The global dollar system has few national winners. In the typical frame, understanding the US dollar means understanding the “exorbitant privilege” it confers on America. But the role of the dollar in structuring the international financial system and defining the relationship between a hegemonic US and the rest of the world is ambiguous—as is the question of who exactly benefits from the current arrangement. Dollar primacy feeds a growing American trade deficit that shifts the country’s economy toward the accumulation of rents rather than the growth of productivity. This has contributed to a falling labor and capital share of income, and to the ballooning cost of services such as education, medical care, and rental housing. With sicknesses like these, can we say for certain that the reserve currency confers substantial benefits to the country that provides liquidity and benchmark assets denominated in that currency?
For the rest of the world, the ills are clear enough. In developing countries, the need to insure their economies against currency crises and debt deflation has meant the accumulation of dollars at the expense of necessary domestic investment. These policies are usually accompanied by a suppression of consumption and incomes to establish a permanent trade surplus vis-à-vis the dollar system. And in many countries, the dollar system allows corrupt elites to safely transport their ill-gotten earnings to global banking centers located in jurisdictions with opaque ownership laws.
A closer look at the underlying dynamics that sustain this arrangement reveals why seemingly no one wants to ‘buck the dollar’ but why all countries, including the US, have an interest in doing so.
Rather than viewing the dollar system as primarily a national tool of the United States government, we should understand it as a consequence of a globalized economy that privileges the preferences of financial elites for the free, international movement of capital. The system rests not on uniformly active support for the dollar as a global currency, but on the absence of robust international monetary governance and accommodations to international money markets. The dollar’s present centrality does not come from the priorities of United States national security or interests. Rather, it is rooted in the preferences of private actors in the global money market that mediates between financial institutions, political and business elites, and states. Traditional views of Westphalian sovereignty are not sufficient to explain the cleavages caused by the dollar in the ‘matrix’ of interlocking balance sheets that make up the global financialized economy. While the dollar system has undoubtedly had a disproportionately negative effect on developing countries, the main fault lines that emerge from the dollar system are along class, rather than national lines.
In this context, it might be tempting to retreat to national boundaries and to advocate for de-globalization of various kinds. However, the fact that the dollar system is primarily based on social, rather than geopolitical conflict means that the best solutions suggest at a reform of the system in a manner that empowers people at the bottom of the global social hierarchy.
The Contours of the Dollar System
The global accumulation of wealth and payments for trade and other transactions are largely denominated in dollars, making it the dominant currency for credit and invoicing. Because most of the entities operating in this system do not fall within the purview of the Federal Reserve, most dollars are supplied via offshore interbank credit, funded by dollar deposits at non-US banks, or ‘eurodollars’. These offshore transactions require safe, dollar-denominated collateral to manage their liquidity—preferably United States Treasury debt. Zoltan Pozsar has long highlighted this feature of the offshore financial plumbing, warning of a ‘black hole’ in the dollar funding market. Offshore dollar pools depend on the liquidity of treasuries and near substitutes as collateral to raise cash in the event of a margin call.
The reason for these dollar pools is twofold. First is the need to fund trade. The Eurodollar system facilitates trading relationships between countries with different currencies by giving them access to a common stable currency in which to denominate trade—the dollar. Dollar credit allows the execution of contracts without actual, US-issued currency being exchanged. Instead, the system functions as an exchange of IOUs to deliver receipts at various periods of time. Banks in major money centers clear this system of credit using a combination of time accounts and, if necessary, repurchase agreements to obtain dollars via short-term loans typically collateralized by US treasury debt.
Because 80% of trade in emerging market economies is denominated in dollars, firms with receipts in a domestic currency acquire unsustainable debt in dollars if the domestic currency falls. For this reason, central banks attempt to stockpile dollar assets, most commonly US debt. To acquire them, they usually run a persistent trade surplus by repressing the real wages of their workers. This might be sustainable in the short run, but in the long run it leads to periods of economic stagnation, or international trade and currency wars.
The second driver of these offshore dollar pools is wealth inequality and outsized corporate returns. Large corporations, pension funds, and extremely wealthy individuals cannot bank their money in the retail banking system. Instead, they hold them in pools of dollar liquid denominated assets that can be converted into dollars quickly. While this ‘shadow banking’ system has legitimate uses, it also facilitates tax evasion and kleptocratic corruption. The repression of real wages only compounds this trend. Ubiquitous global trade imbalances drive more returns to owners of capital, increasing inequality.
The dollar system thus facilitates and fuels the power of elites who have an interest in maintaining the status quo. A globalized system with a dominant key currency aids the accumulation of rents at the expense of higher consumption from workers in exporter countries and the hoarding of those rents in the legal black hole of offshore finance.
