LETTERS TO THE EDITOR

Summer 2010

by Paul Robinson

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Sir

Charles Wyplosz is right that the euro is a long way from dislodging the dollar. But he is wrong on other important points. He claims that “America’s use of the dollar as a formidable instrument for its own economic management has long excited international criticism and resentment”. But this isn’t the case. No one should object to the U.S. controlling its monetary policy, and the currency’s value is crucial for any central bank with a floating exchange rate.

The real concern is that America's political influence is disproportionate, while at the same time the size of external dollar holdings is a U.S. weakness with political implications – weaknesses are rarely ignored in international relations.

If investors are unhappy they aren’t showing it by selling their dollars. Although the U.S. has run a current account deficit for a generation, foreigners still lend to the country. And while people complain about U.S. policy they continue to peg their currencies to the dollar. The conclusion is inescapable: the U.S. provides a valuable service to the rest of the world.

Will the dollar survive as the world’s reserve currency? There are several factors worth noting. The dollar may dominate holdings but it doesn’t have a monopoly, and in the future its share is likely to decline. However, the dollar still underpins the global financial system. Despite the fact that the global financial crisis started in the U.S., international investors scrambled to buy dollars in the greatest flight to liquidity in decades. From mid-July 2008 until March 2009 the euro fell by more than a fifth against the dollar.

As Wyplosz emphasises, this was partly because the U.S. has the world’s deepest and most liquid markets. But it was also because the U.S. has monetary and fiscal credibility which is the sine qua non of a reserve currency and something that other countries can profit from. The ECB may be credible, but as the Greek crisis highlighted, political relations in the eurozone are fragile. Of course the U.S.’s credibility may not last forever, but for the moment it remains intact. The biggest risk is the monetisation of its huge fiscal debt – but the U.S. is not the only country with a large stock of debt.