From the University of Chicago's Booth School of Business, Chicago Booth Review, July 29:
Americans are often told that they benefit from the privilege of the dollar serving as the world's currency. A strong dollar makes imports cheaper, facilitates demand for American companies, and is tied to cheap government borrowing. But what happens when this powerful privilege weakens? What does it even mean for the dollar to be “strong” or “weak” as a medium of exchange and investment? Why should Americans care that the dollar serves as the reserve currency for the world’s central banks?
Harvard’s Kenneth Rogoff, former chief economist for the International Monetary Fund, argues that the dollar’s global dominance will erode in the coming years and that it will eventually share power with the European Union’s euro and Chinese renminbi in a “tripolar” world. On this episode of Capitalisn’t, Rogoff joins hosts Bethany McLean and Luigi Zingales to discuss why the dollar’s shifting dominance matters so much to the United States and what implications this has for the rest of the world’s payment network.Audio Transcript
Kenneth Rogoff: The thing we really care about over the long run is having the dollar be like English, that everybody uses it. That’s what brings our interest rates down on a long-term basis.
Bethany: I’m Bethany McLean.
Phil Donahue: Did you ever have a moment of doubt about capitalism and whether greed’s a good idea?
Luigi: And I’m Luigi Zingales.
Bernie Sanders: We have socialism for the very rich, rugged individualism for the poor.
Bethany: And this is Capitalisn’t, a podcast about what is working in capitalism.
Milton Friedman: First of all, tell me, is there some society you know that doesn’t run on greed?
Luigi: And, most importantly, what isn’t.
Warren Buffett: We ought to do better by the people that get left behind. I don’t think we should kill the capitalist system in the process.
Bethany: Way back in the 1960s, a French finance minister called the position that the dollar occupied in the global financial system “America’s exorbitant privilege.”
Luigi: Then there is the paraphrase of Churchill: “Indeed, it has been said that the dollar is the worst form of reserve currency, except for all those other forms that have been tried from time to time.”
Bethany: That always makes me laugh. I mangle the Churchill quote, or rather, I plagiarize it and change it in so many contexts.
OK, I will admit it, Luigi, in the past, when I’ve seen headlines about a strong dollar or a weak dollar, I mostly tune out—unless I’m about to travel to Europe and buy some shoes, of course.
Let me start with a question for you, Luigi. Why does the strength or weakness of the dollar matter? What does that quote about exorbitant privilege mean?
Luigi: I think that you are mixing two related ideas. One is whether the dollar is strong in terms of the exchange rate vis-à-vis other currencies. The Argentinian peso is relatively overvalued in this moment, but nobody would think about investing or using it as a reserve currency, ever.
You look at the exchange rate, and you compare the exchange rate with what you can buy in that particular country. For example, the magazine The Economist shows how much a Big Mac costs in different countries. If your currency is relatively appreciated, it’s pretty cheap to buy McDonald’s in another country. Vice versa, if your currency is depreciated, then when you go to another country, you spend a fortune to buy a Big Mac.
Bethany: I like the shoe index more than a Big Mac index, but that’s OK. We can keep going.
Luigi: I suspected that was the case, but anyway, you get the point.
A different thing is to what extent people want to use the dollar to, number one, write contracts in dollars; number two, invest in dollars; and number three, pay each other in dollars. This is the use of the currency as a medium of exchange, as a unit of account, and as a reserve of value.
Basically, the dollar has a very large market share of all three components around the world. It is a big advantage that the United States has. This big advantage is twofold. Number one, you can pay for your imports with printed money. Most other countries, in order to import a good, need to export a good and get some currency to pay for the good in foreign currency. The United States can buy foreign shoes just by printing pieces of paper that are dollars, which are very cheap to print. That’s one benefit.
The second benefit, which is connected but even more important, is that people feel safe investing in the US dollar and feel particularly safe when things really, really go badly.
The 2008 financial crisis actually originated in the United States. You would think that this is the last country in the world where you want to have your money invested. But people rushed to the dollar as a safe currency in that moment.
As a result of this unique quality, the US government and US households and firms can issue dollars and pay less than they would otherwise if they were located in the UK or in Europe. That really is an exorbitant privilege because you can save a lot on your debt.
Bethany: That makes sense. The influential economist Ken Rogoff has argued that we pay one-half to one percent lower in interest because of the dollar’s position. I think what you’re saying is that the strength of the dollar isn’t just this abstract financial-markets thing that only currency traders care about. It’s a real-world thing, one that affects the amount households pay in interest on, say, credit-card debt or mortgage debt.
But it’s also this abstract thing in that it serves as an unofficial barometer of US power, in a way. It allows all these advantages that are more abstract than the level of interest you pay but are connected to that and are really important in their own way.
How did the dollar get that role in the first place? It’s not like the world voted for the dollar to have exorbitant privilege—or did it?
Luigi: You know this little thing called World War II?
Bethany: Yeah.
Luigi: There is a fascinating episode of Planet Money about what happened in Bretton Woods. As the war was ending, the Allies met in this little town in New Hampshire called Bretton Woods. They were trying to figure out how they would organize the world moving forward. There was major tension between the UK representative, none other than John Maynard Keynes, and the US representative, Harry Dexter White.
What the Planet Money episode suggests is that surprisingly enough, Harry Dexter White outmaneuvered Keynes. Keynes was trying to save the role that the pound had in the international market. Harry Dexter White said, “No, no, let’s talk generically about a currency and then organize everything as a generic currency without specifying what currency it is.” Then at the last minute, in a tricky moment, he replaced this generic currency with the US dollar. The US dollar all of a sudden had the entire role.
By the way, it’s not related, but it’s too hard to resist: did you know that Harry Dexter White then was accused—and apparently accused rightly—of being a spy for the Soviets?....
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