The Dollar: Privilege or Burden?
2025 04 28
For a serious paper by a renowned scholar and international civil servant Maurice Obstfeld[1] presents a gaseous and un-analytic discussion[2] in “King Dollar’s Shaky Crown”. To start with Obstfeld fails to define what he is talking about. Instead. we get a series of titles and descriptions of the dollar:
“Primacy of the US dollar.”
“Global primacy”
“Dollar supremacy”
“The system’s anchor”
“World’s leading reserve currency”
“Global hegemony”
“Centrality of its banking system”
“Dollar dominance”
“Reliable medium of exchange
“Safe asset”
“Leading position”
“Dollar’s throne”
“Global status”
“Only true international currency”
Sifting carefully, however, we can find four inter-related roles for the dollar:
a) As a reserve currency, the currency in which non-US central banks hold liquid assets which they can use to manipulate their exchange rates. [Earlier, in Bretton Woods days these would have been the assets used to hold exchange rates fairly fixed against the Dollar]
b) As the currency in which most international transactions are conducted. “According to the Bank for International Settlements’ latest triennial survey, over-the-counter foreign-exchange turnover reached $7.5 trillion per day in April 2022, with the US dollar on one side of 88% of all trades.”
c) As the currency of US “deep and open financial markets, openness to trade, a strong commitment to the rule of law, an efficient court system that protects even foreign creditors’ rights, a track record of price stability, and a robust supply of relatively safe benchmark assets” that permits US institutions to manage international payments.
d) An attractive asset held by foreigners for purely pecuniary and portfolio diversification reasons.
Obstfeld clearly sees the role of the dollar as beneficial to the internatinal system as well as to the US, but in view of other opinions -- both that it is an “exorbitant privilege” and an intolerable burden – Obstfeld spend little effort in supporting his view.
A Privilege?
Why could becoming the reserve currency be an exoprotein privilege? Let's start a group of countries trading with and investing in other countries. Now the International Economics Fairy comes and designates the currency of one of those countries as the "reserve" currency, the currency that other countries hold to manage their exchange rates (assuming they “manage” exchange rates). This would, ceteris paribus, lead to a capital inflow into the designated country, a fall in real interest rate in the designated country, an increase in investment and the reverse in the other countries. If the return on the additional investment in the reserve country is greater than the yield paid on the infusing capital, the reserve county benefits from holding the reserves. Exorbitant privilege? Choose your adjective.
I suspect the feeling of privilege first arose in the Bretton Woods era in which countries agreed to maintain fixed exchange rates with respect to each other by keeping exchange rates fixed against the dollar. But this meant curtailment of monetary sovereignty, the ability to choose and adjust interest and inflation rates to maximize each country’s real income growth or other objectives.[3] The Fed in effect became the world’s central bank but with policy chosen only to maximize US real income. But note that THIS part of the privilege is a burden to exchange rate fixing countries without being an addional advantage for the US and it disappears with the demise of Bretton Woods.[4]
Partly as a result of Bretton Woods (but only partly) the US dollar became the currency of international trade and investment and this put US institutions in the position of having a near monopoly in the management of international payments. It is a lucrative service export industry, but interinstitutional competition prevented to much exploitation of the monopoly. The US Government, however, was not so constrained. “Blustein devotes several chapters to an illuminating account of how the US has leveraged the dollar’s global hegemony and the centrality of its banking system to impose crippling extraterritorial sanctions.”
Together these contribute to the US financial system functioning as an international term transformation and risk intermediary. US institutions receive inflows seeking safe, liquid assets which can be turned into higher yielding direct investment.
A Burden?
So how could these advantages, these “privileges,” become a burden? As capital flows in to the “reserve” country, the exchange rate will appreciate, meaning that the relative prices of tradable goods and services (exports and substitutes for imports) will fall relative to non-tradable goods and services. CEA Chairman Miran has said,
"The dollar's status as the world’s reserve currency leads to chronic overvaluation. This overvaluation makes U.S. exports more expensive and imports cheaper, eroding the competitiveness of American manufacturing and contributing to trade (and current account) deficits." “[the dollar’s global role] has placed undue burdens on our firms and workers,” making American goods and labor uncompetitive on the global stage and forcing a decline of our manufacturing workforce by over a third since its peak.”
If this is the substance of Miran's complaint he is only half right. His analysis applies to net capital inflow. There is nothing about the dollar’s role in the world economy that prevents the US from being a net capital exporting/trade surplus economy. One only wonders why even the net capital inflow result is something to be complained about.
One could imagine that tradable goods and services production has some positive externality (R&D investments whose benefit spill over to other firms?), a value to the rest of society that is not captured by the producers. If this were the case, the first best policy would already have grated the positive externality activity a subsidy reflecting the difference between its private and social value. Even if the subsidy cannot be directed at activity, it could still be given at the firm or industry level. The capital inflow would not negate the benefit of subsidizing positive externalities.[5]
Another possibility is that the marginal return on the additional investment generated is less than the return paid to owners of the inflowing capital. I for one cannot think of how this would come about. Maybe Miran has an insight about how this happens that he has not shared.
Now if the causation were the reverse, a policy of reducing savings and increasing consumption, say by reducing taxes and increasing the fiscal deficit — a policy prescription that Republicans (Reagan, GWB, Trump 2017 and Trump 2025) have often favored — then the negative consequences of the induced capital inflow would be realized. This only goes to show, however. that one cannot judge the net benefit of an economic event (price change or flow of funds) in isolation without knowing what caused the event.
Be all of this as it may, if Miran considers the net inflow of capital to be a problem, the solution would be to increase savings (say by raising taxes and reducing the fiscal deficit) drive down the interest rate somewhat discourage the capital inflow and promote capital outflow.
Having the world's reserve currency or key transaction currency or providing safe harbor for internatinal investors is not synonymous with _net_ capital inflows.
Image Prompt: A muscular US dollar preening before other currency symbols
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[Standard bleg: Although my style is know-it-all-ism, I am aware that I could be mistaken or overstate my points. I would, therefore, welcome comments on these views.]
[1] Former chief economist of the International Monetary Fund, Senior Fellow at the Peterson Institute for International Economics, and Professor of Economics Emeritus at the University of California, Berkeley
[2] Obstfeld is reviewing Paul Blustein’s King Dollar and Kenneth Rogoff’s Our Dollar, Your Problem , but the review is sympathetic and I will not try to distinguish Obstfeld’s views from those of Blustein and Rogoff.
[3] A “small” economy loses little by giving up monetary sovereignty but it was a problem faced by some members of the Eurozone in the Euro crisis of 2010.]
[4] At the demise of Bretton Woods Secretary of the Treasury John Connally famously told his G10 counterparts, “The dollar is our currency, but it’s your problem.” Not exactly. The only problem was the desire to have fixed exchange rates between major currency systems. Otherwise, it’s “our currency and nobody’s problem.
[5] Specifically, about using import restrictions to stimulate manufacturing, “Miran expected the currency to rise… which he argued would have the effect of putting the burden on to the tariffed country...”
Expecting the currency to rise is the standard assumed result of increasing import restriction. The rise would not have the effect of putting any of the cost on the tariffed country. Tariffs do of course harm the tariffed country not just the country imposing then; trade, after all, is mutually beneficial. But the appreciating currency of the tariffing country is not the mechanism by whihc the tariffed country is harmed.