The Future of the Dollar

Eric Helleiner, Jonathan Kirshner, Eric Helleiner, Jonathan Kirshner

• Publisher: Cornell University Press
• Year: 2012
• Print ISBN: 9780801448256
• eBook ISBN: 9780801457494
• Topic: Economics
• Subtopic: Monetary Policy
• Index: Economics

For half a century, the United States has garnered substantial political and economic benefits as a result of the dollar's de facto role as a global currency. In recent years, however, the dollar's preponderant position in world markets has come under challenge. The dollar has been more volatile than ever against foreign currencies, and various nations have switched to non-dollar instruments in their transactions. China and the Arab Gulf states continue to hold massive amounts of U.S. government obligations, in effect subsidizing U.S. current account deficits, and those holdings are a point of potential vulnerability for American policy.

What is the future of the U.S. dollar as an international currency? Will predictions of its demise end up just as inaccurate as those that have accompanied major international financial crises since the early 1970s? Analysts disagree, often profoundly, in their answers to these questions. In The Future of the Dollar, leading scholars of dollar's international role bring multidisciplinary perspectives and a range of contrasting predictions to the question of the dollar's future. This timely book provides readers with a clear sense of why such disagreements exist and it outlines a variety of future scenarios and the possible political implications for the United States and the world.

Contributors: David Calleo, The Johns Hopkins University; Benjamin Cohen, University of California, Santa Barbara; Marcello de Cecco, Scuola Normale Superiore di Pisa, Italy; Eric Helleiner, University of Waterloo; Harold James, Princeton University and European University Institute; Jonathan Kirshner, Cornell University; Ronald I. McKinnon, Stanford University; Herman Schwartz, University of Virginia

1

THE FUTURE OF THE DOLLAR

Whither the Key Currency?

Eric Helleiner and Jonathan Kirshner

The U.S. dollar’s status as the leading international currency has been an enduring feature of the post-1945 world order. The greenback has provided the monetary foundation for the international economy and its worldwide role has both reflected and reinforced America’s global preeminence. But questions about the future of the dollar’s international standing are now heard with increasing frequency, and predictions of an impending erosion of the dollar’s global status have now become commonplace. To take only one example, it used to be possible to enter the Taj Mahal for $15—now dollars are not welcome.

We have of course been down this road before—the demise of the dollar has been predicted by observers for decades, and U.S. government officials have spent sleepless nights worrying about the imminent collapse of the dollar and the subsequent implications for American power and the world economy—in the ’60s, in the ’70s, and in the ’80s.1 Yet the sky, sometimes almost stubbornly it seemed, would simply not fall. In defiance of the conventional wisdom, Richard Cooper stated plainly that “at the end of this decade the position of the dollar will not be very different from what it is now.” That was 1973. The prediction was right on the mark—and Cooper is still keeping his powder dry, currently siding with those who do not see fundamental weakness in the dollar-centric international monetary order.2

And indeed, it is important to acknowledge that there are good reasons why the dollar has been so attractive, including the enormous size and institutional depth of the U.S. economy, its capital markets, economic growth, vitality and profitability, and, importantly, its political stability and unmatched physical security. It is also important not to confuse the value (or exchange rate) of the dollar with the extent of its international role. Predictions of the imminent erosion of the dollar’s international position have invariably coincided with periods of dollar depreciation. Today’s situation is no different. Past experience reminds us that the dollar’s global role rests on broader foundations than its value at any given moment.

Given the inaccuracy of past predictions, how seriously should we take those who question today the dollar’s future as an international currency? This book explores this question. It is, of course, impossible to predict the future with any certainty. But in the context of growing public interest, this book is designed to highlight the important contributions that scholars have been making, and can make, to the debate about the future of the dollar’s international position. This book does not aim to marshal consensus in favor of one view. Indeed, we have deliberately invited contributions from distinguished scholars who have reached quite different conclusions about the issue. Some of the contributors are firmly in the “declinist” camp, while others believe the dollar’s international role is sustainable. Our objective is to arrive at a clearer understanding of why scholars, especially those who have written with such authority and wisdom on monetary affairs and the international role of the dollar, can disagree so widely about this question in the contemporary context.

These disagreements, we suggest, stem from the fact that analysts draw on distinct underlying theoretical models that employ quite different sets of assumptions about the mechanisms by which currencies achieve and maintain an international position. These differences, along with alternative views about how to relate contemporary developments to specific models, account for the varying predictions. The goal of this book is not to try to persuade readers that one or another of these perspectives is the more convincing. Our aim instead is to uncover the bases for their disagreements in order to help readers make judgments for themselves. Identifying the sources of these disagreements, we hope, is a useful contribution to the debate as well as to scholarship on international monetary affairs more generally.

The Dollar’s International Role and Its Significance

Before examining these distinct models, let us first clarify the nature of the subject itself. What does it mean to say that the dollar is an international currency?3 Benjamin Cohen outlined six international roles of the dollar that correspond to the three basic functions of money as well as a distinction between public and private use.4 As a medium of exchange, it is used by the private sector to settle international economic transactions or by governments as a vehicle currency to intervene in foreign exchange markets. As a store of value, the dollar might be held as an asset by either foreign private actors for investment purposes or by governments in the form of their official foreign exchange reserves. Finally, as a unit of account, it might be used by market actors as a quotation currency for international trade and investment transactions, or by governments for either this purpose or as an anchor for pegging the national currency.

