Looking at the dollar as reserve currency when Trump is floating his "big and beautiful" agenda
These two new books by well-credentialled economists examine the role of the US dollar in international finance. The story has its origins in the July 1944 meeting at the Mount Washington Hotel in Bretton Woods, New Hampshire, which established the post-Second World War international financial order.
The objective was to facilitate free trade based on convertible currencies and stable exchange rates. The troubled pre-war gold standard, where the standard unit of currency was a fixed weight of gold, was not considered feasible. There was insufficient supply of the precious metal to meet expected demands of international trade and investment in the post-war economy. The communist Soviet Union, emerging as a rival to the USA in the global order, also controlled a sizeable proportion of known gold reserves.
The debate came down to differences between John Maynard Keynes, representing the UK, and a senior US Treasury department official Harry Dexter White, who allegedly was a Soviet spy. Keynes' bold solution was a world reserve currency (the Bancor) administered by a global central bank. White rejected the proposal: "We have been perfectly adamant on that point. We have taken the position of absolutely no."
The meeting took place against the background of a still raging war, the rise of fascism, and the Great Depression. The US had emerged as the pre-eminent economic and military great power as well as the world's richest nation and the biggest creditor. The British and the French, devastated by two world wars, needed American money to rebuild their economies. White's view prevailed.
Bretton Woods established a system where the US dollar effectively assumed the role that gold had played previously in the international financial system. Countries pegged their currencies to the dollar which as the principal reserve currency was to have a fixed relationship to gold ($35 an ounce).
The Bretton Woods system was ultimately undermined by large US budget deficits to pay for the Vietnam War and President Johnson's Great Society programs, inflation and increased dollar outflows. The dollar's convertibility to gold was removed. There was a shift to predominately market set exchange rates.
However, the dollar continued as a major trading and reserve currency. 96 percent of trade in the Americas, 74 percent in the Asia-Pacific region, and 79 percent in the rest of the world is denominated in the currency. Only in Europe where the euro is dominant with 66 percent share is its market share low. About 60 percent of international and foreign currency claims (primarily loans) and liabilities (primarily deposits) are in US dollars.
Its share of foreign exchange transactions is around 90 percent. US dollars constitute around 60 percent of global official foreign reserves. These shares are disproportionate to the size of the US economy (around a quarter of global GDP or 15 percent adjusted for purchasing power).
King Dollar and Our Dollar, Your Problem, as evidenced by the trite titles (the latter based on Treasury Secretary John Connally's much cited barb), offer conventional histories, rarely deviating much from the accepted narrative. Much of this ground was traversed by Barry Eichengreen in his 2010 book Exorbitant Privilege.
Jeffrey Garten's 2021 book Three Days at Camp David- How a Secret Meeting in 1971 Transformed the Global Economy also provides a more nuanced perspective especially on the decoupling from gold. Garten was present during the discussions that led to the suspension and then closure of the gold window.
Both books purport to address the question which has been asked intermittently for over half a century: can the dollar survive as the global reserve currency?
There are broadly two camps. Those who believe that the announcement of the dollar's death, like Mark Twain's, is greatly exaggerated.
Others believe that structural changes in the global economy mean the relegation of the American currency to a lesser, often unspecified, role, perhaps as one of a suite of reserve assets.
Both authors reference the standard problems of a reserve currency.
The first is the 'policy trilemma' or 'impossible trinity' proposition of economists Robert Mundell and Marcus Fleming. It argues that an economy cannot simultaneously maintain a fixed exchange rate, free capital movement, and an independent monetary policy.
The second is the paradox named after economist Robert Triffin. This states that where its money functions as the global reserve currency, a country must run large trade deficits to meet the demand for reserves. Any aspirant to a new global reserve currency status must accept an unacceptable loss of economic control and must run large current account deficits.
Blustein and Rogoff do not see these problems posing any immediate risk to dollar dominance. Arguably no other country, such as Japan, Europe or China, which potentially could fill America's role, would want their currency to function as a reserve currency because of the issues mentioned. That is, if they fulfill all the requirements, which they do not in any case.
Paul Blustein argues that the dollar's dominance is underpinned by American military power, the US rule of law, and confidence in the dollar as a store of value. The latter is somewhat surprising in that the currency has lost some 99 percent of its purchasing power due to inflation since the early 1970s. King Dollar argues that its long-standing role in trade and capital flows creates a network effect which makes it hard to displace.
Rogoff takes a similar position. Our Dollar, Your Problem examines the reasons behind the failure of the Soviet Union (to the surprise of this reader), the Yen, the Euro and Renminbi to reduce the role of the dollar. Rogoff, best known for his controversial This Time It's Different, does express concern that US debt levels, high interest rates, inflation and geopolitical instability could undermine the dollar's position.
