The dollar, other currencies and control over the international financial system
Jorge Costa Oliveira
After the Bretton Woods agreement in 1944, other currencies began to maintain a fixed exchange rate with the US dollar (dßollar), which in turn was backed with gold – the “gold standard system”. By 1970, 85% of central banks reserves were in dollars. With the onset of successive budget deficits from 1960 onwards, the U.S. began to lose the massive gold reserves it had built up and the gold-dollar standard was abandoned by the U.S. in 1971.
But in the meanwhile, the dollar had already become the preeminent currency of the international financial system, having become the main currency of the vast majority of foreign exchange reserves of other countries, the medium of payment in which international trade is carried out, the currency in which raw materials were quoted on commodity markets, and the reference currency in countless contracts, including the issuing of public debt by many other countries.
This status of the dollar – called an “exorbitant privilege” by France and other countries – allows the U.S. to enjoy benefits that other countries do not have: (i) access to inexpensive financing in the domestic currency; (ii) benefits of seigniorage, (iii) regular FDI flows, especially in situations of economic uncertainty, due to the absence of alternatives that offer the scale and depth of the U.S. financial markets, (iv) official and private investors around the world becoming dependent on dollar-denominated financial assets; (v) no need to balance its current account (since its imports are paid for in its own currency); (vi) ability to issue Treasury bonds with hardly any limits.
Various entities – China, Russia, the Gulf Cooperation Council, UNCTAD, the IMF – have proposed adopting a new independent currency or using the Special Drawing Rights as a reserve currency. However, this is unlikely to happen.
Other countries would like their currency to have a similar status, but this has only been partially the case with the euro. The IMF’s 2020 data on the composition of foreign exchange reserves by major currencies shows that the dollar remains the leading currency (59%) followed by the euro (21.2%); a long way behind are the yen (6%), the British pound (4.7%) and the yuan (2.2%). The country’s influence in international trade, the size of its economy, the relevance of its financial markets, and its purchasing power (despite trillions of dollars in debt) have kept the dollar as the world’s preeminent currency reserve. The euro was the first currency to threaten the international preeminence of the dollar (which explains several attempts to discredit the euro).
The yuan also meets some of these requirements and the Chinese government is promoting a policy of internationalization of the yuan, but there is much to be done before the yuan can be recognized as a widely accepted currency.
While there are good economic reasons for the U.S. itself to favor more reserve currencies of global significance, in the short-term political-strategic considerations of asserting world leadership, a desire to maintain the benefits of the dollar’s status as the preeminent currency, and maintaining control of the international financial system should prevail.
