“Exorbitant Privilege:” The Future of the US Dollar
Michael Crittenden and Barry Eichengreen had a fascinating debate over the future of the US dollar in last week’s edition of the Wall Street Journal. Crittenden avers that the dollar, despite talk to the contrary, will remain the global reserve currency because nothing presents itself as a legitimate alternative to the dollar at this point. However, the US will experience diminishing returns for the status of the dollar. On the contrary, Eichengreen posits that the US dollar will lose its global reserve status due to long-term deficits and competition from China’s renminbi and the Euro.
Publicly questioning the global reserve status of the US dollar has become a trendy way to check US power for many political leaders. Crittenden notes, “French President Nicolas Sarkozy is expected to make the issue a priority for France’s presidency of the Group of 20 meetings this year, and even U.S. officials have acknowledged that a rethink of the dollar-centric world is inevitable.” Sarkozy is not the first French president to question the US dollar’s global role. Charles de Gaulle famously referred to the US dollar’s favored status as “exorbitant privilege,” threatening to exchange France’s entire dollar reserves for gold bullion on multiple occasions.
Three possibilities present themselves in this debate over the future of the US dollar: a single currency overtakes the US dollar as the global reserve currency; multiple countries vie for influence in a multi-polar system where currencies dominate by region; and, a supranational or global currency. Let us examine these possibilities in order.
The first scenario is the most parsimonious, and hence the most plausible. Yet, it suffers not from a theoretical lacuna but an empirical one: what is the viable alternative to the US dollar? Which countries are positioned to challenge the US dollar’s cherished reserve status? Only two possibilities present themselves as counterweights to the US dollar: China and the Eurozone.
The ostensible strength and viability of the Euro was far different in 2009, than, say, in 2011. The passing of just a little time can make a world of difference. Europe is engulfed in a maelstrom of economic problems from rapid inflation (i.e., United Kingdom) to a full-blown sovereign debt crisis. Greece and Ireland accepted bailout money; bailouts of Spain, Portugal, Belgium, and Italy are in the offing, according to some economists. All Eurozone central banks are cross-parties to one another; they hold vast amounts of one another’s sovereign debt. The future of the Euro may depend on the appetite for bailouts by democratic publics and the bailout capabilities of Germany and France, specifically.
It is perhaps not surprising that the Euro is experiencing a precipitous decline. After all, the Eurozone never satisfied Nobel Laureate Robert Mundell’s conditions for an “Optimum Currency Area (OCA).” Mundell argues that monetary union is the last stage of economic integration. For instance, Optimum Currency Areas have similar business cycles; similar openness with capital mobility and price/wage flexibility across the region; similar labor mobility across the region; and a risk sharing system that cooperates and coordinates policy in response to adverse effects in the aforementioned categories. Needless to say, Europe fell well short of Mundell’s stringent criteria for monetary union.
Those who argue in favor of the Chinese Yuan have a large burden of proof. Beijing has so far stymied repeated US-efforts at monetary reform. China is adept at resisting international pressure to allow the value of its currency to rise. Crittenden also notes that it has a very underdeveloped financial system (most of it is state-owned). Indeed, it is hard to imagine the Chinese currency playing any role as the world reserve currency until it undertakes drastic monetary reform—namely, allowing a floating exchange rate no longer pegged to the US dollar.
The second scenario, a multi-polar world dominated by regional currencies, is hard to imagine because rapidly developing nations like China, India, and Brazil would doubtless play a large role in any multi-polar monetary regime. Yet, these nations are clearly not ready to lend their currencies to reserve status, because each uses monetary policy as an integral part of its own domestic growth policies, and none has proven the long-term stability of their currency system (and hence garnered the trust of investors). The Euro’s troubles no longer make it attractive either. It is also dubious whether multi-polar monetary regimes would increase efficiency. Therefore, absent a world shock in the confidence of the US dollar—not a scenario that is totally out of the realm of possibility—regional currency formations will likely fail to gain traction.
The third scenario, a supranational or global currency is nearly impossible. Many experts reject the idea of a supranational or global currency. It is also dubious whether financial markets would trust such a scenario, judging by their lukewarm reaction to the International Monetary Fund’s Special Drawing Rights, which could serve as a proxy for a global currency. What is more, setting international monetary policy in a quick or unified manner would necessitate a global governance structure on a scale hitherto unprecedented (the United Nations system would not even come close). The amount of cooperation and coordination for such an endeavor is merely insurmountable at this time. The Eurozone’s struggle in devising timely policy responses and coordination in the sovereign debt crisis serves as a case-in-point—and this is only a microcosm of the problems a structure of global financial governance would engender.
In sum, the US dollar is likely to remain the world reserve currency, at least in the short and medium term. The US may experience diminishing returns from such status, but the three scenarios highlighted above are all highly doubtful. To be sure, the US faces many deep and mounting problems, from the world’s largest trade imbalance with China to structurally unsustainable amounts of government debt. However, despite the US-origins of the recent financial crisis, central banks and investors fled to the dollar during precipitous portions of the crisis. Indeed, “The dollar’s supremacy during such a disruptive period demonstrates its resiliency,” Crittenden argues. Thus, despite murmurings and political pushes to the contrary, de Gaulle’s “exorbitant privilege” will remain in the hands of Americans for some time to come.