Future of Dollar Hegemony: The Dollar's Role after the Euro Crisis

Harvard International Review, Summer 2012 | Go to article overview

Future of Dollar Hegemony: The Dollar's Role after the Euro Crisis


The events of this past year's Euro Crisis have upset not only the international balance of power between currencies but also the suspected future balance of those currencies. As the effects of the Great Recession hit debt-ridden countries like Greece and Portugal, worsening their economic prospects and compounding the effects of speculation-driven spending sprees, the viability of their sovereign debts began to fall question. These debts, denominated in euros, represented not only a threat to the value of the currency in the short term but also to the solvency of highly exposed banks all over Europe.

This systemic risk, and eventually systemic crisis, revealed the paradox of the Euro/one's partial integration: the interconnected nature of these economies had led to enough cross-national exposure that a collapse of one or more Eurozone economies threatened the entire system while at the same time the economies were not connected enough to tree member states from different monetary policy needs. As Greece's import-export ratio worsened, the expansionary monetary policy it needed was off the table, worsening economic conditions and undermining any hope of paying off its sovereign debt. Hi is dizzying combination of factors has led to dozens of proposed solutions, countless summits and negotiations, but only one near-universal conclusion: the euro system was plagued from the start and cannot be trusted as a stable alternative to the hegemonic dollar.

Since the mid-twentieth century, the dollar has enjoyed almost unrivaled status as the world's preferred reserve currency, or the currency in which most nations denominate most of their international currency reserves. The deep pool of relatively liquid assets denominated in dollars, from the multi-trillion dollar pool of US government securities to the securities of many large corporations, and perceived stability of the currency have given sovereign investors and countries engaged in international trade a large incentive to keep their currency reserves in dollars. For the past sixty or seventy years, this has allowed countries to park their holdings in a stable currency and reduce transaction costs in international trade. This same system has led the majority of international commodities markets, most notably the oil market, to price goods in dollars in order to take advantage of these lower transaction costs and facilitate the mechanisms of trade. In turn, the United States has benefited from slightly lower transaction costs than any other country in the world (it hardly ever needs to exchange currency for trading purposes) and the ability to issue debt at a much lower interest rate than similarly situated countries, as there is almost. always demand for assets denominated in the reserve currency.

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While this system, known collectively as "dollar hegemony," has endured with few disruptions since the end of World War II, the recent emergence of the euro as a seemingly strong and stable international alternative, as well as the unprecedented growth of the Chinese economy, have led to calls for the end of this system. Russian Prime Minister Vladimir Putin has decried dollar hegemony as allowing the United States to live "like parasites off the global economy," while China's central bank has taken the more subtle route of issuing a proposal for the creation of a new, international currency to replace the dollar. All of these proposals have relied on the strength of the euro as the lynchpin of any shift, arguing that the existence of a second, internationally viable currency warrants a shift awav from the dollar and toward a more equitable international monetary system. According to the IMF, between the first quarter of 2006 and the first quarter of 2010, foreign exchange reserves denominated in euros almost doubled, all while the value of the euro remained 25 percent above that of the dollar.

Unfortunately for dollar hegemony's detractors, Europe's sovereign debt crisis has unleashed market turmoil that far outstrips anything seen in the United States, even at the height of the US financial crisis. …

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