Despite near-constant predictions of its looming and imminent demise, the dollar remains king for many reasons. These include the size of the US economy, historical inertia and the deeply embedded hierarchical network structure of the international monetary system.
The US has its share of economic and political problems, and other currencies such as the Chinese renminbi are beginning to play a larger role in global finance. Yet dollar hegemony rests on far deeper and more durable foundations than the sceptics realise. Chief among these are the unparalleled deep, liquid private financial markets of the US, and its willingness to act as the lender of last resort in global financial crises.
Beyond its structural advantages, the dollar remains dominant because none of the supposed competitors are remotely close to meeting the criteria necessary to replace it. Despite America’s problems that have raised uncertainty about US political and economic hegemony – the increasing extremism of the Republican party and President Donald Trump threatening to withdraw from Nato – the dollar remains unchallenged as the centrepiece of the international monetary system.
To see why this is the case, one need only look at the possible alternatives. First, the euro – the number two international currency by a wide margin – is a currency without a government. The European Union is the world’s largest economy, but the euro area is neither a fiscal nor a political union, and this makes it difficult to persuade others that they can really rely on the euro in hard times.
The euro was set up to minimise its role as a safe haven during crises. The euro area’s ‘no bailout clause’ guarantees limited transfers from surplus to deficit countries with the monetary union during times of stress. This serves the internal political purposes of the euro area’s most powerful countries (most of all Germany), but it does not serve the external purpose of making the euro a viable option as the dominant global reserve currency. Until the euro area and its member states finally resolve the festering structural problems within the monetary union, the euro will remain a distant second to the dollar at the global level.
Second, the renminbi is not even close to rivalling the euro or Japanese yen, let alone challenging the dollar’s monetary hegemony. China lacks deep and liquid private financial markets, does not allow free flows of capital and President Xi Jinping’s government has shown no sign that it will accept the political economy trade-offs necessary for the renminbi to lead in the international monetary system. Moreover, as an authoritarian regime, China lacks the credibility and transparency to play the role of the international lender of last resort. The day may come when the renminbi challenges dollar hegemony, or at least becomes a major player as one of the big three global reserve currencies. But that remains many years, if not decades, away.
Finally, despite the evangelism of their aficionados, cryptocurrencies such as bitcoin simply cannot fill the role played by the government-based reserve currencies that dominate global finance. Cryptocurrencies perform none of the three functions of money (medium of exchange, unit of account, store of value) domestically, let alone at the international level. Instead, they are merely speculative assets, without the political backing or foundations they would need to become reserve currencies, especially during episodes of financial instability. The world economy cannot function with a monetary standard that is not backed by sovereign political power, and which cannot be rapidly increased in supply to provide global liquidity in times of financial crises.
Until and unless the EU becomes a true fiscal and political union — or until China becomes an accountable liberal government, develops its private financial markets and finally accepts the free movement of capital flows – the dollar will remain dominant in global finance. The international monetary system, for better or worse, will continue to be backed by American dollars for years to come.
Mark Copelovitch is Professor of Political Science and Public Affairs, University of Wisconsin – Madison.
This article was originally published in the Global Public Investor 2023.
