60 Finance & economics The EconomistAugust 8th 2020
I
t has beenan ugly summer for America and the dollar. The
greenback fell by more than 4% against a basket of other major
currencies in July, the largest monthly decline in a decade, as the
value of euros, gold and even bitcoin soared. In a year packed with
extreme market movements, the dollar’s wobbles might seem un-
impressive. As they played out against a backdrop of American tur-
moil, though, they have fed fears that a reckoning looms for the
world’s economic hegemon. An abysmal response to the pandem-
ic, a stuttering economic recovery and soaring debt understand-
ably contribute to concern about America’s economic wherewith-
al. But if there is reason to question the dollar’s dominance, it is
not that America is becoming less economically mighty, but that
the world order it built looks increasingly vulnerable.
Reserve-currency status is often cast as a matter of economic
fundamentals. A reserve-currency issuer should play an outsize
role in global trade, which encourages partners to draw up con-
tracts in its currency. A historical role as a global creditor helps to
expand use of the currency and encourage its accumulation in re-
serves. A history of monetary stability matters, too, as do deep and
open financial markets. America exhibits these attributes less
than it used to. Its share of global output and trade has fallen, and
today China is the world’s leading exporter. America long ago
ceased to be a net creditor to the rest of the world—its net interna-
tional investment position is deeply negative. Soaring public debt
and dysfunctional government sow doubt in corners of the finan-
cial world that the dollar is a smart long-run bet. And whispers,
suggesting that the day of the dollar’s eclipse by the euro or the
yuan looms, grow louder from time to time.
Debates about a changing of the guard are hampered by a dearth
of historical comparisons. The replacement of one currency by an-
other as the modern world’s monetary bulwark has occurred pre-
cisely once—when the dollar overtook sterling. That makes identi-
fying its critical causal factors nearly impossible. Economists once
thought that network effects made reserve-currency status a win-
ner-take-all affair. It is more attractive to conduct trade or hold
savings in a currency that is widely used by others, giving reserve
currencies an edge over challengers. That America’s output over-
took Britain’s as early as 1880, while the dollar did not clearly dom-inate until enshrined in the Bretton Woods economic institutions
more than 60 years later, seemed to prove that dominant curren-
cies are not easily dislodged. But accumulating evidence suggests
a revision of these views may be warranted. In practice, leading
currencies often share a reserve role with others. Sterling ruled the
roost before the first world war, but still accounted for no more
than two-thirds of global currency reserves at the end of the 19th
century (German marks and French francs made up most of the
rest). Furthermore, the dollar overtook sterling much earlier than
once thought. By the early 1920s it already accounted for at least
50% of major economies’ foreign-currency reserves. Reserve-cur-
rency status may not be so unassailable after all.
Even so, challengers have for decades failed to knock the green-
back from its perch. Part of the explanation is surely that America
is not as weak relative to its rivals as often assumed. American pol-
itics are dysfunctional, but an often-fractious euro area and au-
thoritarian China inspire still less confidence. The euro’s mem-
bers and China are saddled with their own debt problems and
potential crisis points. The euro has faced several existential crises
in its short life, and China’s financial system is far more closed and
opaque than the rich-world norm.
Dollar dominance also reflects factors that conventional eco-
nomic analyses sometimes omit: geopolitics. Sterling ruled dur-
ing a long period of increasing global integration to which Brit-
ain—as a financial, industrial and military powerhouse—was
central. The first world war brought an end to that era, and sterling
soon lost its position. It shared reserve-currency status with the
dollar into the 1940s, but under very different circumstances than
prevailed in pre-war times; global trade and cross-border invest-
ment did not return to the levels of 1913 until the final third of the
20th century. It was not just American economic superiority that
put the dollar at the centre of the post-war order, but its unrivalled
geopolitical might as well, which it used to reforge an integrated
global economy. Work published by Barry Eichengreen of the Uni-
versity of California, Berkeley, and Arnaud Mehl and Livia Chitu of
the European Central Bank highlights the role of power politics in
currency choice. Analysing reserve holdings before the first world
war, the authors find that military alliances influenced the compo-
sition of reserves. A pact, they reckon, boosted a currency’s share
in an ally’s reserve holdings by 30 percentage points.Get the buck out of here
So the global role of the dollar does not depend on America’s export
prowess and creditworthiness alone, but is bound up in the geopo-
litical order it has built. Its greatest threat is not the appeal of the
euro or yuan, but America’s flagging commitment to the alliances
and institutions that fostered peace and globalisation for more
than 70 years. Though still unlikely, a collapse in this order looks
ever less far-fetched. Even before the pandemic, President Donald
Trump’s economic nationalism had undercut openness and alien-
ated allies. Covid-19 has further strained global co-operation. The
imf thinks world trade could fall by 12% this year. Supply chains
that sprawl across national borders may retreat amid concerns
about economic conflict and national security. America and China
seem to be sliding into a new cold war.
Though America’s economic role in the world has diminished a
little, it is still exceptional. An American-led reconstruction of glo-
bal trade could secure the dollar’s dominance for years to come. A
more fractious and hostile world, instead, could spell the end of
the dollar’s privileged position—and of much else besides. 7Free exchange Change for the dollar
The greenback’s status is as secure as American global leadership