“The dollar is our currency, but your problem.”
John Connally
US Treasury Secretary, Nixon Administration
1971-72
Although Connally’s statement was made nearly half a century ago, it is still especially relevant in today’s global economy.
While the US Dollar may not hold an official title, it is widely considered the de facto currency of the world. As of the first quarter of 2019, 61% of all known central bank foreign exchange reserves is made up of the US Dollar. Additionally, approximately $580 billion in U.S. bills are used outside the country, consisting of 65% of all US dollars. In addition, while the US accounts for only 10 per cent of world trade and 15 per cent of global GDP, more than one-third of global GDP comes from countries that peg their currencies to the US Dollar. That includes seven countries that have adopted the US Dollar as their own and another 89 countries that keep their currency in a tight trading range relative to the Dollar.
The Dollar is arguably the global currency and it has been for some time.
After World War Two, the global economy was governed by a formal agreement called the Bretton Woods System. Under this system, global central banks fixed their currencies to gold which was directly linked to the US Dollar due to America’s control of two-thirds of global gold reserves. In the late 1960s, the system suffered due to conflicts of economic interests between America’s short-term domestic objectives and it’s long-term international objectives particularly as it’s national currency also serves as the world’s reserve currency. This resulted in what was known as the “Triffin Dilemma” and ultimately led to the collapse of the Bretton Woods System.
After the collapse, most industrialised nations had a free floating currency and sustained this for a period of time in the 1980’s. However, the US Dollar began to sharply appreciate against all other currencies and became relatively more expensive. This lead to the Plaza Accord in 1985, an agreement to devalue the dollar keeping the exports of US manufactured goods competitive. This led to the world’s increasing demand for US Dollars which has continued to this day.
Similar to the fall of the Bretton Woods System, we are now seeing a resurgence of the “Triffin Dilemma”. The fact the US Dollar is still the main global reserve currency means that the US must be willing to supply the world with its currency to fulfil global demand for foreign exchange reserves. The benefit for the US is that it enjoys lower interest rates, increased investment and cheaper consumption, allowing it to borrow and spend more than other countries. In fact, the world’s need for dollars has allowed the US Government as well as Americans to borrow at lower costs, giving the US an estimated benefit in excess of $100 billion per year. The inverse of this, however, is that the US must also be willing to run a large trade deficit the very thing President Trump is against.
Trump has repeatedly called for a weaker Dollar to increase trade competitiveness with other countries and continues to place unprecedented pressure on the politically-independent US Federal Reserve, tweeting recently that: “Jay Powell and the Federal Reserve fail again.”
The issue emerges when there isn’t global synchronised economic growth. When this happens, countries with large US Dollar reserves have their economies influenced by factors such as the US economy, White House foreign policy (particularly relevant with the trade war with the China) and the US Federal Reserve’s monetary policy, rather than their own policies. These countries are forced to compromise their monetary and economic sovereignty in order to stabilise capital flows.
The serious problems with the dollar’s dominance in the global economy has led to a renewed interest in possible alternatives, particularly in light of Trump’s current trade policies.
In late August the Bank of England’s Governor Mark Carney proposed to replace the position of the US Dollar as the world’s reserve currency with a global digital currency. His virtual “synthetic hegemonic currency” (SHC) would, he said, be best provided by the public sector.
“An SHC would dampen the domineering influence of the US dollar on global trade. If the share of trade invoiced in SHC were to rise, shocks in the US would have less potent spill overs “ he said. Carney did, however, concede there would be execution challenges in creating a SHC and that “changing the game” within the global system is a long term goal.
Other commentators have argued that there is no need for a new currency as there is already an existing frame work, the IMF’s Special Drawing Rights (SDRs). The SDR represents a basket of the world’s leading currencies, with its value based 42 per cent on the dollar, 31 per cent on the euro, 11 per cent renminbi, 8 per cent sterling and 8 per cent yen, a weighted combination of the world’s major currencies. An SDR market would be a valuable asset for the world and would help contribute to a more stable international monetary system.
The death of the US dollar has been entertained many times, however, yet again this topic in being discussed in light of recent political events and a rapidly changing globally economy. If a change were to occur, it will be interesting to see the impact on the US economy. The status of the dollar as the world’s reserve currency enables Americans to live beyond their means, lowering the cost of imports and the cost of borrowing even as US budget deficits and federal government debt are soaring. Only one thing is sure, a change of this size in the global economy will not be smooth or easy. However, maybe now is the time.
