Trade and Investment

No currency can compete: Here's why the US dollar still rules

A woman passes by a reflection of a poster of a Benjamin Franklin 100 dollar bill at a money changer in Singapore November 3, 2014. A year-long investigation into allegations of collusion and manipulation by global currency traders is set to come to a head on Wednesday, with Britain's financial regulator and six big banks expected to agree a settlement involving around ?1.5 billion ($2.38 billion) in fines. The settlement comes amid a revival of long-dormant volatility on the foreign exchanges, where a steady rise of U.S. dollar this year has depressed oil prices and the currencies of many commodity exporters such as Russia's rouble, Brazil's real and Nigeria's naira - setting the scene for more turbulence on world financial markets in 2015. Picture taken November 3, 2014. REUTERS/Edgar Su (SINGAPORE - Tags: CRIME LAW BUSINESS POLITICS)ATTENTION EDITORS: PICTURE 12 OF 23 FOR WIDER IMAGE PACKAGE 'ANOTHER DAY ANOTHER DOLLAR'TO FIND ALL IMAGES SEARCH 'CURRENCY TRADERS' - RTR4DT04

Since the end of World War II, the United States’ share in world GDP has fallen from nearly 30% to about 18% Image: REUTERS/Edgar Su

Carmen M. Reinhart
Minos A. Zombanakis Professor of the International Financial System, Harvard Kennedy School of Government
Share:
Our Impact
What's the World Economic Forum doing to accelerate action on Trade and Investment?
The Big Picture
Explore and monitor how Development Finance is affecting economies, industries and global issues
A hand holding a looking glass by a lake
Crowdsource Innovation
Get involved with our crowdsourced digital platform to deliver impact at scale
Stay up to date:

Development Finance

Since the end of World War II, the United States’ share in world GDP has fallen from nearly 30% to about 18%. Other advanced economies have also experienced sustained declines in their respective slices of the global pie. But you wouldn’t know it from looking at the international monetary system.

Over the same period, China’s share of world GDP almost quadrupled, to around 16% (just behind the US), and emerging markets now account for about 60% of global output, up from about 40% in the immediate post-war years. Given that advanced-economies’ growth prospects remain subdued, these trends are likely to continue – even with the evident slowing in China and other emerging markets.

And yet global finance has not mirrored this shift in balance from the advanced to the emerging. The post-war Bretton Woods arrangements institutionalized the role of the US dollar as the main reserve currency, and until the 1970s, about two-thirds of global GDP was anchored to the greenback. The remainder was largely split between the British pound and the Soviet ruble.

In a recent study that I undertook with Ethan Ilzetzki and Kenneth Rogoff, we document that the US dollar has retained its dominant position as the world’s reserve currency – and by a significant margin. Over 60% of all countries (accounting for more than 70% of world GDP) use the US dollar as their anchor currency. Other metrics, which include the proportion of trade invoiced in dollars and the share of US assets (notably Treasuries) in central banks’ foreign exchange reserves, suggest a similar degree of “dollar dominance.”

The euro is a distant second. From the early 1980s until the introduction of the euro in 1999, the Deutsche Mark’s (DM) influence expanded first in Western Europe and later in Eastern Europe. But the rise of the euro, which consolidated the DM and French franc (Africa) zones, appears to have stalled. By some measures (given the shrinking share of Europe in world output), its global importance has declined.

No other major established international currencies currently compete for global leadership.

The divergence between the trends for production and finance, shown in the figure, emerges as a relatively smaller US economy supplies reserve assets in step with rising global demand for them (primarily from emerging markets).

 Image 1
Image: Top Economy Database

This divergence is not entirely new. With recovery from WWII underway in Europe and global trade expanding, demand for reserves grew rapidly in the 1950s and remained high into the early 1970s. At that time, the US dollar was backed by gold. Given that the world’s gold supplies were not increasing as fast as global demand for reserves, the gap was filled by US (paper) debt.

Over time, fulfilling the global demand for reserves caused a steady rise in the ratio of “paper dollar” reserves to gold reserves, which was incompatible with maintaining the official dollar/gold parity. The incompatibility of the national goal (maintaining the parity) and America’s international role as sole provider of the reserve currency was the essence of the dilemma that the Belgian economist Robert Triffin foresaw (as early as 1960) as a risk to the Bretton Woods system.

Two devaluations, relative to gold, in December 1971 and February 1973, were not enough to correct the “overvaluation” of the US dollar. The Bretton Woods system came to an end in March 1973, when the dollar and other major currencies were allowed to float and the dollar depreciated further.

Now as then, the US could meet the rest of the world’s appetite for dollars by issuing more dollar debt. This would require the US to run sustained current-account deficits, mirrored in fiscal deficits. Of course, while the link to gold is passé, any domestic fiscal objective to curb US debt growth would be at odds with the international role as sole provider of the reserve currency.

One way or another, China will figure prominently in the resolution of this modern “Triffin dilemma.” One possibility is that the inevitable reduction of US current-account deficits (whenever that comes) may result from sustained dollar depreciation (as in the 1970s), implying a capital loss for China and other major holders of US Treasuries. Alternatively, China could eventually become a new supplier of reserve assets. In this scenario, the supply of the reserve asset would align with the world’s fast-growing regions.

This connection could be direct, if the renminbi acquires reserve-currency status; or indirect, if the International Monetary Fund’s unit of account, special drawing rights, becomes a favored asset of reserve managers, as the renminbi is now in the SDR currency basket. Reserve status for the SDR is a long-held IMF ambition, though the idea has never gotten much traction.

But there is a third possibility: global demand for US reserve assets may subside. While China’s ongoing capital flight is fueling an immediate and substantial decline in demand for US Treasuries, a more sustainable scenario would entail China’s transition to a managed floating exchange-rate regime with a deeper domestic financial market – and less emphasis on maintaining a credible war chest of foreign reserves.

Don't miss any update on this topic

Create a free account and access your personalized content collection with our latest publications and analyses.

Sign up for free

License and Republishing

World Economic Forum articles may be republished in accordance with the Creative Commons Attribution-NonCommercial-NoDerivatives 4.0 International Public License, and in accordance with our Terms of Use.

The views expressed in this article are those of the author alone and not the World Economic Forum.

Related topics:
Trade and InvestmentEconomic GrowthBusiness
Share:
World Economic Forum logo
Global Agenda

The Agenda Weekly

A weekly update of the most important issues driving the global agenda

Subscribe today

You can unsubscribe at any time using the link in our emails. For more details, review our privacy policy.

US hikes tariffs on Chinese imports, and other global trade stories to read this month

Guillaume Dabré

May 24, 2024

About Us

Events

Media

Partners & Members

  • Join Us

Language Editions

Privacy Policy & Terms of Service

© 2024 World Economic Forum