The Corner

Economy & Business

The Downside of the Dollar’s Reserve-Currency Status

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Martin Sandbu of the Financial Times posits that President Donald Trump’s decision to withdraw from the Iran deal could greatly diminish America’s economic power. Sandbu’s story is a bit involved, but the short version is that if the U.S. decided to bar companies that do business with Iran from using the U.S. financial system and dollar transactions, European governments might decide to build up an alternative global payment and settlement system. Though he acknowledges this would take “more nerve and assertiveness than Europeans have mustered till now,” Sandbu ends his column on a chest-thumping note, warning that Trump’s America First approach might herald the end of the U.S. dollar’s role as the world’s reserve currency. And that would be a disaster, or so he leads us to believe.

But there is another possibility Sandbu neglects, namely that the so-called exorbitant privilege of supplying the world’s reserve currency is in fact an “exorbitant burden,” as veteran China-watcher Michael Pettis has argued on numerous occasions. For a good distillation of this line of argument, see Gwynn Guilford and Corinne Purtill in Quartz. Supplying the world’s reserve currency ensures that the U.S. always has access to cheap financing. However, as a modern market economy, the U.S. has more than enough savings to fund productive investments. So where does the cheap financing go? Guilford and Purtill observe that it contributes to credit-backed consumer and asset bubbles, as seen during the subprime housing bubble. Moreover, they point to the fact that inflows of foreign capital push up the value of the dollar, which in turn makes the U.S. tradable sector less competitive than it would be otherwise. According to Pettis, the dominant reserve-currency status of the dollar has proven extremely destabilizing for the U.S. economy, which is why other major economies have resisted rather than embraced the prospect of sharing in America’s dubious “privilege.”

There are many good arguments against Trump’s decision to withdraw from the Iran deal, e.g., Kenneth Pollack’s nuanced case that we ought to have pressured Iran on other fronts with an eye towards degrading their strategic position before pressing to revise the deal in concert with our allies. But if his decision leads Europe’s fiscal and monetary authorities to share in the “exorbitant burden,” as Sandbu suggests it might, it would be cause for celebration. Let’s hope the Europeans muster the necessary nerve and assertiveness.

Reihan Salam is president of the Manhattan Institute and a contributing editor of National Review.
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