Among the legacies of the 60s – the hippies, the war in Vietnam and Hitchcock’s Psycho – there is a famous phrase from Valéry Giscard d’Estaing, the then French Minister of Finance. Referring to the United States’ monetary position in the post-World War II world, he coined the term ‘exorbitant privilege’. Those words were uttered a long time ago. They still matter today.
The exorbitant privilege Monsieur d’Estaing talked about to was the fact that the US – then just as now – is the holder of the world’s currency reserve and, as such, enjoys a special status worldwide. The United States, for instance, can print money and accumulate debt without facing the problems that other counties would encounter. After the financial crisis struck in 2007 money fled to the US – the epicenter of the financial earthquake – rather than away from it: despite the Lehman debacle, dollars were still a safe bet.
The debate on Washington’s responsibilities toward the world and the possibility that the dollar’s supremacy might one day be over has been going on for a long time. The latest entry in the literature that calls for an end to the dollar hegemony was made recently by Justin Yifu Lin, Taiwanese former chief economist at the World Bank and now advisor to the Chinese government. Talking to the Bruegel, a Brussels-based think tank, he reiterated his belief that a supranational currency is needed because “the dominance of the greenback is the root cause of global financial and economic crises.” On different occasions, Mr Lin had explained that what he means by ‘supranational currency’ is paper gold – a currency pegged to gold which could be used by states around the world.
It is not clear whether his plan his realistic. Tatiana Fic, a research fellow at the National Institute of Economic and Social Research (NIESR), Britain’s longest established independent research institute, told us that setting up a supranational currency would be difficult at the present stage because “the creation of a paper gold currency would require political consensus and modifications to the global financial architecture.” According to her, “it seems that it is unlikely that these would be achieved soon, because it would also require a lot of research – e.g. whether there would be any national governments that would back this currency, whether the IMF would play the role of a super central bank, what the existence of paper gold currency would imply for national currencies, etc.”
Alongside those who complain about it, there is also a group that predicts that the end of the exorbitant privilege is nigh. According to Jeffrey Frankel, a professor at Harvard University’s Kennedy School of Government, the US dollar’s role as an international currency has been waning since 1976, even though Mr Frankel’s opinion piece on Project Syndicate ends by saying that “the day may come when the dollar, too, succumbs to a rival. But today is not that day.”
The financial crisis has contributed to heating up the debate. For one, because the fiscal position of the US has become more fragile, generating concerns about the ability of Washington to maintain its monetary role. But also because the non-conventional policies of the Federal Reserve have created large outflows of money to countries which could now suffer from an interest rate normalization – and which are now criticizing US monetary policies.
In 2011, Barry Eichengreen, a professor of economics and political science at the University of California, Berkeley, argued in a piece published on the Wall Street Journal that the dollar’s reign is close to its end. According to the author of “Exorbitant Privilege: The Rise and Fall of the Dollar and the Future of the International Monetary System,” the historic decline is going to be driven by three developments. First, technological innovations have lessened the need for a single world currency. Second, the fiscal position of the US has lost strength as debt ballooned. Third, the emergence of two rivals – the euro and the renmimbi – will likely challenge the American monetary stronghold.
The first contender does not look in the best of shapes. In 2004, C. Fred Bergsten, the director of the Institute for International Economics, wrote that “the launch of the euro probably represents the most successful episode in the entire history of the European integration movement.” That was why, Mr Bergsten contended, “countries throughout the world are expressing their admiration for the euro by seeking to join or emulate it.” Ten years later those words resemble a prehistoric fossil: terms commonly attached to the euro are now trap, disaster, mistake, failure. But the euro is not dead, and according to Dr Eichengreen it is not likely to be gone anytime soon – as long as Europeans are willing to tackle their debt and work out a system to spread risk among the Union’s members.
The second challenger, the Chinese currency, is on its way to internationalization, even though most experts say China still has a long way to go before its currency will have a clout similar to that of the dollar. According to Dr Fic, “the dollar remains one of the major world currencies,” but “the relative role of the euro, and renminbi is likely to increase over time.”