A financial Dutch disease
The fracture between elite beneficiaries and working losers under the dollar system exists within the United States as well. The US suffers massive negative economic consequences from its position as issuer of the dominant reserve currency—the effects of which are unevenly distributed. Demand for high quality dollar-denominated assets saddles the United States with a financial ‘Dutch Disease’; a situation in which the reliance on exporting a single commodity raises the exchange rate and thus squeezes out the production of tradeable, value-added goods in favor of services and financial rents. Classic examples of countries where ‘Dutch disease’ has taken place have usually been commodity exporters such as Holland in the 1970s (after the discovery of North Sea Oil) as well as Nigeria and Russia. Dutch diseased economies often result in a shrinking, narrow elite whose power rests on income from sales of the single commodity, or the services and management that bloom around the cash flows generated by this commodity.
For the United States, this single commodity just happens to be the dollar. The mechanism behind this process is not hard to understand. From the point of view of simple accounting, every asset must be matched by a liability. That means that a surplus on the capital account—or the desire of the world to purchase safe, US dollar-denominated, assets—is offset by a deficit on the current account. Thus, the United States budget deficit and its trade deficit are both endogenous to the dollar system. When US budget deficits fall either as the result of an increased trade surplus, or the cutting of the budget, financial risk increases as markets substitute safe US government debt for risky collateral, such as the infamous mortgage backed securities of the 2008 crisis.
The most visible cost of the disease is the steady appreciation of the dollar since the 1980s, despite a falling US share of global gross domestic product. The main domestic symptom has been the rising costs of non-tradable goods—such as medicine, real estate rents, and education—over tradable goods. This disconnect is at least in part responsible for the country’s low rate of inflation, falling wage share, and increased economic insecurity despite access to a wider range of consumer goods. While the American consumer can now purchase an ever expanding set of appliances, electronics, and small luxuries, services that are necessary for economic mobility and household sustainability are increasingly out of reach.
It is hard to see how the US is economically benefiting from this system. In the early post-war years, it might have been true—in a narrow, arithmetic sense—that this arrangement was, economically, a net benefit for the United States. The cost of having a reserve currency was smaller after the war, simply because the non-US share of global GDP was considerably smaller than it is now. In the present, however, now that the American share of a larger pie is relatively smaller, the costs of the global demand for dollars are higher. Most other governments would, in fact, actively discourage substantial and sustained purchases of their currency.
If this system is so sub-optimal, why is it still in place? The answer is that it is the locus of a new kind of transnational class politics.
The class politics of dollarization
Frameworks for understanding the persistence of the dollar system tend to vary from from reductionist to outdated, often examining international politics with discrete nation states as the main unit of analysis. In this view, the dollar is a product of hegemonic US interests, wielded as a tool of statecraft. But global financialization has upended this framework: elite interests are not aggregated domestically but internationally, and are transmitted via the balance-of-payments mechanism and the financial system. US leaders and technocrats do not directly compel developing countries to invest their balance-of-payments inflows into Treasuries; nor is it really the active decision making of, say, the People’s Bank of China that’s led to the accumulation of Chinese dollar reserves.
Let us assume that Chinese authorities wanted the People’s Bank of China to reduce its dollar holdings. In order to resolve their external imbalance with the US, they would need to resolve their domestic imbalances. That is because basic accounting identities hold that everything not consumed domestically is saved; those savings are then ‘exported’, largely to the United States, in the form of capital flows. As Michael Pettis has consistently argued, the low household share of income in China (high levels of income inequality caused by rapid growth) have led to a high domestic savings rate and underconsumption. Too great a share of the national income is in the hands of high-saving entities with dollar liquidity preferences, such as high net worth individuals and large corporations. To reverse this imbalance, income would have to be transferred from these powerful interests to China’s workers—a dynamic described by Albert Hirschman as early as 1958. Barring a drastic redistribution of income, perhaps the People’s Bank could simply seek out another reserve currency and an equivalent safe asset. But neither of these would be forthcoming, since no country other than the US has deep, liquid markets in a benchmark asset.
The implicit assumption here, however, is that the financial sector and corporate elites actually want an alternative. There is no reason to believe that this is the case. The system, as it is constituted, does not have many disadvantages for current entrants, and any alternative would require a distributional shift. China’s vast dollar reserves illustrate how emerging market economies with domestic imbalances caused by years of lopsided growth can use dollar-denominated assets as a politically convenient method of maintaining growth without having to resort to intersectoral transfers—from, say, profits to wages. Developed world exporters like Japan and Germany also maintain a growth model based on cost competitiveness and wage suppression. An increased role for the Euro or the Yen would undercut these models. For resource exporters, it facilitates corruption and tax evasion through simple capital flows. In the United States, it benefits financial industry elites, who can reap the rewards from intermediating capital inflows into US markets, while the cost of non-tradable services like tuition, healthcare and real estate rises for everyone else. Across all countries, elites win.
