Commentary Type

Why the World Needs Three Global Currencies

Op-ed in the Financial Times


Many nations have long regarded the dominant international role of the dollar as bestowing an "exorbitant privilege" on the United States. But the privilege has now become a burden. It is time for the United States to anticipate, and begin to build, an era in which there will be several global currencies to rival its own.

Seen from abroad, the dollar's role provides automatic financing for US external imbalances and enables it to live beyond its means. At home it is understandable that US politicians, with their short-run time horizons, welcome this opportunity to evade needed discipline. But such pressure from abroad can be constructive in promoting needed adjustment.

The free fall of the dollar in the late 1970s forced the United States to tighten monetary policy and address its budget deficits, commencing the correction of double-digit inflation. In the mid-1980s, large current account deficits and a sharp dollar decline helped produce initial cuts in budget deficits. Most importantly, the recent crash came after record imbalances had seen huge capital inflows into the United States, keeping monetary conditions loose and interest rates low.

It is time for the United States to anticipate, and begin to build, an era in which there will be several global currencies to rival its own.

The current system has other big weaknesses. Much of the inflow in recent years has come from the huge build-up in dollar reserves by foreign monetary authorities, especially China. This is a direct consequence of America's reserve currency status, and the United States would clearly be better off without the addictive financing inherent in its currency role. This also allows others to set the dollar exchange rate-because China keeps the renminbi greatly undervalued, and thus the dollar overvalued by intervening directly in dollars.

Historically, the dollar-based system evolved as a grand bargain, under which other countries could determine their exchange rates against the United States and would finance whatever deficits it ran as a result. Surplus countries, from Germany to Japan to China, have periodically grumbled about their "excessive" build-up of dollars, but have generally kept their part of the deal.

The system was strained when the United States decided to adjust rather than finance, and demanded negotiation of large dollar depreciations in the early 1970s (Smithsonian Agreement) and the middle 1980s (Plaza Accord). A similar situation has arrived again.

Now America can terminate its reliance on debt-financed consumer demand, and sustain recovery, only by a big improvement in its trade balance and supportive investment. This requires a substantial decline of the dollar, primarily against the renminbi and a few other undervalued Asian currencies, which the dollar's role impedes.

More generally, the dollar was the world's dominant currency for a century simply because it had no rival. The euro changed that. The eurozone's embrace of "coordinated fiscal austerity" and likely issuance of genuine eurobonds suggests it may well restore its currency's appeal in the next few years, especially if the United States fails to trim its gargantuan budget deficits.

The share of foreign exchange reserves held in dollars has fallen in the past decade to about 60 percent. The share in euros has risen to more than 25 percent. The rise of China implies the renminbi will qualify for global currency status whenever it achieves full convertibility and sheds its protective capital controls. In short, the international monetary system is already becoming bipolar, and may soon be tripolar.

The United States should accept this and even promote its acceleration. The goal should be roughly to equate the international positions of the dollar and the euro in the next decade or so, and subsequently to bring the renminbi into the mix along with steady creation of special drawing rights (SDRs). It should encourage China and others to intervene in euros as well as in dollars. It could intervene in euros itself if the dollar-euro rate became misaligned. It could also overtly discourage dollar build-ups by foreign monetary authorities through countervailing currency intervention and by taxing the income on their dollar holdings. It could support the creation of a Substitution Account at the IMF, as it did in 1979-80, through which foreign authorities could convert some of their dollars into SDRs.

These changes would not resolve all the problems of the international monetary system. They would certainly not absolve the United States of the need to get its fiscal house in order. But they would speed up needed rebalancing of the world economy and reduce the risk of future crises.

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