The Almighty Dollar Needs a Rival

(Bloomberg Businessweek) -- There’s a serious imbalance at the heart of the world economy. Even though the output of the U.S. has shrunk as a share of world gross domestic product, the U.S. currency remains as essential as ever. The dollar is actually more important than it deserves to be, because of a network effect: People use dollars because other people use dollars, just the way people learn English because the people they have to deal with speak English. 

The main harm is to less developed countries whose economies are discombobulated by fluctuations in U.S. interest rates and the value of the dollar. This was discussed in an important paper delivered at the recent monetary policy conference in Jackson Hole, Wyo., by Mark Carney, governor of the Bank of England, who warned against “blithe acceptance of the status quo.” Here’s a link.

If you heard anything about Carney’s paper, it’s probably his approving mention of Libra, the digital currency proposed by Facebook Inc. But that’s one small part of his bigger argument, which is simply that the dollar’s status as a “hegemon” is “putting the global economy under increasing strain” and needs to end, somehow.

In 1971, President Richard Nixon’s Treasury secretary, John Connally, is supposed to have told European finance ministers that the dollar “is our currency, but your problem.” Carney wrote that in the almost half-century since, America’s message has broadened to “any of our problems is your problem.” 

What, exactly, is so bad about the dollar’s centrality? Carney’s paper cites a wealth of research by other economists, including Gita Gopinath of Harvard, now the chief economist of the International Monetary Fund. A key problem—which is a little confusing when you first hear it—is the seemingly minor issue of how imports are invoiced.

Here’s the idea in a nutshell: “The dollar represents the currency of choice for at least half of international trade invoices, around five times greater than the U.S.’s share in world goods imports,” Carney writes. So let’s say some poor nation needs to buy oil. It’s priced in dollars, even though the oil isn’t from the U.S. Now the local currency falls versus the dollar. Suddenly the same volume of oil costs more—a huge burden on ordinary citizens.

It would be nice if the poor country’s higher bill for imports were offset by a big increase in exports. But if its exports are also priced in dollars, that’s not what happens. Export volumes are unchanged because their dollar price is unchanged. So the country loses on the import end and doesn’t win on the export end. True, the poor country’s exporters earn windfall profits because their costs are in the local currency, but it takes time—maybe years—for the export sector to expand as a result and put more people to work.

A 2017 paper by Gopinath and others concluded that a 1% appreciation of the dollar against all other currencies is associated with a 0.6% to 0.8% decline in total trade among countries in the rest of the world. Here’s a layman’s explanation of the paper from the National Bureau of Economic Research.

This invoicing issue has ripple effects. Because companies need dollars to pay for imports, they build up (or try to build up) big war chests of dollars. “Two-thirds of both global securities issuance and official foreign-exchange reserves are denominated in dollars,” Carney writes. The demand for dollars pushes down U.S. interest rates. This makes it attractive to borrow in dollars. That means countries need dollars to pay off the loans, so it makes sense for them to invoice even more in dollars, and so on in a dollar-demanding spiral.

“The global financial cycle is a dollar cycle,” Carney writes, citing Helene Rey, a French economist at London Business School. If a poor nation’s currency falls against the dollar, all that dollar debt becomes harder to service. When the Federal Reserve raises interest rates, borrowing costs can rise in developing nations. “Bank research suggests that the spillover from tightening in U.S. monetary policy to foreign GDP is now twice its 1990-2004 average, despite the U.S.’s rapidly declining share of global GDP,” Carney writes.

Carney considers whether the rise of China’s renminbi could ease the problems by creating a second global reserve currency. Things got messy the last time something like this happened, when the U.S. dollar began to supplant the British pound, he writes. “Some would argue,” he writes, that “the lack of coordination between monetary policy makers during this time contributed to the global scarcity in liquidity and worsened the severity of the Great Depression.”

Rather than counting on China, he writes, the better bet “would be to build a multipolar system.” That’s where Facebook’s Libra might come in. He describes it as “a new payments infrastructure based on an international stablecoin fully backed by reserve assets in a basket of currencies including the U.S. dollar, the euro, and sterling.” But Carney says it’s also possible that a new currency “would be best provided by the public sector, perhaps through a network of central bank digital currencies.” 

“It was a remarkable speech,” Olli Rehn, who sits on the European Central Bank’s Governing Council, told Bloomberg. “It’s an idea worth pondering in a wider context of the digitization of our monetary and banking system.”

Even for the U.S., the dollar’s centrality isn’t all upside. True, the dollar’s dominance gives the U.S. some important geopolitical advantages, such as the ability to sanction countries by depriving them of access to dollar-based payments networks, as I wrote in a Remarks column, “The Tyranny of the U.S. Dollar,” for Bloomberg Businessweek last year. But the world’s appetite for dollars can push up the exchange rate, making American goods more expensive in global markets and hurting U.S. employment.

Carney doesn’t have all the answers, but he’s asking the right questions. He concluded his address in Jackson Hole with this: “Let’s end the malign neglect of the IMFS [international monetary and financial system] and build a system worthy of the diverse, multipolar global economy that is emerging.”

To contact the editor responsible for this story: Eric Gelman at egelman3@bloomberg.net

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