The Global Domain of the Dollar: Eight Questions

Since the late 1950s, the rest of the world has come to use the dollar to an extent that justifies speaking of the dollar’s global domain. The rest of the world denominates much debt in U.S. dollars, extending U.S. monetary policy’s sway. In addition, in outstanding foreign exchange deals, the rest of the world has undertaken to pay still more in U.S. dollars: off-balance-sheet dollar debts buried in footnotes. Consistent with the scale of dollar debt, most of the world economic activity takes place in countries with currencies tied to or relatively stable against the dollar, forming a dollar zone much larger than the euro zone. Even though the dollar assets of the world (minus the United States) exceed dollar liabilities, corporate sector dollar debts seem to make dollar appreciation akin to a global tightening of credit. Since the 1960s, claims that the dollar’s global role suffers from instability and confers great benefits on the U.S. economy have attracted much support. However, evidence that demand for dollars from official reserve managers forces unsustainable U.S. current account or fiscal deficits is not strong. The so-called exorbitant privilege is small or shared. In 2008 and again in 2020, the Federal Reserve demonstrated a willingness and capacity to backstop the global domain of the dollar. Politics could constrain the Fed’s ability to backstop the growing share of the domain of the dollar accounted for by countries that are not on such friendly terms with the U.S.

Banking, Trade, and the Making of a Dominant Currency*

We explore the interplay between trade-invoicing patterns and the pricing of safe assets in different currencies. Our theory highlights the following points: (i) a currency’s role as a unit of account for invoicing decisions is complementary to its role as a safe store of value; (ii) this complementarity can lead to the emergence of a single dominant currency in trade invoicing and global banking, even when multiple large candidate countries share similar economic fundamentals; (iii) firms in emerging-market countries endogenously take on currency mismatches by borrowing in the dominant currency; and (iv) the expected return on dominant-currency safe assets is lower than that on similarly safe assets denominated in other currencies, thereby bestowing an “exorbitant privilege” on the dominant currency. The theory thus provides a unified explanation for why a dominant currency is so heavily used in both trade invoicing and in global finance.

The International Monetary and Financial System

International currencies fulfill different roles in the world economy, with important synergies across those roles. We explore the implications of currency hegemony for the external balance sheet of the United States, the process of international adjustment, and the predictability of the US dollar exchange rate. We emphasize the importance of international monetary spillovers and of the exorbitant privilege, and we analyze the emergence of a new Triffin dilemma.

The Dollar and the United States' Exorbitant Power to Sanction

With the Trump administration's reimposition of financial sanctions on Iran, the power of the weaponized dollar is yet again making headlines—and putting distance between the United States and its allies. The dollar's special status as the world's key currency affords the United States an unrivaled sanctioning power. Because access to dollars is a near-necessity for multinational businesses and financial institutions, the United States can unilaterally impose costly sanctions by denying such access to a target—whether a state, company, or individual. This capability is one form of the “exorbitant privilege” afforded to the United States by the dollar's international role. This essay considers why the dollar's status affords the United States this sanctioning power and how the United States exercises it. I first summarize the nature of the dollar's role. Next, I explain the means by which the United States has weaponized that role, especially through financial sanctions. I conclude by offering some potential limitations on that power and exploring the ways in which other countries might seek to erode it.