IGTA Journal - Winter 2020/2021

Dollar Dethroned? Why The U.S. Dollar’s Exorbitant Privilege Is Stronger Than Ever O ne of the frequent concerns we’ve heard lately is that the exchange value of the U.S. dollar is due for a major drop versus its peers, perhaps coinciding with the dollar losing its status as the world’s reserve currency. 1 While these prognostications make great fodder for ashy newspaper headlines and online clickbait, we think the reality is the complete opposite: e dollar is more important than ever, and the most recent nancial crisis proves it. Further, understanding why the dollar reigns is essential to understanding what, if anything, could displace the dollar from its prominent role. Two factors matter most: e contender must be a global destination for invested capital, and it must o er a better, safer system for saving, borrowing, lending, and settlement. In what follows, we explain. CURRENT ACCOUNT MADNESS Dollar doom prognostications are nothing new. In the mid-2000s, doomsayers predicted a ight from the dollar for the same reasons they touted in 2020: the yawning “current account de cit.” In other words, we import more than we export. e U.S. as a whole “saves too little” and spends too much. at bar tab, or “de cit,” has to be nanced somehow, they say. To make it work, the U.S. depends on the kindness of strangers to “ nance” our imports. For theatrical are, dollar bears love to chart the country’s current account “imbalance” and predict a sharp drop in the currency’s value. Putting aside the overly simplistic analogy (e.g., “running a bar tab”), the current account de cit only tells, at best, half of the story . e other half is the capital surplus . America is an unparalleled destination for global capital. Savings from around the world are invested into U.S. Treasury bonds, corporate bonds, and the equity of world-leading companies (e.g., Apple). All of that inbound capital means the U.S. can get by on lower domestic savings and higher domestic consumption, all else equal, because the U.S. is intermediating the world’s savings. e savings show up as a capital surplus, which is almost the mirror image of the current account de cit ( see Figure 1 ). Like a clever magician fooling audiences with her sleight-of-hand technique, the dollar bears never show you the other side of the equation. Observers should also note: the last time the U.S. current account de cit “improved” dramatically was between 2006 and 2008, but it is di cult to argue that Americans enjoyed better economic outcomes during that period—the country and the world were mired in a devastating recession. Far from eeing the dollar, investors clamor to get their hands on it! It’s a privilege to be the currency in demand, yes, some might say, an exorbitant privilege, 2 but a privilege hard-won by being global leaders in innovation, o ering safe and liquid nancial assets, and having a reliable legal system. Anyone arguing that the dollar is due for a beating needs to start by explaining which destination for global capital will be more attractive than the U.S. THE DOLLAR REMAINS MORE DOMINANT THAN EVER: EXHIBIT A. RESERVE HOLDINGS AND BORROWING Dollar bears may not accept it, but the dollar is a truly global currency that everyone uses—even in preference to their local currency at times. Foreign investors keep savings in dollars, and companies borrow in dollars. It makes sense: Why take on added foreign exchange risk when you can use a common currency? For example, o cial foreign exchange reserves are predominantly in dollars ( see Figure 2 on page 10 ). is picture has not changed much in 30 years, and it is always a good idea to keep a stack of dollars on hand to ensure payments can be settled. Global borrowing is also done predominantly in dollars.As a proxy for global borrowing, according to estimates from the Bank for International Settlements, non-U.S. banks held $13 trillion in U.S.-dollar-denominated liabilities at the end of 2019. While European banks have reduced their dollar liabilities (a consequence of the global nancial crisis), Chinese, Japanese, Taiwanese, Canadian, and U.K. banks have increased their dollar liabilities since 2008. EXHIBIT B. FLIGHT INTO DOLLARS e March 2020 nancial crisis is a reminder of the dollar’s vital role. As the global pandemic took hold, investors panicked and sought out, rather than ran from, U.S. dollars. For individuals, that meant keeping more cash on hand or in bank deposits. For corporations, that meant tapping credit lines and accruing bank deposits. But holding dollar-denominated assets was not enough. After all, you can’t eat Treasury -$1,000 -$800 -$600 -$400 -$200 $0 $200 $400 $600 $800 $1,000 '70 '74 '78 '82 '86 '90 '94 '98 '02 '06 '10 '14 '18 Billions of Dollars Recession Net Lending (Capital Account) Balance on Current Account fig 1. MIRROR IMAGE: CURRENT ACCOUNT VERSUS CAPITAL ACCOUNT SINCE 1970 Source: Board of Governors of the Federal Reserve, Bureau of Economic Analysis «UNDERSTANDING WHY THE DOLLAR REIGNS IS ESSENTIAL TO UNDERSTANDING WHAT, IF ANYTHING, COULD DISPLACE THE DOLLAR FROM ITS PROMINENT ROLE» 9 IGTA eJournal | Winter 2020/21 | 54