By Milton Ezrati
The dollar is back. After no end of death sentences issued over the years, the greenback today still stands as the world’s premier currency for trade and finance, what economists and bankers call “the global reserve currency.” And it will likely retain that status for some time to come, for even considering this country’s economic and financial problems, the dollar still has more of the necessary of the attributes than any alternative.
Much has changed, of course, since the days when the dollar first rose to global reserve status in the 1940s and 1950s. Then, the United States had overwhelming dominance on every front. The Second World War had devastated almost every other economy in the world. Financial arrangements overseas were a shambles. Governments across Europe and in Japan looked anything but stable or reliable. By comparison, the U.S. economy was at the peak of its relative strength, accounting at times for half the world’s total production and half the world’s trade flows. Every major business, wherever it was located in the world, had to deal in dollars and hold them. Washington’s public finances were strong, which, along with the country’s relative political stability, made a convincing case that the greenback offered stable purchasing power over time. America’s adherence to the rule of law further promised to protect all, including foreign holders, from threats of expropriation or arbitrary taxation, while the power and scope of America’s diplomacy and military assured all that the county could protect its and the currency’s interests. Further enhancing the dollar’s appeal as a global reserve, the U.S. financial markets, the largest and most active in the world, gave all who held dollars a wide array of investment options and the ability to trade into it and out of it at almost a moment’s notice.
Recent decades have, of course, seen a marked erosion of this absolute American dominance. Europe and Japan, have long since recovered, gaining relatively on the United States. Emerging economies, most notably China and India, have made remarkable gains in recent decades. Now China and the euro-zone each stand as economic peers to the United States in both the size of their economies and the reach of their trade. Europe and the United Kingdom have developed financial markets of comparable size and dynamism to those of the United States. Due to increasing wealth and years of relative stability, these other countries have created more reliable political institutions than once existed. Against these gains, the United States faces increasing problems. The growth pace of its economy has slowed. The country’s political institutions seem to have lost effectiveness. Government finances have deteriorated, raising questions about whether the currency can maintain its purchasing power over the longer term. Matters have gone so far that in 2011 the Standard and Poor’s rating service downgraded Washington’s credit quality. As if to underscore this relative decline in the dollar’s base, other countries, most notably China, have begun to reject the greenback’s use in aspects of their trade, creating substitutes of either their own currencies or baskets of currencies. It is on these bases that periodic forecasts of the dollar’s demise have rested.
But for all this, the dollar has retained its status. It remains by far the world’s most traded currency. Some 87 percent of all trades on foreign exchange markets involve dollars. Almost 90 percent of the world’s trade contracts are written in dollars, whether an American is involved or not. The remaining 10 percent are divided over a number of other currencies. No single one stands out. For all the headlines about China pushing its currency forward as a trading vehicle, barely 1.5 percent of the world’s trade contracts are written in yuan, and then only when a Chinese national is involved. The International Monetary Fund reports that the dollar still equals some 62 percent of all international reserves held by the world’s central banks, far more than any other currency.
This remarkable staying power is hardly a tribute to American economic or financial management, strength, or health. Nor does it detract from the gains made by other countries. Rather it stems simply from the recognition that, despite America’s relative decline and the relative gains of others, no other currency has anywhere near the credentials necessary for the role. China’s economy, for instance, may have comparable size and scope to the U.S. economy, but the country lacks either the rule of law or the diplomatic and military reach of the United States. Outside Asia, in fact, Chinese diplomacy revolves exclusively around commerce. China also lacks the active and diverse financial markets needed to support a global reserve currency. Indeed, China’s financial markets are not even entirely open to foreigners. The United Kingdom and the euro-zone can boast the rule of law and more than adequate financial markets, but the UK’s economy and the scope of its trade are too small for the job, while Europe’s ongoing fiscal-financial crises leaves doubts about whether the euro has a future and, if so, what character it will have.
Someday, no doubt, a currency will rival the dollar and perhaps in time replace it as the world’s reserve. For now, however, no such alternative exists or likely will for quite some time. America has many economic and financial problems and is no longer the hegemon it once was, but when it comes to the global reserve, the verdict may come down to the old, if somewhat cruel saying: in the land of the blind, the one-eyed man is king.
MILTON EZRATI is the author of Thirty Tomorrows: The Next Three Decades of Globalization, Demographics and How We Livehas spent over forty years in the finance sector. Ezrati has extensive media experience through his position as senior economist, market strategist, and partner at Lord Abbett and Co., a money-management firm that handles approximately $132.6 billion in assets. He is an affiliate of the Center for the Study of Human Capital and Economic Growth at the State University of New York at Buffalo. A New York native, he has worked at Citibank, Chase, Lionel D. Edie & Co, and Nomura Capital Management.