The dollar: still No. 1

| May 05, 2023

About two years ago I made the mistake of getting into an argument with someone who believed that cryptocurrency was the future. Pro tip: Never argue with the crypto crowd. They have more time and energy than you do to spend on their cause.

This particular crypto trader argued that the dollar’s demise, if not imminent, was a possibility. What then? I think the trader was taking the stance from a doomsday perspective—some gold investors have the same perspective. But economists have questioned whether the U.S. dollar would remain the world’s reserve currency of choice. Alan Greenspan, head of the Federal Reserve, even questioned the dollar’s status in a 2004 speech.

There have been periodic concerns about the world’s appetite for the dollar. But no other currency has been able to replace it. The euro was weighed down by Greece’s financial collapse and Brexit. Japan’s relatively low growth and maturing population—it loses one person a minute—holds back the yen. Globally there’s distrust in China’s so-called surveillance capitalism, preventing the renminbi’s ascent.

Meanwhile, the U.S. dollar has remained the top reserve currency. There are two lessons here. One, our institutional strength as a country forms a strong backbone for the dollar. This comes in the form of a rule of law, vigorous intellectual property rights, and separation of power in government.

Two, don’t underestimate the network effect. It’s real and it’s spectacular. The network effect, in short, occurs when a good or service gains in value as more people use it. If you’re going to put clothing up for auction, for example, you’ll likely use eBay because everyone else uses it.

And the dollar enjoys a strong network effect. It’s by far the top currency bought and sold in global foreign exchange transactions. When foreign debt is issued in a currency other than the home currency, the bonds are likely in the U.S. dollar. And there’s a lot of U.S. paper currency floating around overseas.

So why do we care about the U.S. dollar’s status? One reason is that it helps our economy. The government can borrow at favorable rates relative to other countries, supporting domestic growth and development. Other benefits is that the currency we’re using is highly liquid and trusted to hold its value, helping businesses that do business around the world.

One related misconception, by the way, is that most U.S. government debt is owed to foreign entities such as China and Japan, which raises concerns if they decide to sell their bonds en masse. The reality is that most U.S. debt is held domestically.

We’re in a highly competitive global economy, so the dollar will have its challenges in both the short term and long term. But a history of stability, liquidity, and strong government backing (not enjoyed by cryptocurrencies) counts for something.