The US dollar is the dominant global currency, but is it possible that the dollar could one day lose its top-tier status? And, if so, would that necessarily be a bad thing? To find out the answers to those and other questions, I asked AEI’s Steven Kamin.

Kamin’s research at AEI centers on international macroeconomics and finance. Prior to AEI, Kamin worked at the Federal Reserve as director of the Division of International Finance.

What follows is a lightly edited transcript of our conversation. You can download the episode here, and don’t forget to subscribe to my podcast on iTunes or Stitcher. Tell your friends, leave a review.

Pethokoukis: Steve, welcome to the podcast.

Kamin: Thanks, Jim. It’s great to be here.

Let’s start with just a basic question. The dollar is the dominant global currency. What are the basic reasons why that is?

Well, there’s a number of reasons. Number one, we’re a very large economy accounting for upwards of a fifth of global GDP and economic activity. So that, by its nature alone, is going to make us a very important participant in global financial markets.

Secondly, we’ve got unusually, exceptionally deep, broad, and liquid financial markets. And what that means is that the investors all over the world can count on being able to buy US dollar securities, they can store them safely, and then, if they need to sell them, they can sell them easily without their price being changed. So that’s a great attraction for investors all over the world.

A third factor that keeps the dollar in business is basically that US dollar treasuries are the safest asset known to man. Everybody has complete faith in their value, and so they’re happy to store their savings in those treasuries.

As a related matter, our country has impressive rule of law and protections for investors, both foreign and domestic. So investors around the world can hold our assets without fear of arbitrary expropriation.

And then finally, on top of all that, the dollar remains globally dominant because the dollar is globally dominant. What do I mean by that? Well, there’s a lot of inertia in international currency markets. Right now, everybody transacts in dollars. Because everybody transacts in dollars, people are willing to accept dollars, and that type of inertia—everybody uses them because everybody uses them—basically helps to keep the dollar going. Now, if you didn’t have all those other favorable aspects of the dollar as a dominant currency, then eventually the inertia associated with these so-called “network effects” would erode. But for now, the dollar is indeed numero uno.

I found it interesting during the pandemic, there were occasional articles calling America—or at least raising the question, is America a failed state? And I guess because of our politics, as well as the pandemic . . . but if I were looking for evidence of that that America had somehow failed and lost the confidence of the world, I would guess I would look at the US dollar. If the US dollar wasn’t in collapse, I would think, “Well no, we may have troubles, but we’re not yet a failed state.”

I think that’s right. Now I want to be clear to you and your listeners and that it’s important to distinguish between the value of the dollar in international currency markets—in other words, how many other euros or yen it takes to buy a dollar—and the role of the dollar in international financial transactions. Those are different things, and the dollar could lose value against other currencies but still retain its preeminent role in international financial markets.

Now, as it happens, at the moment, the dollar’s preeminence is in both areas. In terms of the value of the dollar against other currencies, the dollar is, historically speaking, unusually strong; in other words, valuable in terms of other currencies. And on top of that, the role of the dollar in the global financial system remains preeminent. It is true that the share of US dollar assets in global foreign exchange holdings, foreign reserve holdings, has touched down a little bit, maybe from 70 percent a few years ago to 60 now, but it seems to have been bouncing around that range for decades. So, again, looking at the dollar as a metric for whether the US is a failed state, I don’t see it. But let me just add that if failures of US economic and political management were to cause the dollar to lose its preeminent rule, probably it would take place over time because of that inertial effect that I talked about earlier. So just the fact that the dollar retains his preeminence now shouldn’t give us a lot of security that all our economic policies are on track.

If I were writing a column, an economics or finance column, and it was a slow day, maybe July, middle of summer, and I didn’t know what to write about, I think a good go-to story would be about the continued dominance of the dollar: Is it under threat, whether it’s from a China or the euro? And if I wanted to give it a little spice, I’d say maybe the dollar will be replaced by a cryptocurrency: Bitcoin, or maybe some sort of new, special currency cooked up by the IMF [International Monetary Fund] or World Bank. What are the competitors? What does that field look like? Can you handicap the field for me?

