Today, we present a guest post written by Jeffrey Frankel, Harpel Professor at Harvard’s Kennedy School of Government, and formerly a member of the White House Council of Economic Advisers. A shorter version appeared in Project Syndicate.
This is a good time to gauge the rankings of the dollar and its rivals as major international currencies. The Bank for International Settlements came out in September with its triennial survey of turnover in the world’s foreign exchange markets. The IMF’s statistics on central bank holdings of foreign exchange reserves have gotten much more reliable lately, because China has joined in on reporting its holdings to the IMF (as Eswar Prasad explains). And SWIFT offers every month its numbers on use of major currencies in international payments.
The results? The bottom line is that the US dollar remains in first place by a wide margin, followed by the euro, the yen, and pound sterling. In September 2019, 47% of payments were in dollars, far ahead of the euro’s share [31%; SWIFT]. In April, 88% of foreign exchange trading involved the dollar, more than double the share of the euro [32%; BIS]. In the second quarter of this year, 62% of reserve holdings were in dollars, more than triple the share in euros [20%; IMF]. The dollar easily dominates other measures of use in trade and finance as well.
After the top four currencies, the ranking depends what measure one uses. The vaunted RMB is still only in 8th place in terms of foreign exchange market turnover. But it has recently passed the Swiss franc to attain the #7 spot judged by SWIFT payments, and has also passed the Canadian and Australian dollars to attain the #5 position when judged in terms of central banks’ holdings of foreign exchange reserves.
Predictions of 8 years ago that the RMB might challenge the dollar for the number one spot by 2020 have not been borne out. Although China’s currency has two of the three necessary conditions to be a leading international currency — economic size and the ability to keep its value — it still lacks the third: deep, liquid, open financial markets.
It is possible to discern a downward trend in the dollar’s share, particularly since the beginning of this century. But it is a slow gradual trend. The 62 % of reserve holdings that are in dollars is down from almost 70% in 2001. The 88% of fx trading in dollars is down from 90% in 2001.
The euro’s share as a reserve currency has been declining more rapidly (since 2007) than the dollar’s share. Who is rising? The yen and a smattering of smaller currencies (and also gold).
Despite years of US fiscal and current account deficits and a current path of rising debt/GDP ratios, the dollar remains ensconced as #1 currency. Presumably the reason is the lack of a good alternative.
The language of international monetary policy has turned militaristic. The phrase “currency war” has been popular since 2010 and more recently we hear of “weaponization” of the dollar. If readers took such language at face value, they might infer that a country with sufficient financial power first weaponizes its currency [perhaps by accumulating a war chest of international reserves], and then launches a speculative attack against a rival’s currency; if others do the same in retaliation, that is a currency war.
This would be nonsense. One can make a serviceable metaphor out of each of the three militarist terms, but they are inconsistent with each other. Let’s take currency wars first, then attacks, then weaponization.
When Brazilian leaders popularized the phrase currency war in 2010-11, it was to accuse the US and other countries of pursuing competitive depreciation. Major governments subsequently agreed to refrain from competitive depreciation or currency manipulation to seek competitive advantage. They committed to refrain from targeting exchange rates [G7, Feb. 2013], which was understood to include:
i) the narrow sense of intervening to push down the foreign exchange values of their currencies; but also
ii) officials either “talking down their currencies” or
iii) pursuing monetary stimulus in deliberate or explicit efforts to depreciate their currencies.
No major country has violated this 2013 agreement… with one exception. That exception is not China (which since 2015 has intervened in the direction opposite to depreciation, to keep its currency up); it is the United States. Donald Trump has repeatedly engaged in “verbal intervention” to talk down the dollar (unsuccessfully). More worryingly, he has crudely pressured the Fed to lower interest rates with the explicit objective of depreciating the dollar.
Typically, analysts of international relations associate the exercise of geopolitical power with a strong currency, not a weak one as in the currency war logic. Sometimes the militaristic language is used to describe the danger that China will dump its vast stockpile of US treasury securities, which could drive down the dollar and drive up the interest rates that the US treasury has to pay.
Again, this is the opposite of competitive depreciation. When a strategic rival like China sells dollars, it does not depreciate its own currency. If anything, it appreciates it.
More broadly when a country habitually runs large budget deficits ($1 trillion for the US now, even with unemployment at 3 ½ %) and when this translates into big current account deficits (the famous twin deficits), it runs the risk of eventually losing geopolitical power. Exhibit “A” is the experience of the UK in the course of the 20th century.
The US of course inherited the “exorbitant privilege” from Britain. Exorbitant privilege is defined as an ease of financing deficits because other countries want to hold the world’s number one international currency. Despite decades of current account deficits, the dollar’s role as by far the leading international currency continues, as already documented by the statistics on international use of the major currencies.
The most dramatic illustration of the dollar’s special status occurs every time international financial markets swing into “risk off” mode: the response is a safe-haven flight into dollars, and this happens even when the impetus for the increase in perceived risk is some serious stumble in the US itself (such as the 2008 global financial crisis or Trump’s trade war).
The weaponization of the dollar generally refers to exploitation by the US government of the dollar’s role as #1 international currency to extend the reach of US law and policy extra-territorially. The most salient example is US enforcement of economic sanctions against Iran. The US is shutting Iran out of the international banking system, in particular the SWIFT payments system.
Even before Iran agreed to halt its nuclear weapons program, there was occasional grumbling in Europe about extraterritoriality, some suspicion that the US might be quicker to impose large penalties on European banks for violating sanctions than on US banks. But since President Trump abrogated a treaty that Iran was abiding by, enforcing the sanctions via SWIFT does seem an abuse of the exorbitant privilege, an exercise in US hegemony that can no longer be justified as conducting the international orchestra (in Kindleberger’s phrase) in the name of a global public good.
Russia has made some progress switching out of dollars, a defensive move against US sanctions. It shifted its reserves out of dollars in 2018 [into euros and RMB] and is selling its oil in non-dollar currencies [roubles or euros].
The significance of Russia’s move away from the dollar is relatively small. But I still find it hard to believe that Europe or China will not succeed in efforts to develop alternative payments mechanisms to allow Iran to sell some of its oil. This might undermine the dollar’s role in the long run.
American foreign policy has lately run counter to its traditional post-war objectives. The Administration has undermined important institutions, both domestically and abroad. As it carelessly gives up leadership of the global multilateral order, eventually the US might yet lose the primacy of the dollar as well.
This post written by Jeffrey Frankel.