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T
HE global economic crisis hasagain raised the question o theuture o reserve currencies. Fornearly a century, the U.S. dollarhas reigned supreme as the world’s top in-ternational money. In recent decades, how-ever, condence in the greenback has beenundermined by the United States’ persistentcurrent account decits and growing oreigndebt. Increasingly, observers have predictedan end to the dollar’s dominance. For many,the dollar’s ate seemed sealed ollowing thecollapse o the U.S. housing market in mid-2007, which triggered the greatest upheavalin U.S. nancial markets since the GreatDepression.As it turned out, the crisis proved to beanything but atal or the dollar. Not even thetroubles o the U.S. inancial sector, whichrequired massive government interventions,suiced to tip preerences decisively. Instead,ironically, the crisis temporarily reinorced thegreenback’s global standing, as investors ledto the dollar or saety. Late last year, globaldemand or U.S. treasury bills was so intensethat yields ell to zero or below. Nonetheless,the dollar’s uture continues to be hotly debated (Helleiner and Kirshner, 2009). Overthe longer term, it is widely held, the declineo the greenback will undoubtedly resume,ending the currency’s reign once and or all.But that begs a critical question: Whatwould replace the dollar? Some say it will bethe euro; others, perhaps the Japanese yen orChina’s renminbi. And some call or a newworld reserve currency, possibly based on theIMF’s Special Drawing Right or SDR, a reserveasset. None o these candidates, however, iswithout laws. In act there is no obvious alter-native to the dollar lurking in the wings, justwaiting to take center stage. To paraphraseWinston Churchill’s amous remark aboutdemocracy, the dollar may turn out to be theworst choice—except or all the others.The most probable outcome is apt to bemore ambiguous—more like the interreg-num between the two World Wars, whenBritain’s pound sterling was in decline andthe dollar on the rise but neither was domi-nant. Coming years, I submit, will see theemergence o something similar, with severalmonies in contention and none as clearly inthe lead as in the recent past. The economicand political impacts o a more ragmentedcurrency system could be considerable.
When eonomi nd politiinteet
In the absence o a world currency backed by an eective global government, oreign tradeand investment must rely on acceptable na-tional currencies to play international roles.A disconnect thereore exists between the ju-risdictions that are the source o internationalmonies and the domains o the markets inwhich they operate, which introduces a po-litical dimension that is oten overlooked inpurely economic analyses.The conventional ramework or the study o international currencies separates out thethree standard unctions o money—mediumo exchange, unit o account, and store o value—at two levels o analysis: the privatemarket and government policy. In markets,an international currency plays a role in or-eign exchange trading, trade invoicing, andinancial investments. For governments, theunctions o international money are as anexchange rate anchor and as a reserve cur-rency. At the market level, economic consid-erations typically dominate in determiningpreerences. At the government level, the addi-tional ingredient o politics is unavoidable.Politics enters because an international cur-rency oers unique advantages or the nationthat issues it—political as well as economic.Economists naturally tend to ocus on the eco-nomic beneits involved, such as internationalseigniorage—the gain o real resources thatresults when a country’s currency is acquiredand held abroad. Economic beneits alsoinclude the increased lexibility o macroeco-nomic policy that is aorded by the ability toinance deicits in one’s own currency—what
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September 2009
Fo nely enty, theu.s. dollh eignedpeme, bte thoedy ove?
