Back in 1965, Valéry Giscard d’Estaing, then France’s Minister of Finance, famously called the benefits that the United States reaped from the dollar’s role as the world’s main reserve currency an “exorbitant privilege.” The benefits are diminishing with the rise of the euro and China’s renminbi as competing reserve currencies. And now US President Donald Trump’s misguided trade wars and anti-Iran sanctions will accelerate the move away from the dollar.
The dollar leads all other currencies in supplying the functions of money for international transactions. It is the most important unit of account (or unit of invoicing) for international trade. It is the main medium of exchange for settling international transactions. It is the principal store of value for the world’s central banks. The Federal Reserve acts as the world’s lender of last resort, as in the 2008 financial panic, though we should recognize too that the Fed’s blunders helped to provoke the 2008 crisis. And the dollar is the key funding currency, being the major denomination for overseas borrowing by businesses and governments.
In each of these areas, the dollar punches far above America’s weight in the world economy. The US currently produces around 22% of world output measured at market prices, and around 15% in purchasing-power-parity terms. Yet the dollar accounts for half or more of cross-border invoicing, reserves, settlements, liquidity, and funding. The euro is the dollar’s main competitor, with the renminbi coming in a distant third.
The US gains three important economic benefits from the dollar’s key currency role. The first is the ability to borrow abroad in dollars. When a government borrows in a foreign currency, it can go bankrupt; that is not the case when it borrows in its own currency. More generally, the dollar’s international role enables the US Treasury to borrow with greater liquidity and lower interest rates than it otherwise could.
A second advantage lies the business of banking: The US, and more precisely Wall Street, reaps significant income from selling banking services to the rest of the world. A third advantage lies in regulatory control: The US either directly manages or co-manages the world’s most important settlements systems, giving it an important way to monitor and limit the flow of funds related to terrorism, narco-trafficking, illegal weapons sales, tax evasion, and other illicit activities.
Yet these benefits depend on the US providing high-quality monetary services to the world. The dollar is widely used because it has been the most convenient, lowest-cost, and safest unit of account, medium of exchange, and store of value. But it is not irreplaceable. America’s monetary stewardship has stumbled badly over the years, and Trump’s misrule could hasten the end of the dollar’s predominance.