Exorbitant Privilege: The Rise and Fall of the Dollar and the Future of the International Monetary System. Barry Eichengreen. Oxford University Press 2011, pp. 215, $27.95 The Great Recession, precipitated in part by excessively low interest rates in the early 2000s, has caused more Americans to pay attention to monetary policy than they have in [...]
Exorbitant Privilege: The Rise and Fall of the Dollar and the Future of the International Monetary System. Barry Eichengreen. Oxford University Press 2011, pp. 215, $27.95
The Great Recession, precipitated in part by excessively low interest rates in the early 2000s, has caused more Americans to pay attention to monetary policy than they have in the past. Governor Rick Perry, former Speaker Newt Gingrich, and Congressman Ron Paul, to various degrees and in different ways, all made criticism of the Federal Reserve components of their presidential campaigns. Academics and policymakers have debated the necessity and wisdom of the Fed’s two quantitative easing initiatives. Unquestionably, the fiscal and monetary outlook of the United States is not nearly as rosy as it looked when President George W. Bush took office, a time when the United States was running a budget surplus.
Is the current situation in the United States so perilous, however, that we should worry about an imminent dollar crash? And if so, who would be to blame for an occurrence that would have far-reaching financial and geopolitical implications? In Exorbitant Privilege, a nuanced study of how the dollar became the international reserve currency and what the future might hold for the dollar, Barry Eichengreen concludes with his assessment, “that the only plausible scenario for a dollar crash is one in which we bring upon ourselves.” In contrast to those who contend that China can, or will, cause the dollar to crash, Eichengreen contends that the dollar’s fate is in our hands, making it “within our grasp to avoid the worst.” The United States, it would seem, is not a passive actor, merely biding its time before it is swept away by a rising China. Not yet anyway.
In this comprehensive and clearly written academic monograph, Eichengreen argues that, while the dollar is now by far “the most important currency for invoicing and settling international transactions,” this may not necessarily be the case in the future. According to Eichengreen, the dollar’s status as a reserve currency does not make as much sense now as it did fifty years ago when the United States was more economically dominant.
For much of the period since the Second World War, the United States benefitted from what former French finance minister Valery Giscard d’Estaing critically termed America’s ‘exorbitant privilege.’ The noted statesman was referring to Washington’s ability, due to the dollar’s sole status as the international currency, to run an external deficit amounting to the difference between what it must pay on its liabilities and the rate of return on the country’s foreign investments. In other words, cheap money from abroad allowed Americans to live beyond their means.
As specific examples of exorbitant privilege in action, the author cites how, in 2008, when the financial markets were in turmoil, Washington was able to borrow at low interest rates because foreign investors flocked to the dollar, believing it to be the safest currency at the time. Likewise, in 2010, when market volatility spiked, investors went for treasury bonds, lowering the cost of borrowing for the federal government and, subsequently, mortgage interest rates.
Eichengreen criticizes what he perceives to be the conventional wisdom regarding the dollar’s current status and its likely future. He contrasts the view that widespread use of a country’s currency internationally gives it geopolitical power with his belief that “it is a country’s position as a great power that results in the international status of its currency.” He also criticizes the notion that incumbency is exceedingly advantageous in the global competition for reserve currency status, citing how the dollar began to rival sterling by the mid-1920s shortly after the Federal Reserve system was established in the United States.
Most significantly, Eichengreen argues that, “the idea that the dollar is doomed to lose its international currency status is equally wrong.” Both the euro and the renminbi, he suggests, have their problems, arguing that, “the fundamental fallacy behind the notion that the dollar is in a death face with its rivals is the belief that there is room for only one international currency.” It is the author’s belief that the late twentieth-century, when the dollar reigned supreme as the world’s reserve currency, was unique by historical standards.
Eichengreen foresees the possibility of a global economy wherein countries bordering China may use the renminbi, countries close to the Eurozone utilize the euro, and countries transacting with the United States will make use of the dollar. Reserve currency status, therefore, may not be a zero-sum game. “The world for which we need to prepare,” contends Eichengreen, “is thus one in which several international currencies coexist.” The dollar may have future international competition, he suggests, but it won’t decline just yet because of external pressure from China.
In conclusion, the dollar is not about to crash tomorrow. Eichengreen is most likely correct in his contention that, “the plausible scenario for a dollar crash is not one in which confidence collapses on the whims of investors or as the result of a geopolitical dispute but rather because of problems with America’s own economic policies. The danger here is budget deficits out of control.” Sobering words indeed.
Jon Lewis (c) 2012