May 26, 2013

For years, the dollar’s role as the major global currency has been termed an “exorbitant privilege” — a phrase coined by French Finance Minister and later President Valéry Giscard d’Estaing. Now it may be turning into an extravagant curse. The United States wants export-led growth. So do most other countries. Not all can succeed; one country’s export surplus must be others’ deficits. But the dollar’s global role puts the United States at a special disadvantage. It’s one cause of slow U.S. growth and high joblessness.



A global currency needs two qualities: trust and usefulness. People — government officials, money managers, business executives, consumers — have to believe the money will hold its value and that other people will routinely accept it. The greatest threat to the dollar’s international role occurred in the 1970s when high inflation, averaging 10 percent annually from 1977 to 1981, undermined America’s commitment to a stable currency. With inflation conquered in the 1980s, confidence returned. Dollars can be converted into most currencies. They can be easily invested in U.S. stocks, bonds and real estate, or they can be parked in relatively safe U.S. Treasury securities.

No other money offers so much. China’s renminbi (RMB) has one large use: buying Chinese goods. Otherwise, China regulates money flows in and out of RMB. Although the euro is more versatile, it has drawbacks. Europe’s stock and bond markets aren’t as deep as America’s. And the euro crisis has made European government bonds riskier than U.S. Treasuries.

The “exorbitant privilege” is that the United States can pay for imports with its own currency. By contrast, most countries have to earn dollars or euros by exporting. If exports lag, they have to suppress economic growth to curb imports. The United States is spared this indignity; it can create more dollars. In addition, foreigners’ investment of their dollars holds down U.S. interest rates.

But there was always a price. Foreigners didn’t spend all their dollars on imports. Their demand for dollars kept the dollar’s exchange rate up, making U.S. exports more expensive and imports here cheaper. Since 1980, the United States has run trade deficits in every year totaling about $9 trillion. All this produced grumbling from U.S. manufacturers and unions but was tolerated while most countries, including the United States, enjoyed relatively low unemployment.

No more. It’s not just joblessness. Many Americans believe that foreigners have manipulated their currencies to enshrine their export advantage. In a recent lecture, economist Fred Bergsten of the Peterson Institute, relying on the work of his colleague Joe Gagnon, argued that at least 20 countries have regularly intervened in foreign exchange markets by buying dollars and euros “to keep those currencies overly strong and their own currencies weak, mainly to boost their international competitiveness and trade surpluses.”

The resulting buildup of foreign exchange reserves is immense. At the end of 2012, according to Bergsten’s calculations, China had $3.4 trillion of reserves; Japan, $1.2 trillion; Singapore, $519 billion; and Russia, $476 billion. One result is lopsided and weak global growth. Countries dependent on exports (China) need stronger domestic demand; countries dependent on domestic demand (the United States, some euro-zone nations) need stronger exports.

Bergsten contends that the world trading system has already succumbed to “currency wars” as countries vie for competitive advantage. He proposes that the United States retaliate against “manipulators.” His suggestions, if adopted, would sow wider economic conflict. Some foreign governments view the Federal Reserve’s easy money policies as retaliation, designed to depress the dollar’s value, though the Fed denies this.

The global dollar poses other hazards. Eichengreen writes that either a political dispute between the United States and China or a “sudden shift in market sentiment” could trigger a panicky flight from the dollar. The odds of that are impossible to calculate. But this much is clear: Long a boon to the world economy, the dollar standard now looms as a potential source of instability.