JEFFREY FRANKEL
CAMBRIDGE – The language of international monetary policy has turned militaristic. The phrase “currency war” has now been popular for a decade, and the United States government’s more recent “weaponization” of the dollar is generating controversy. But ironically, a martial approach could end up threatening the US currency’s global dominance.
This is a good time to gauge the relative strengths of the dollar and rival international currencies (meaning currencies that are used outside their home countries). In September, the Bank for International Settlements released its triennial survey of turnover in global foreign-exchange markets. The International Monetary Fund’s statistics on central-bank holdings of foreign-exchange reserves have become much more reliable since China began reporting its holdings. And the SWIFT payments system issues monthly data on the use of major currencies in international transactions.
The bottom line is that the US dollar remains in first place by a wide margin, followed by the euro, the yen, and the pound sterling. Some 47% of global payments currently are in dollars, compared to 31% in euros. Furthermore, 88% of foreign-exchange trading involves the dollar, almost three times the euro’s share (32%). And central banks hold 62% of their reserves in dollars, compared to just 20% in euros. The dollar also dominates on other measures of currency use in trade and finance.
As for China, the renminbi is still in eighth place in terms of foreign-exchange market turnover. But it rose in August to fifth place in SWIFT payments, and, after leapfrogging the Canadian and Australian dollars, ranks fifth in central banks’ foreign-exchange reserves.
Predictions early in this decade that the renminbi might challenge the dollar for the number one spot by 2020 clearly will not be borne out. True, China’s currency fulfills two of the three necessary conditions to be a leading international currency, namely economic size and the ability to keep its value. But it still has not met the third: deep, open, and liquid financial markets.
Although the dollar’s share of foreign-exchange reserves and trading has trended downward, particularly since the turn of the century, the decline has been slow and gradual. Moreover, the euro’s share of reserves has fallen more rapidly (since 2007) than that of the dollar. Despite years of US fiscal and current-account deficits, and the country’s rising debt-to-GDP ratio, the dollar remains ensconced as the number one global currency – presumably owing to the lack of a good alternative.
Descriptions of exchange-rate policies have become increasingly extreme. If we took the three militaristic terms in vogue at face value, we might infer that a country with sufficient financial power first weaponizes its own currency, and then launches a speculative attack against that of a rival. If that elicits retaliation, a currency war has broken out.
However, such an interpretation would be nonsense, because these three military terms are inconsistent with each other in a currency context. To see why, let’s consider them in reverse order: first currency wars, then attacks, and weaponization last.
When Brazilian government ministers popularized the phrase “currency war” in 2010-2011, they were accusing the US and other countries of pursuing competitive depreciation. G7 finance ministers and central-bank governors subsequently pledged in 2013 not to target exchange rates, which was understood to include officials either “talking down their currencies” or pursuing monetary stimulus in a deliberate or explicit effort to depreciate them.
The one major country to have violated this 2013 agreement is not China, but the US. President Donald Trump has repeatedly engaged in “verbal intervention” to talk down the dollar. More worryingly, he has crudely pressured the US Federal Reserve to lower interest rates with the explicit objective of depreciating the currency.
By contrast, international relations specialists typically associate the exercise of geopolitical power with a strong currency. This is why some highlight the danger that China could “attack” America by dumping its vast stockpile of US treasury securities, thereby driving down the dollar and driving up the US government’s borrowing costs. That would work to appreciate the renminbi and thus would be the opposite of competitive depreciation.
More broadly, when a country runs chronic budget and current-account deficits, it undermines its geopolitical power – as the United Kingdom showed in the course of the twentieth century. The US inherited the UK’s “exorbitant privilege”: it can finance its deficits easily because other countries want to hold the world’s leading international currency.
Finally, the “weaponization” of the dollar generally refers to the US government’s exploitation of the currency’s global dominance in order to extend the extraterritorial reach of US law and policy. The most salient example is the Trump administration’s enforcement of economic sanctions against Iran in an attempt to shut the country out of the international banking system, and in particular SWIFT.
Even before Iran agreed to halt its nuclear weapons program under the 2015 nuclear deal, Europeans occasionally grumbled about US extraterritoriality, suspecting that the US might be quicker to impose large penalties on European banks than on their American peers for violating sanctions. But, because Trump abrogated a treaty that Iran was not violating, enforcing US sanctions via SWIFT is a real abuse of the exorbitant privilege. Arguably, it can no longer be justified in the name of a global public good.
Faced with US sanctions, Russia shifted its reserves out of dollars in 2018 and is selling its oil in non-dollar currencies. Likewise, Europe or China may succeed in developing alternative payment mechanisms that would allow Iran to sell some of its oil. That might in turn undermine the dollar’s role in the long run.
More generally, US foreign policy under Trump continues to run counter to America’s traditional post-war objectives. The prospect might seem a distant one, but should the US carelessly relinquish leadership of the global multilateral order, the dollar might eventually lose its own long-standing primacy.
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