Why the global economy runs on dollars

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Monday evening, the co-founder and ex-CEO of Twitter tweeted the question “When did the dollar lose its status as the world’s reserve currency?” Like many other people who study political economy, I have pointed out that Jack Dorsey was wrong. Equally predictable, a flood of commentators said it had happened before – when President Biden took office, or when the US imposed sanctions on Russia, or in 2009, or every times they thought disaster had struck.

The dollar clearly has not lost its status as a reserve currency. Reserve currencies are those widely held by governments, central banks, and private institutions for conducting 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 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 is hit by a financial cold war

The growing strength of the dollar goes against the preferred popular narrative. A veritable cottage industry of news articles and opinion pieces regularly comes up with new predictions about the impending demise of the dollar. The drumbeat of predictions of the end of the dollar’s “exorbitant privilege” has intensified in the wake of the coronavirus crisis and Russia’s invasion of Ukraine, accompanied by hyperbolic claims that the United States is facing hyperinflation and may soon be unable to borrow or repay its debts. These views suggest that the end of the dollar’s role as the world’s primary reserve currency is only a matter of time. Here’s why these views are almost certainly wrong.

The dollar remains the dominant reserve currency in the world

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

As a 2020 Bank for International Settlements report points out, the dollar dominates in several respects. Almost half of cross-border bank loans are denominated in dollars — only a third are denominated in euros, with loans in other currencies accounting for less than 20%. The dollar is only slightly less dominant in areas of the global economy such as debt securities, commercial invoicing and payments using the SWIFT financial messaging system. Nearly 90% of currency transactions involve the dollar on one side of the transaction.

Simply put, the global economy runs on dollars. This has been true for decades, despite repeated predictions of impending change. Indeed, we are now entering our sixth decade of grim predictions of the demise of the dollar, dating back at least to 1971, when President Richard M. Nixon ended the convertibility of the dollar into gold. In the 1980s and 1990s, the yen would take over. In the 2000s, it was the euro. Experts are now praising bitcoin and the Chinese renminbi as new heirs apparent. Nevertheless, the hegemony of the dollar persists.

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

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

There are reasons why the dollar is still king

Dollar pessimists overlook the deep and enduring 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 US economy and historical inertia, but also because of deep and liquid private financial markets. unprecedented and strong property rights protections in the United States. Moreover, as international political economist Daniel McDowell has shown, people rely on the dollar because the United States is much more willing than the European Union, China or Japan to act as as 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 fulfill these roles. The EU is the world’s largest economy, but the eurozone is neither a fiscal union nor a political union, which makes it difficult to persuade others that they can really rely on the euro in difficult times. China is on the rise and the renminbi is slowly becoming a global reserve currency. Yet China lacks deep and liquid private financial markets, does not allow the free flow of capital and its leaders have shown no sign at all that they will accept the political economy compromise necessary for the renminbi to challenge the dollar, or even the euro.

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

Ultimately, the question of whether the dollar will remain a global reserve currency answers itself. To quote a famous authority on political economy, “a day may come when the dollar will lose its central role as the dominant global reserve currency, but that is not the day.” It’s not even this decade, and most likely not even this century. This will not even become a possibility until the EU becomes a true fiscal and political union – or until China develops a responsible liberal government and much more developed private financial markets and finally accepts the free movement of capital flows. Neither of these scenarios seems likely to happen anytime soon.

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Marc Copelovitch (@mcopelov) is Professor of Political Science and Public Affairs and Director of European Studies at the University of Wisconsin-Madison. He is the author (with David A. Singer) of “Banks on the Brink: Global Capital, Stock Markets, and the Political Roots of Financial Crises(Cambridge University Press, 2020).

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