The preference of global elites, and therefore global markets, for the dollar system demonstrates the futility of applying a Westphalian framework to the global financial system. Herman Mark Schwartz, one of the foremost experts on the dollar and American hegemony, offers a better way to think about the dollar—namely, as the state money of a quasi-imperial global system, in which the different economic regions are tied together by a shared reserve currency. This ‘imperial currency’ is more of a by-product, and less of an enabler of (or even an enabling constraint on) American expansionism and military adventurism, both of which preceded the reserve currency status of the dollar.
Two clear geopolitical advantages accrue to the US because of its reserve currency status: dollar liquidity swap lines, and the dreadful power of American sanctions. But the ability of the US to wield that power has been built ad hoc, over several decades, and in periods of great contingency. Recent research shows the international dollar system was not purposely designed, but rather assembled by elites who believed that international money markets must not be actively structured toward a notion of the common good, but backstopped. The system of swap networks that we associate with the 2008 financial crisis had its origins in efforts to backstop the eurodollar as early as the 1960s, and a decision by leaders that it would be better to facilitate it than to fight or restructure it. As long as domestic inequalities are not resolved at the expense of these elites, the dollar will remain hegemonic.
The source of the Federal Reserve’s power over the eurodollar system—and the vulnerability of emerging markets within it—is the global reliance on central bank backstopping. In the 2008-9 crisis, the Fed deployed so-called central bank liquidity swap lines to backstop the global system. These took the form of reciprocal currency arrangements between central banks: The Fed replenished the dollar reserves of other central banks in exchange for local currency. The real power of the swap lines is not who gets them but rather who doesn’t. In a recent piece for the Nation, Andres Arauz and David Adler highlight how these swap lines can be used for a form of monetary triage, in which the United States decides which countries have better prospects for weathering economic storms. However, the Covid-19 crisis has thrown even this into doubt. Not only has the Fed extended its swap support to a wider range of countries than in 2008 and 2009, but on March 31, 2020, it opened a repo facility with foreign international monetary authorities (FIMA). The FIMA Repo Facility allows other central banks and other monetary authorities to directly exchange their Treasury securities for dollars, thereby avoiding having to sell their Treasuries outright into an illiquid market. In doing so, the Fed created an additional source of dollar liquidity for any central bank.
Reforming the dollar system
Dedollarization seems like a distant prospect. There is no equivalent euro-denominated safe asset, for instance, and capital markets in the eurozone are not as developed as those of the US. Attempts to deepen capital markets and introduce a common debt instrument have been dealt repeated blows by EU countries belligerently opposed to financial risk sharing. The recent scuttling of the ‘coronabond’ proposal provides ample testimony on this dynamic. As long as countries like Germany and the Netherlands remain firm in their opposition to necessary financial integration in the eurozone, the currency composition of international reserves will remain heavily skewed towards the dollar. The political prospects for creating Bancor, a synthetic currency first proposed by John Maynard Keynes, are equally bleak.
Instead, we should opt for managing the current system to mitigate its harms, a process in which the United States must take a leading role. We have some proposals.
First, the United States should offer its trade counterparties direct access to the Federal Reserve balance sheet via institutionalized swap lines that are part of trade agreements. The United States should give its partners access to high quality dollar liquidity in exchange for maintaining a balanced trade policy. This tradeoff would decrease the American trade deficit, while placing upward pressure on the real wage in trade counterparties.
Secondly, as Nathan Tankus recently suggested, the Federal Reserve can extend its swap line to the International Monetary Fund (IMF). This would allow the IMF to act like a global fiscal policy maker by issuing so-called special drawing rights (SDRs). In their current form, SDRs are largely illiquid and cannot be converted into dollars or even other currencies in which emerging market debt is denominated. Providing swap line backstops to SDRs is a politically expedient way of using the institutions we already have to ensure that SDRs are actually redeemable in dollars. Tankus’ proposal has been advocated in a letter to the G20 signed by many world leaders under the leadership of former UK Prime Minister Gordon Brown.
Thirdly, the United States should begin to view its deficit not as a problem but as a public resource, and to manage it like energy exporters use sovereign wealth funds to avoid Dutch Disease. To administer this public good, the US should establish a series of public banks to fund specific economic investment initiatives. The Federal Reserve would guarantee the debt of these institutions by discounting it at a penalty rate for reserves or United States Treasury debt or dollar reserves. These securities could thus trade at a slightly higher yield than treasuries and provide investors with an alternative product to general purpose treasuries. The liabilities of these investment vehicles would provide global collateral and promote financial stability while also offsetting the effects of dollar hegemony on domestic industry via permanent, active investment.
But the right set of tools are not enough. To go beyond managing the status quo, we need to first recognize that the dollar system evolved not as a tool of imperial statecraft, but as the project of a transnational elite that has effectively usurped control of an international public good. As long as active confrontation with elite interests remains wanting, the dollar system will persist as a zero-sum game—a state of affairs that, in the long run, is unsustainable for the global political economy. And, following Herbert Stein’s quip: that which is unsustainable will not be sustained.