In all of these respects, the dollar has been by far the world’s most important international currency throughout the postwar period, and it remains in a preeminent position today. As a medium of exchange, one indicator of its dominant role is the fact that the dollar continued to be used on one side of about 86 percent of all foreign exchange transactions at the time of the last Bank for International Settlements survey of foreign exchange trading—whereas its nearest rivals, the euro and yen, have shares of only 37 percent and 16.5 percent respectively.5 As a store of value, the dollar still made up 64 percent of the world’s official foreign exchange reserves at the end of 2007, compared to about 26.5 percent for the euro and below 5 percent for the yen. The dollar’s shares in 2006 of international bank deposits (48%) and the stock of international debt securities (44%) also remained above those of the euro (28% and 31%), with the yen again very far behind.6 In addition, the dollar continues to be by far most popular currency in which to denominate international trade, with the euro used prominently only in trade with the euro area itself. As an official unit of account, the dollar is used as the anchor currency in almost two-thirds of all the countries in the world that peg their currency in various ways, while the euro is the anchor in only about one-third (and they are almost all in Europe or in French-speaking African countries).7

One further indicator of the dollar’s global role is its use within many countries’ domestic monetary systems. Earlier literature on international currencies often assumed that all states maintained an exclusive national currency within the territory they governed and that “international” monetary transactions took place largely between these “territorial currency” zones. In the contemporary age, however, the lines between domestic and international have become increasingly blurred as territorial currencies have eroded in many parts of the world. In this context, many have highlighted how the dollar’s international status today stems from its role as a medium of exchange, store of value, and unit of account not only in “inter-national” economic activity but also at the domestic level in “dollarized” countries such as Russia or many parts of Latin America.8 The phenomenon of “euroization” is largely restricted to countries on the geographical edges of the euro zone.9

Given the various possible functions of an international currency, one might question whether it is possible to make any concise generalizations about the dollar’s future. As we shall see, differing predictions on this subject do indeed sometimes reflect the fact that analysts are focusing on different aspects of the dollar’s international role. Declinists are more likely to highlight the store of value functions, while their critics often cite its medium of exchange and unit of account functions. This raises the question of whether the distinct international functions of the dollar could increasingly experience a different fate in the future.10 Some—including Marcello de Cecco in this book—suggest that they could. States and private actors could continue to rely heavily on the dollar as an international medium of exchange, while actively diversifying their reserve portfolios. At the same time, too wide a divergence is probably unlikely since each of the functions of an international currency tend to reinforce the others in important ways.11

Why should we care if the dollar’s international role were to fade? Because the dollar has acted as the monetary foundation of the postwar international economic order, any diminution of its role raises the prospect of international economic instability. Some draw a lesson from the interwar period, that a more multipolar international monetary system will inherently be more unstable than a hegemonic one. Others, however, argue that a multipolar currency order may be more stable since no one leader can exploit its hegemonic position. But even advocates of this latter position usually acknowledge that the transition phase from hegemony to multipolarity is likely to bring many risks for the international economy.12

Since the U.S. dollar’s global role has helped boost U.S. hegemony in the postwar period, any decline in that role will also have important distributional consequences among states in the international system. What precise benefits has the dollar’s role provided the United States?13 To begin with, when foreigners have held dollars, they have provided the equivalent of an interest-free (in the case of Federal Reserve notes) or low-interest (in the case of U.S. Treasury securities) loan to the United States. According to some estimates, in recent years this “seigniorage” profit has totalled over $20 billion per year (Cohen 2008, 258). The dollar’s international role has also reduced exchange rate risks for U.S. firms involved in international commerce, and U.S. banks have gained a competitive advantage in dollarized financial markets because of their privileged access to the Federal Reserve’s resources.

The dollar’s global role has also strengthened the capacity of the United States both to delay and deflect adjustments to its current account deficits.14 The power to delay has stemmed from the greater ease the United States has in financing its deficits because of the dollar’s international role. The power to deflect the costs of adjustment onto foreigners has partly reflected the ability of the United States to depreciate the currency in which it has borrowed funds from foreigners. At the same time, the depreciation of the dollar has also generated political pressures for expansionary policies within countries dependent on dollar-based markets, policies that in turn have helped the United States correct its trade position by expanding exports. Countries that tried to resist this “dollar weapon” by supporting the dollar usually found themselves pursuing expansionary policies anyway because of the difficulties of sterilizing accumulating dollar reserves. Through these channels, U.S. policymakers were able, since the early 1970s, to indirectly prompt foreigners to absorb much of the burden of adjustment to U.S. current account deficits.15

In addition, the international position of the dollar has bolstered the U.S. state’s coercive power in more direct ways. Countries relying on the dollar are vulnerable to the United States because of their dependence on access to U.S.-based dollar clearing networks. The United States has exploited this vulnerability effectively as a tool of both foreign policy (e.g., vis-à-vis Panama in the mid-1980s) and to encourage cooperation with U.S. regulatory goals (e.g., anti-money-laundering regulations).16 The dollar’s role also has given the United States a uniqu...

Table of contents

• Figures and Tables
• Preface
• Contributors
• 1. The Future of the Dollar
• 2. The Enduring International Preeminence of the Dollar
• 3. U.S. Current Account Deficits and the Dollar Standard’s Sustainability
• 4. Enduring Top Currency, Fragile Negotiated Currency
• 5. Housing Finance, Growth, and the U.S. Dollar’s Surprising Durability
• 6. From Monopoly to Oligopoly
• 7. Toward a Leaderless Currency System
• 8. Twenty-First Century Geopolitics and the Erosion of the Dollar Order
• 9. After the (Relative) Fall
• 10. Summing Up and Looking Ahead
• References