doubts of bank customers who have been told that all fees have been raised because management needs to prioritize shareholders first. The statement may be technically correct, but it’s a questionable business strategy. At a moment when other economic powers continue to emerge, these agreed rules and shared constraints become all the more important to protect U.S. interests. Amid accelerating political and technological change, they become more valuable still.