Will this time be any different for international dominance of the US dollar?
Recent Economist magazine article “Change for the dollar” published on August 8, 2020, muses on the ability of the US dollar to continue its dominance as the international reserve currency for long term. While it raises concerns, it concludes on the optimistic note that American led reconstruction of the global trade could ensure continued long term dollar dominance. I would like to believe in this optimism of American-led reconstruction of global trade, but it is difficult to believe that it will necessarily only be with continued dominance of US dollars for years to come.
The US, Europe and China have roughly similar percentage shares of world trade volume. But according to the Wikipedia ‘most traded currencies’ article, US dollars are bought or sold 44% of the time in the forex trading market, the largest financial market in the world. US dollar benefits from the network effect similar to the way internet technology services firms are benefited. This network effect exists because disparate trading agencies trust the currency for international trade (transaction use) and foreign reserves (storage use), in lieu of outright dominance in the share of world trade. This trust is derived from the observance of the rule of law in domestic and international affairs, in respect for the world trading system, in commitments to neoclassical macroeconomic policies and principles with prudence and in ability and willingness to exercise muscular power for that cause, if necessary.
However, with declining trust from erosion of these underlying attributes over the years, the causal argument on dollar dominance has now changed. Euro and Yuan are the two closest candidates for competition based on world shares of trade and GDP. However, general prevalent consensus rightly is that these currencies do not really threaten dollar dominance. That is because these currencies do poorly on the international trust scale than the dollar, with even lower levels of underlying necessary building blocks for trust.
Still I find it rather disconcerting that the prior positivist causal argument for dollar dominance is now replaced with the relativist one. Should one conclude that the dollar dominance is guaranteed just by looking at its current competition? Just like the internet tech services firms know very well, the threat to dominance in network economy may not necessarily always come from direct competition. It may also come from innovation through seemingly unrelated sources.
Is it possible that countries come together just to devise an ideal currency that is used only for international trade purposes while individual countries continue to retain domestic fiscal and monetary policy freedom through floating exchange rate? Such a currency could adhere to Milton Friedman’s quantity theory of money. That is, the currency supply would strictly be mechanically governed based on the need for smooth functioning of the international trading system. With this limited purpose, trading currency money supply does not need to be concerned about other issues in domestic economies like employment or price levels. Individual countries or private agencies should find it hard to manipulate the currency for their own benefit at the expense of other trading partners.
This foreign trading currency is not a case for common global currency that replaces individual country currencies. Certainly common global currency has its primary advantage in reducing transaction costs related to exchange rate fluctuations. Common trade currency does not eliminate those costs, though with zero interest rate and no fluctuations in the trading currency as in Friedman’s theory to be accounted for, such costs would purely be one sided and therefore possibly be low. The experience of Euro has shown that one size fits all straight jacket policy of common currency replacing individual country currencies has challenges of its own.
More closer analogy to such a common trading currency is that of the IMF’s SDR or Special Drawing Rights, though they are not identical. The differential is that the former relies simply on trade volume while the latter is based on the basket of top 5 exporter currencies with their weights determined by some political compromise with historical continuity in a 5 years interval.
(Ironically, as the Guardian News article from March 2009 stated, China had requested the IMF to expand the use of SDR as the reserve currency in 2009. Telegraph article at the time further stated that Tim Geithner, then US Treasury Secretary was initially warm to the idea but rejected it later. The above mentioned recent Economist article does not mention this episode. Now China is intent on replacing dollar dominance with Chinese Yuan as the dominant currency.)
There are certainly advantages for common trading currency. US percentage share of world trade is in slow decline. Importantly, after taking into account the world shares of US, Europe and China, there is a growing fat tail of share of many new emerging economies and developed countries. As the ex chief economist of the World Bank Kaushik Basu points out, emerging economies find it difficult to manage their own economies in the unintended consequences of waves of Quantitative Easing (QE) and Quantitative Tapering (QT), both episodes meant for managing domestic US economy. Certainly the US receives overall net benefits from the current dollar dominance. But if this dominance is being weakened by challenges, it may find a common trading currency a better option to fractured international trading environments, in a game theoretic setting. In other words, I share optimism of America’s leadership in reconstruction of global trade in rule based settings with the Economist article, but not necessarily in the same form.
I also see other political benefits in such a scenario. Countries are drifting away from international law and order, not just in trade issues but also in other global issues such as climate change and pandemics. Cooperation with the common trading currency could also help rebuild trust needed in addressing these other issues.
I do not pretend to possess in depth academic or professional knowledge and experience in international trade or monetary regimes and in political economics. I am sure that academicians and practicing professionals will find laughable absurdity and impracticability in my raw and incomplete thinking. They probably have already debated trading currency issues at length in academic journal papers and policy think tanks. The purpose for my blog therefore is primarily to seek out this knowledge in easily understandable form so a wider common man audience could benefit from it. It is therefore worth exposing my ignorance.
