The dollar in decline? Not so fast.
Paul Krugman (NYT)
The dollar is about to become “toilet paper,” says Robert Kyosaki, author of “Rich Dad, Poor Dad.” “Get rid of your U.S. dollars now,” says the investor and economic commentator Peter Schiff. They aren’t alone: I’m seeing a lot of stuff like this in my inbox lately.
Now, some of this is coming from “Weimarists,” people who are always predicting hyperinflation. Schiff, for example, insisted back in 2009 that the Obama administration’s policies would cause runaway inflation. (For the record, they didn’t.) Still, as it says on investment prospectuses, past performance is no guarantee of future results: People who have been consistently wrong in the past could be right in the future.
And today’s Weimarists have a new argument. Recently a number of countries, alarmed or maybe just annoyed by what they perceive as the weaponization of the dollar against Vladimir Putin, have been taking at least symbolic steps to reduce the dollar’s role in the world economy. For example, China has asked oil producers to accept payments in yuan instead of dollars.
This has even relatively sober commentators like Fareed Zakaria warning that the dollar’s status as the world’s reserve currency is at risk. And losing reserve-currency status, many people imagine, would be an economic catastrophe for America.
Put aside for the moment the question of whether dollar dominance is really at risk. (Short answer: no. But I’ll get to that.) Let’s ask instead whether losing reserve currency status would really be a disaster.
So let me start with what should be an obvious point: Most of the world’s currencies aren’t widely used outside their issuing nations. Yet many of these non-international currencies do just fine at home, continuing to serve the traditional roles of money: medium of exchange, store of value, unit of account.
For example, the Canadian dollar, the Australian dollar, the New Zealand dollar and the Swedish krona have never been reserve currencies. A few decades ago Japanese officials had ambitions of turning the yen into a global currency, but that never went anywhere. Yet Australians, Swedes and Japanese continue to do domestic business in their own currencies, with nary a hyperinflation in sight.
The British pound is an even more interesting example, because once upon a time it was an international currency, and one as dominant as the dollar later became. When Phileas Fogg set off to go “Around the World in Eighty Days,” he traveled with a carpet bag full of pound notes, because he knew that British currency would be accepted anywhere.
But the pound’s international role rapidly declined after World War II, essentially disappearing by 1970. Here’s a chart from Barry Eichengreen, Livia Chitu and Arnaud Mehl:...
Now, that’s what you call reserve currency collapse. Strange to say, however, Britain’s economy still runs on pounds. The pound sterling’s demise as an international currency didn’t even prevent London from, if anything, strengthening its role as a global financial hub.
The great economist and historian Charles Kindleberger once wrote an illuminating essay comparing the international role of currencies with the international role of languages. These days, English is the global language of commerce, science and much popular culture: Everyone doing global stuff speaks English, because everyone else speaks English, just as everyone uses dollars because everyone else uses dollars. One can, however, imagine that changing; maybe someday people doing global stuff will need to speak Mandarin instead. (That’s actually a bit easier than imagining the yuan replacing the dollar; I’ll get there.) But we’d still speak English at home, just as Swedes still speak Swedish, the French still speak French, and so on.
Actually, French has experienced something like the linguistic equivalent of sterling’s international decline. It was once the premier language of diplomacy and much international culture. That’s all gone now — which has, one must admit, damaged national pride. But France still speaks French.
Still, how would the transition work? Foreigners probably hold more than a trillion dollars in U.S. currency, mainly in the form of $100 bills. What would happen if all the foreign holders tried to cash in all of that money?
The answer is that the Federal Reserve would pay them off, withdrawing the currency from circulation, something it could easily afford to do by selling off some of its $5 trillion holdings of Treasury debt or $2.5 trillion in mortgage-backed securities. If you imagine that vast foreign holdings of dollars are the only thing sustaining our currency, let alone our economy, you just haven’t done the math.
In sum, there’s no reason to be terrified of the consequences if the dollar should lose its special international status. But that said, it’s really hard to see that happening in the first place.
It’s true that with the rise of China there are now two bona fide economic superpowers. (There would be three if the euro area were less fragmented.) So it may seem plausible that the yuan could pose a challenge to the dollar.
But the dollar has three big advantages. One is incumbency: Since everyone is already using dollars, it would take exceptional circumstances to get them to switch. A second is that U.S. financial markets are open: Unlike China, we don’t impose controls on people trying to move money into or out of the country. The third is the rule of law. Unless you’re a dictator planning to commit major war crimes, you needn’t fear that the U.S. government will impound your assets; in China, your assets may be at risk if you say something the strongman in charge doesn’t like.
Why, then, all the panicky commentary about the dollar? Well, I studied with Charles Kindleberger, and one of the things he told his students was that “anyone who spends too much time thinking about international money tends to go mad.” The global role of the dollar sounds important and seems mysterious; that makes it a natural subject for conspiracy theories and catastrophic thinking.
In reality, however, the dollar’s role looks pretty secure — with one major caveat. I have no idea what will happen if, as seems all too possible, we end up defaulting on debt payments because a Republican House refuses to raise the debt ceiling. But it’s not likely to be good. Who will trust the currency of a nation that appears to have politically lost its mind?
But if that happens, the threat to the dollar’s reserve-currency status will be the least of our problems.
