Currencies

Why the global economy runs on dollars

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On Monday night, Twitter’s co-founder and ex-CEO tweeted the question, “When did the dollar lose global reserve currency status?” Like many other people who study political economy, I pointed out that Jack Dorsey was wrong. Equally predictably, a flood of commenters chimed in that it had already happened — when President Biden took office, or when the U.S. imposed sanctions on Russia, or in 2009, or whenever else they thought disaster had struck.

The dollar has clearly not lost reserve currency status. Reserve currencies are those held widely by governments, central banks and private institutions to conduct international trade and financial transactions. The dollar shares this distinction with only a few other major currencies, including the euro, Japanese yen, Swiss franc, British pound, Canadian and Australian dollars, and the Chinese renminbi. In fact, the dollar’s status as the dominant global reserve currency is stronger than ever and has become even more entrenched in the wake of the coronavirus pandemic and economic crisis.

Russia’s been hit by a financial Cold War

The dollar’s increasing strength goes against the preferred popular narrative. A veritable cottage industry of news articles and op-ed pieces regularly offers new predictions about the imminent demise of the dollar. The drumbeat of predictions of the end of the dollar’s “exorbitant privilege” has grown louder in the wake of the coronavirus crisis and Russia’s invasion of Ukraine, accompanied by hyperbolic claims that the U.S. faces hyperinflation and may soon be unable to borrow or service its debts. These views suggest that the end of the dollar’s role as the key global reserve currency is only a matter of time. Here’s why these views are almost certainly wrong.

The dollar is still the world’s dominant reserve currency

Jack Dorsey’s claim belies the facts. The dollar is not only a global reserve currency, it is the dominant global reserve currency. In 2019, 62 percent of official government/central bank foreign exchange reserves were in dollars, with the euro second at 20 percent, the yen in a distant third at 5 percent, the pound at 4.5 percent, and others, including the renminbi, all below 2 percent. (These figures are approximate.)

As a 2020 Bank for International Settlements report highlights, the dollar dominates across several dimensions. Nearly half of cross-border bank loans are dollar-denominated — only a third are euro-denominated, with loans in other currencies representing less than 20 percent. The dollar is only slightly less dominant in areas of the global economy like debt securities, trade invoicing and payments using the SWIFT financial messaging system. Nearly 90 percent of foreign currency trading involves the dollar on one side of the transaction.

Put simply, the global economy runs on dollars. This has been true for decades, despite repeated prognostications of imminent change. Indeed, we are now entering our sixth decade of dire predictions of the dollar’s demise, dating back at least to 1971, when President Richard M. Nixon ended the dollar’s convertibility into gold. In the 1980s and 1990s, the yen was going to take over. In the aughts, it was the euro. Pundits now praise bitcoin and the Chinese renminbi the new heirs apparent. Nevertheless, dollar hegemony persists.

Still, each time there is a crisis like the pandemic or Ukraine war, people claim that this time is different. But as economist David Beckworth points out, the pandemic has reinforced the dollar’s centrality rather than weakening it. Likewise, the rapid and near-total financial isolation of Russia by the Group of Seven nations has demonstrated the combined dominance of the dollar and euro as the world’s two main reserve currencies.

Banning Russia from SWIFT is a big deal. But the real pain comes from sanctions.

There are reasons the dollar is still king

Dollar doomsayers overlook the deep and durable foundations of dollar hegemony. As former senior Treasury Department official Mark Sobel notes, the dollar remains king not only because of the size of the U.S. economy and historical inertia, but because of the unparalleled deep, liquid private financial markets and strong protections for property rights in the United States. Moreover, as international political economy scholar Daniel McDowell has shown, people rely on the dollar because the United States is far more willing than the European Union, China or Japan to act as the lender of last resort in global financial crises. Finally, as political scientists Aashna Khanna and W. Kindred Winecoff explain, the dollar’s enduring dominance is due to the deeply embedded hierarchical network structure of the global monetary and financial order.

No other country enjoys these advantages, and no other currency is ready to fill these roles. The E.U. is the world’s largest economy, but the Eurozone is neither a fiscal nor a political union, and this makes it difficult to persuade others that they can really rely on the euro in hard times. China is rising, and the renminbi is slowly becoming a global reserve currency. Still, China lacks deep and liquid private financial markets, does not allow free flows of capital and its rulers have shown no sign at all that they will accept the political economy trade-offs necessary for the renminbi to challenge the dollar, or even the euro.

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Meanwhile, bitcoin and other cryptocurrencies are not really currencies. They are speculative assets, without the political backing or foundations they would need to become reserve currencies, especially in periods of financial instability.

Ultimately, the question of whether the dollar will remain a global reserve currency answers itself. To misquote a famous authority on political economy, “A day may come when the dollar loses its central role as the dominant global reserve currency, but it is not this day.” It is not even this decade, and quite likely not even this century. It won’t even become a possibility until the E.U. becomes a true fiscal and political union — or until China develops an accountable liberal government and much more developed private financial markets and finally accepts the free movement of capital flows. None of those scenarios seems likely to happen soon.

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Mark Copelovitch (@mcopelov) is professor of political science and public affairs and director of European Studies at the University of Wisconsin at Madison. He is the author (with David A. Singer) of “Banks on the Brink: Global Capital, Securities Markets, and the Political Roots of Financial Crises” (Cambridge University Press, 2020).

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