Unfortunately published before the new US administration took office, both titles look prematurely dated. The world has changed. The Trump administration sees major problems with the dollar's role as a reserve currency.
One concern is that it led to overvaluation which has destroyed America's industrial and manufacturing base. A related issue is persistent trade deficits which have driven the US to become the world's largest debtor (foreign liabilities exceed foreign assets by $26 trillion). The arguments, whether correct or not, were raised before in the 1970s and 1980s. A new issue is the President's obsession around US military expenditure which provides allies with security cover. He argues, not without cause, that it has allowed beneficiaries to enjoy free-rider benefits diverting spending to other productive areas without compensating America for its high cost.
President Trump and his advisors have plans to tackle the problem. Tariffs are one part of the program. The reason that these target allies is that some hold dollars and, in the poorly founded opinion of the administration, all can be coerced into helping the US implement its agenda.
Another involves further weaponising the dollar through sanctions, asset seizures and control of payment systems, a process that has been underway for the last two decades. Both Blustein and Rogoff mention these measures although their impact was better covered in British historian Mark Galeotti's 2022 book The Weaponization of Everything: A Field Guide to the New Way of War.
The most far-reaching step (proposed by Stephen Miran, now chair of the US Council of Economic Advisers) would entail user fees for holding US Treasuries (effectively a withholding tax), forcibly exchanging US treasuries for low- or zero- coupon century (100-year) or perpetual bonds (arguably a default) or placing the bonds in escrow (a seizure). Other options include capital controls and denying access to US capital markets.
In essence, Trump's "big and beautiful" agenda is for other states to accept tariffs on their exports to the US without retaliation, invest in America by relocating production facilities, purchase US exports and pay tribute to the US (preferably all while prostrating and abasing themselves to access the biggest market in the world!). It is difficult to see how large sovereign countries or groupings like China, Japan, India, Brazil and Europe will find this acceptable. For a start, it would be political suicide domestically.
Instead, these actions undermine the dollar's value as well as foreigners' willingness to hold the currency and US assets. The new US administration's cavalier disregard for legal process and the courts are also unlikely to build confidence in the integrity of the US or its financial system.
The 'sell America' movement already underway may accelerate quickly as allies shift away from the US, seeing it as an unreliable and rogue actor. Nothing focuses the mind better than the threat of evisceration of your savings and wealth.
What King Dollar and Our Dollar, Your Problem skirt is the unsustainable trade and capital imbalances in the global economy that have been building for a long time. These fundamentally underlie the need for a reserve currency.
Where India imports more than it exports to China, if denominated in rupees, would leave the Chinese with surplus Indian currency. Alternatively, if denominated in Chinese renminbi, India would have to finance the deficit. This requires unfettered access to investments or funding in the respective currencies. The US tariffs and increased focus on sovereignty and security mean that trade is likely to become more bilaterally balanced. This would reduce surpluses to invest or deficits to finance decreasing the need for a reserve currency. The structure can be extended to encompass trading blocs where imbalances net out between members when aggregated and multi-lateral arrangements such as currency swaps to manage surpluses and shortfalls as needed.
High saving rates and mercantilist policies, exporting more than you import and amassing surpluses to finance control of resources and assets, are not sustainable in the long term. As East Asia and the petrostates are discovering, the security of foreign investments is never guaranteed. These states are tentatively moving to increase currently modest domestic consumption, improve low credit availability and expand limited state social infrastructure for education, the aged and healthcare. This would reduce their reliance on trade and exports. Alongside improving domestic capital markets and the range of available investments, this would reduce surpluses requiring investment overseas.The movement away from free trade and capital flows has implications for prosperity, especially for smaller and emerging nations. But it is difficult to see how this can be avoided.
The drift to autarky underway with reductions in trade and saving imbalances may diminish the need for reserve currencies. It implies a world of multiple trading and reserve currencies which has existed at various times in history.
King Dollar and Our Dollar, Your Problem are overly US-centric and overoptimistic in their core belief that the dollar's reserve currency status is secure. Given America's economic, political and social problems, this confidence will be tested over the coming years.
Satyajit Das is a former banker and author of numerous technical works on derivatives and several general titles: Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives (2006 and 2010), Extreme Money: The Masters of the Universe and the Cult of Risk (2011) and A Banquet of Consequence – Reloaded (2021). His latest book is on ecotourism – Wild Quests: Journeys into Ecotourism and the Future for Animals (2024).
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