Benjamin J. Cohen
The
 
Fte
 
of 
 
reeve cenie
 
Charles de Gaulle had in mind back in the 1960s when hecomplained about America’s “exorbitant privilege.” But thereare political beneits as well. The government o a country with an international currency is given more room to pur-sue diplomatic or military initiatives outside its borders, amaniestation o what political scientists call “hard” power.The issuing country gains geopolitical inluence. Nor can wediscount the enhanced prestige and status that is associatedwith international money—“sot” power, according to politi-cal scientists. As Nobel laureate Robert Mundell (1993) oncewrote, “Great powers have great currencies.”There may also be disadvantages or the issuer, o course,especially once a substantial overhang o its currency accumu-lates in oreign hands. Interest rates might have to be raisedto sustain the money’s value in exchange markets. Ultimately,policy autonomy may be seriously compromised by the needto avert a light to other assets. As Britain’s long ordeal aterWorld War II testiies, the deense o a great currency—once indecline—can be very costly indeed. Both at home and abroad,signiicant sacriices and concessions may be required.All these matters are at issue when governments choose whatmoney to use as a reserve currency. The preerences o mar-ket actors, based essentially on economic calculus, also play arole; no government will opt or a currency that is not already widely used by the private sector. Central bankers are clearly sensitive to issues o liquidity, exchange convenience, and com-parative rates o return. But when choices are made rom thesmall pool o alternatives avored at the market level, politicalactors are sure to intervene, too. Key considerations includeboth the quality o governance in a currency’s home economy and the nature o relationships between states. Is the issuer o acurrency capable o ensuring political stability at home? Can itproject power abroad? Does it enjoy strong intergovernmentalties—perhaps a traditional patron-client linkage or a ormalmilitary alliance? The uture o reserve currencies is a matter o 
 political economy 
, not economics alone.
rnne-p
Consider the euro, or instance, widely considered to be themost natural rival to the dollar. The euro began lie a decadeago with many o the attributes essential to international ac-ceptance, including a large economic base, political stability,and an enviably low rate o infation, all backed by a jointmonetary authority, the European Central Bank, which isully committed to preserving condence in the money’s u-ture value. Europe is the equal o the United States in outputand trade. Why, many ask, should it not be America’s equal incurrency matters, too?But the question overlooks the act that, or all itsstrengths, the euro is also handicapped by several criti-cal shortcomings. Among these is a strong antigrowth biasbuilt into the euro area’s provisions or monetary and is-cal policy, compounding other actors that tend to weakenEurope’s output potential (or instance, aging populations,rigid labor markets, and strict government regulations). Asluggish European economy can hardly be expected to makethe euro attractive or trading or investment purposes. Andthe amiliar ambiguities o the euro area’s governance struc-ture are bound to give outsiders pause. Everyone knows thatthe euro is an artiicial construct, the complex product o aninternational treaty, which can be only as good as the multi-lateral agreement underlying it.Not surprisingly, thereore, the euro’s international recep-tion has been relatively muted. In private market activity,
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adjusting or the elimination o intra–euro area transactions,the euro has managed to do little more than hold its owncompared with the past shares o its several “legacy” curren-cies. Given that Germany’s old deutsche mark had already attained a number-two ranking on the global stage, anythingless or the euro would have been a real shock. Ater a aststart, market use o the euro has broadly stabilized or thepast hal-decade. Moreover, growth o usage has been unevenacross sectors—greatest in issuance o debt securities butscarcely noticeable in such areas as oreign exchange trading.Activity has also been concentrated in economies with closegeographical and/or institutional links to the euro area—what might be considered the euro’s natural hinterland inEurope, the Mediterranean, and parts o Arica.Yet many continue to predict a bright uture or the euro atthe government level, as a reserve currency. Although Europe’smoney today accounts or no more than a quarter o globalreserves, compared with a nearly two-thirds share or the dol-lar, the euro could nonetheless surpass the greenback within asew as 10 years, according to one well-publicized econometricorecast (Chinn and Frankel, 2008). But is that realistic? A sta-tistical study highlighting no more than three causal variables,all economic in nature, can hardly be considered deinitive.Where are the diplomatic and military considerations that arebound to play a major role in shaping government choices? Toignore the political side in this context is like trying to mounta perormance o Hamlet without the prince.Japan, or instance, has long relied on a ormal security umbrella provided by the United States to protect it againstexternal threats; and the same, less ormally, may be said o most o the major Gul oil exporters as well. Can we really imagine any o these nations, all very large dollar holders, casu-ally jeopardizing their established ties to Washington or thesake o a ew basis points o return on their reserves? The euroarea, as we know, is composed o a gaggle o sovereign stateswith interests that only partly coincide in practice. It deies theimagination to believe that Europe could substitute eectively or the political or military inluence o the United States inthe Middle East or beyond. Scenarios based on parsimoniouseconometric models surely have their uses, but they are almostcertainly incomplete and misleading, i not downright wrong.