Sure. I would add, just parenthetically, that a lot of people are writing that article.

It’s a great go-to.

I’ll keep that in mind if I’m ever bored.

When you go through the laundry list of the competitors, some of them look able to hold their own as kind of a secondary pole of currency activity, but none of them are able to dislodge the dollar. So what do I mean? Alright, well the most prominent competitor to the dollar is the euro. And, indeed, a substantial fraction of global reserve holdings are indeed held in euro, much less than dollar, but still prominent, I think around 20 percent, and an awful lot of financial transactions are conducted in euros as well.

But most of those financial international transactions in euros are being done within the euro area or within Europe. And so the euro hasn’t really managed to dislodge the dollar as a global currency. And even though there were concerns when their euro was created some decades ago that the euro might indeed dislodge the dollar, that didn’t happen. Why? Well, there might be a number of reasons. First, the euro-area economy has not proven as vibrant and fast-growing as the US economy. On top of that, it suffered a lot of concerns, stresses, and problems associated with the fact that some parts of the euro area, particularly Italy and Greece, have proven poor performers that have actually threatened financial crisis. On top of that, they haven’t come up with the unified, fully-integrated financial and capital markets that we have in the States. So for all those reasons, after its share in global financial transactions rising for a bit with the creation of the euro at the end of the ’90s, it’s kind of flattened out and doesn’t seem to have much promise. So anyway, as I say, the euro could have its separate pole of activity in a multipolar world, unlikely to dislodge the dollar.

The next candidate, of course, is the Chinese RMB, and people talk a lot about that, both because China’s a very rapidly growing economy with the potential—though it remains unclear if it’ll be realized—to overtake the US economy. And on top of that, a very prominent role in the global trading system, more so than the United States. But if you recall the characteristics of a dominant currency I mentioned earlier, such that as the rule of law, the protection of foreign investors, a broad liquid, and deep financial markets, those are all characteristics that the Chinese economy lacks. And particularly given the somewhat anti-market, anti-foreign bias of the current stance of policy in the Chinese government, it seems unlikely that those drawbacks to a dominant currency are going to be reversed anytime soon.

Let me now go to the final set of currencies you mentioned, basically cryptocurrencies. Alright, starting with the true cryptocurrencies like Bitcoin: way too speculative to ever be an interesting store of value for many countries and many investors. So let’s put aside non-stable coin types of crypto assets.

Secondly, let’s move to stable coins. What are stable coins? They’re crypto assets whose value is linked to some safe asset so you don’t have to worry about its value bouncing around. Well, what do most stable coins invest in order to retain their value? It tends to be dollar assets. So even if the stable coin were to increase, it’s pervasiveness around the world would probably boost rather than reduce the use of the dollar in global financial markets.

And then finally, let’s talk about—going back to China—China’s e-CNY, its electronic currency which a lot of people feel could, in principle, dislodge the dollar in many third markets like Latin America, Asia and Africa. Let’s put it this way: An electronic currency is only as good as the government that issued it, and only as safe as the government that issued it, and for the same reasons that I think investors are unlikely to regard the Chinese currency as a good store of value, they’re unlikely to view the e-CNY, China’s electronic currency, as a good store of value either. Now, I should note as an aside that you could see these types of electronic currencies replacing the dollar partially in some functions, such as trade. And you could imagine, for trade purposes, the Chinese RMB, as well as the electronic version, or stable coin, replacing the US dollar in some regards. But in terms of the big stuff, like holding international reserves, I don’t see cryptocurrencies basically filling the dollar’s role.

How significant of a plus to the United States is this dominance, and is that overrated?

I think it’s material, to use an ambiguous phrase that I think Greenspan used to use a lot, but not huge, and probably overrated. There’s a number of benefits that the United States garners from having a dominant dollar, which I think are obvious. First, we get some seigniorage revenues because people use US cash dollars for both the store value and in their transactions in other countries without having to pay interest, as if, alternatively, they held US bonds. My calculation suggests that that represents a very small fraction of US GDP.

