February

21-22
2014

Past Event

The continued dominance of the dollar

Friday, February 21 - Saturday, February 22, 2014
Brookings India
2nd Floor

No. 6 Dr. Jose P. Rizal Marg
New Delhi
110 021

Content from the Brookings Institution India Center is now archived. After seven years of an impactful partnership, as of September 11, 2020, Brookings India is now the Centre for Social and Economic Progress, an independent public policy institution based in India.

Following the launch of his latest book The Dollar Trap: How the U.S. Dollar Tightened its Grip on Global Finance, Professor Eswar Prasad, Senior Fellow, Brookings Institution, presented his findings at an event hosted jointly by Brookings India and ICRIER. Dr. Subir Gokarn, Director of Research, Brookings India; Dr. Jaimini Bhagwati, RBI Chair at ICRIER; and Abheek Barua, Chief Economist, HDFC, served as discussants, and responded to the points raised by Professor Prasad. The discussion was attended by economists, journalists, policymakers, and representatives from international organizations.

The U.S. Financial System Retains its Safe Haven Status:

Professor Prasad explained how the economic crisis notwithstanding, the U.S. financial system retains its “safe haven” status, causing the dollar to remain the world’s reserve currency. With the onset of the global financial crisis in 2008, the U.S. built up debt, with privately held debt increasing by $5.5 trillion. The U.S. financial system was the epicenter of the global financial crisis, with the aftermath leading to a massive expansion of the U.S. government debt coupled with liquidity injections by the Federal Reserve. Such actions, normally, would lead to a loss of confidence amongst investors’ desires to hold the dollar. However, what actually happened was the opposite – the position of the dollar actually strengthened, and the dollar’s value is the same as it was in 2007.

Professor Prasad explained this phenomenon, stating that the financial crisis led to an increased demand for safety among foreign investors. This increased demand for safety caused more money to enter the U.S. for protection, thereby causing the U.S. to become a “safe haven” for foreign investors, particularly those from emerging markets.

Strong Institutional Structures:

Even today, the US system is seen to be reliable, owing primarily to the strong institutional structures in place. Consequently, even though the U.S. was situated at the center of the financial crisis, it remains an attractive destination for emerging market investments.

A manifestation of the dollar continuing to be the most powerful currency in the world is that the ramifications of the U.S. Federal Reserve Bank’s policy actions can be seen around the world, and not just the US. What the U.S. Federal Reserve does to interest rates, does not just impact the United States, but also the entire global economy – this is because the U.S. dollar continues to tighten its grip as the world’s reserve currency. Foreign investors have an incentive to keep the dollar afloat, even when the value of the currency declines – this is what Professor Prasad calls the “Dollar Trap”.

Absence of an Alternative:

While there are many reasons for the dollar to lose its position as the global reserve currency – with new rivals emerging in the Euro and more recently the Chinese renminbi – good institutional structures play a key role in the dominance of the dollar as the reserve currency. The dominance of the dollar in global finance is not a story of “American exceptionalism,” but one about relativeness – it is hard to think about a dollar alternative. One of the main reasons that the Chinese renminbi is unable to compete is the lack of trust in the Chinese institutional structures. Similarly, for the Euro to compete with the dollar, the Eurozone would need to see more monetary and fiscal integration. Eventually then, the questions remains – if not the dollar, then what? If countries had a good mix of policies with good financial markets, there would be no need for a reserve currency, or the other alternative could be to have more reserve currencies. Such systems, however, are not a real possibility hence, the dollar at the moment is the best bet and will continue to dominate global finance.