alo-n nd othe poibilitie
Are there any other possibilities? Japan’s yen was once thoughtto be the dollar’s heir apparent but now looks more like a sad,aded also-ran. During the 1970s and 1980s, when the ast-growing Japanese economy seemed destined or superpowerstatus, international use o the yen accelerated switly, par-ticularly in global bond markets. But, at the end o the 1980s,the bursting o Japan’s “bubble economy” abruptly halted thecurrency’s upward trajectory. Today, ater years o domesticstagnation, the yen appears to ace a gradual erosion o marketstanding not unlike sterling’s long decline in an earlier era.As the yen declines, could China’s yuan rise? The currency o one o the world’s largest economies, the renminbi (“people’smoney”) certainly has much going or it. International use,however, remains rudimentary despite recent eorts by Beijingto broaden the currency’s appeal. Acceptance is discouragedby obstacles ar more severe even than anything blocking theeuro or yen, including a ull panoply o capital controls and aseverely underdeveloped inancial system. In time, these hand-icaps may be surmounted—but not anytime soon.
Dk hoe
Most recently, debate has turned to the possibility o a newworld reserve currency, most likely building on the already existing SDR. Stimulated in particular by comments romChinese and Russian ocials, the idea has been endorsed by a United Nations commission headed by ormer World Bankchie economist Joseph Stiglitz. Some see a start in the newbonds to be issued by the IMF, which China and Russia aim touse to diversiy a portion o their reserves away rom the dol-lar. But here too the obstacles are daunting. Even with the new$250 billion allocation o SDRs just implemented by the IMF,total SDRs in existence will amount to less than 5 percent o global reserves. Can enough be created to make a signicantdierence? Can supply be provided more fexibly? And mostcritically, who would have the authority to manage it? With-out an eective government to back it, a world reserve cur-rency o any kind—whether based on the SDR or invented
denovo
—would have diculty attaining even a minimal levelo credibility. The ambiguities o the euro area’s governancestructure would seem trivial by comparison.In act, nothing better illustrates the politics inherent inthe choice o reserve currencies. Large dollar holders likeChina and Russia are understandably rustrated by the lacko satisactory alternatives to the greenback and earul o what might happen to the value o their hoards should therebe a run on the U.S. currency. But, more to the point, bothalso are aspiring powers that make no secret o their resent-ment o what they call Washington’s global “hegemony.” Eachis well aware o the role played by the dollar in underwritingU.S. geopolitical privileges. In their appeals or a substituteor the greenback, thereore, it is hard not to see an implicitcampaign to clip the American eagle’s wings. The ideahas symbolic value as a threat to U.S. hard and sot power.Whether it has any practical plausibility is o distinctly sec-ondary importance.
Fgmented ytem
In short, while prospects or the dollar may not be as brightas they once were, the outlook or its main rivals appears littlebetter. Some movement away rom the greenback can be ex-pected as the center o gravity in the world economy shitstoward China, India, and other emerging markets, which nowaccount or the largest share o global reserves. Not many o these countries are as close to the United States as America’straditional allies in Europe and Japan. But the scope o any turn away rom the dollar is sure to be limited by the lack o aclearly attractive alternative.A more ragmented currency system thus seems in the o-ing, with much competition and no money clearly dominant.The economic and political impacts could be considerable,despite the shock absorbers provided by loating exchange
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