It’s also likely the case that, because of the dominant role of the dollar, there’s a high demand for US treasuries, and that lowers the interest rate that the US Treasury pays on those bonds, compared to if the dollar was not so dominant. It’s a little bit unclear exactly what the savings are from the Treasury being able to issue bonds in a dominant currency. My guess, if you’re looking at a comparison of real treasury yields issued by the States, compared to in Japan and Germany, that the benefit that our country derives, in terms of lower interest rates, is there, but it’s not large.

A third possibility that people point to is that, because the dollar is a dominant currency, and because people want the dollar, it’s value becomes higher, that leads to a current account and trade deficit, which basically means in order to acquire dollars, the rest of the world is willing to pay us for them and export more goods to us than we export to them. I think there’s something to that, I think there’s a small benefit coming from that. But, on the other hand, from the standpoint of employment and exports, our country suffers as a result of this dominant dollar.

And then the final point is, because so much of the world’s trade is denominated in dollars that means that when our exchange rate bounces around, we have a smaller impact on the prices of our imports, and thus inflation, than will be the case for other countries. Again, a small benefit, not huge.

Well, you briefly mentioned it: If not an exorbitant privilege, if it’s maybe just a privilege, is it an exorbitant burden, or maybe just a burden because of the job impact, that the over-valued dollar disadvantages US manufacturing? There seems to be some focus on that in politics right now.

There is a focus on politics on that issue. I think it’s probably overrated as a key issue, and kind of the easiest way to think about it is the fact, that compared to the 1950s and ’60s, we now have a much larger trade and current account deficit as a share of our economy than we had many decades ago. And yet, our unemployment rate is in the neighborhood of its lowest levels in many decades, so clearly we can maintain employment—and productive employment—and growth without the need for a near-balanced trade in current accounts.

Yet there is talk in the Trump campaign about ways to devalue the dollar, should they devalue the dollar—I don’t know if that’s something former president Trump is interested in, but it seems there’s some advisors who are talking about that in a possible second term. What is the risk and benefit of doing that? And how do you do that, exactly? Do you do it on your own? Do you need to talk to our allies and we all start buying and selling dollars? How does that process . . . how would that even work?

Let me just say as an aside, you read a lot of these articles, but they rarely name these advisors by name. It’s a little bit unclear where all this is coming from. But, to the point, if a government wanted to devalue its currency, the most obvious way that it could do that would be by lowering interest rates, and so the Trump administration could not do that alone. It would have to encourage, or convince, or coerce the Federal Reserve.

There might be a plan for that too, I hear! There might be a plan to perhaps make that a lower barrier.

There might well be. I think I’ve said what needs to be said there, but let just say that if Trump administration were able to lower the independence barriers of the Fed so as to browbeat it in order to reduce interest rates, in order to devalue the currency, the devaluation of our currency would be the least of our problems compared to the massive hit to the credibility of our monetary policy and the stability of our prices that would occur in that situation.

Is there some other way to do it that would not involve the Federal Reserve, that we could come to an agreement with other major economies or something like that? Or is it only really through the Fed?

Well, there’s a couple of options besides brow the Fed that the Trump administration could have. One of these is it could, either unilaterally or in cooperation with our allies, or whatever allies were remaining, to basically pursue intervention foreign exchange markets. In other words, the Fed could sell dollars, and other governments with dollar holdings also sell dollars, buy other currencies, and in that way try to push the dollar down. Now, foreign exchange intervention without a change in interest rates here and abroad is not considered a very effective way of changing the currency. And it probably would not even work, given that, compared to the scale of international currency holdings and the size of international financial markets, the amount of actual reserves held here and abroad are not very large.

Didn’t we try something like that in the ’80s?

Exactly. So in the ’80s we pursued several agreements: Louvre Accord, Plaza Agreement, to do this foreign exchange intervention. That was at a time when I think there was more faith in the efficacy of foreign exchange intervention than there is today. And since then, almost all governments in most situations—I mean all advanced economy governments—have foresworn the use of foreign exchange intervention as a tool. It has been used actually rather recently by the Japanese, or so it has said, and even there it doesn’t seem that effective. But I’m just saying that’s a route they could go.

The alternative route, which actually seems a little closer to some of the chatter coming out of the Trump people would be to use a tariff policy. And, just as a mathematical nicety, an exchange rate devaluation can actually be approximated by a combination of higher tariffs and greater export subsidies. And so they’re already certainly talking a lot about higher tariffs. I haven’t heard as much talk about export subsidies, but the point is that that, too, would have the effect of raising the cost of imports, thereby potentially lowering those imports, maybe raising exports, and it would have some of the same effects as an exchange rate devaluation. Again, not a policy that most economists would embrace.

I just want to return to the point about—we talked Bitcoin or the euro and different potential competitors, but your point that if, you really want to devalue the dollar, if you don’t like it . . . run the government really, really bad, have a lot of debt ceiling crises, make people wonder about the soundness of our electoral system, the soundness of our legal system . . . That we can do. Maybe that’s the easiest way to devalue the dollar, is just run America in a way that we haven’t been running it.

Yes. That would be an excellent approach toward that.

That we seem fully capable of, perhaps.

Well that is the issue that my colleague Mark Sobel and I kind of flagged as most important in our paper that we wrote recently. Mark is an ex Treasury official. I’m an ex Fed official, so we think it would be a fun thing to collaborate. And we highlighted that the number one threat, and the most dangerous threat, to the dominance of the dollar would be continued very poor fiscal policies that led to excessive debt, eventually excessive inflation, a reduction in the vitality and of the US economy. All those things, especially if coupled with infringements on the rule of law, would be the things that indeed could dislodge dollar from its dominant position. And, as we noted in the paper, if that were to occur, the loss of the dollar’s dominant position would be the least of our worries.

And we of course will be linking to that paper. Maybe a little bit of a curveball question: I know down in Argentina they’ve talked about scrapping the peso and replacing it with the boring US dollar. Any thoughts on that? Is that something you’ve been thinking about, discussing? Any comments there?

I have many thoughts on that. And actually, where I come from on this is as a young economist at the Federal Reserve, back in the early 1990s, I was following Argentina during its hyperinflation, which obviously was not a good thing for children, and flowers, and others. And when that hyperinflation finally went away in the early ’90s, they replaced it with a currency board, basically a way to stabilize the exchange rate. And there was tremendous lip service being paid to getting rid of those fiscal deficits which were causing the inflation in the first place. And at that time I thought the Argentines had finally found religion, but I unfound that later in the decade. When those fiscal debits started getting bigger again, they had another financial crisis in the early 2000s, and I thought that was it. But then a more conservative, market-oriented president, Mauricio Macri, came back into power around 2015, and I thought “Finally, they have gotten religion,” but that went kablooey, too. So now, last year actually, their president, Javier Milei, ran on a platform of dollarization, and at that point I strongly supported it because I felt, “This is an economy, and this is a society, that cannot handle its own currency.” And so I actually wrote a note, while my colleague, Mark Sobel, wrote one saying they shouldn’t dollarize, they should just focus on getting the fiscal situation in order. And so we actually had a little steel cage match as an AEI webinar.

But to your point, right now, Argentina doesn’t have the money to dollarize, and you need dollars in order to buy out the amount of pesos in circulation. And the president is focusing its efforts at the moment, not on dollarizing, but on just reducing the fiscal deficit and getting inflation down. And so far he’s actually been getting a fair amount of traction. He has cut the deficit—although a lot of times through these one-time measures that might not be good on a sustainable basis. Inflation is coming down. The IMF has tentatively agreed to give it some more of the money as part of its program. So things could be looking good for a couple of years. My view is that, in order to prevent debt backsliding, as their situation gets stronger and as they can afford to do so, they should lock in those gains by dollarizing.

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