Exorbitant Privilege: US Dollar

The financial community of the world is at a consensus that the current economic system provides the United States government with exorbitant privileges. This means that the system does not treat all countries equally. Rather it provides an unfair advantage to the United States because the dollar is the reserve currency of the world.

The Infamous Comment

In 1965, The French President General Charles De Gaulle referred to the dollar having “exorbitant privilege” while addressing a press conference. The view presented by Charles De Gaulle was that the United States government was receiving excessive privileges even though many economists think that the dollar should ideally be considered to be obsolete given the decline in the United States economic prowess and the rising price of gold at that time.

Chinese President Hu Jintao has recently described the dollar as being a “product of the past”. Also, French President Nicolas Sarkozy has continued the French tradition by criticizing the dollar. In this article, we will have a closer look at why the world considers that the Americans and the dollar have an unfair advantage given the way the current monetary system has been structured.

The Exorbitant Privilege Explained

The dollar is the reserve currency of the world. This means that it has replaced gold as being the standard mechanism of exchange between currencies. Let us say for example that India and China trade with each other and as a result India owes China $100. Notice the fact that India owes China money in dollars and not in rupees! In fact the Chinese would not accept payment in rupees. They would only accept payment in dollars. This is because once they receive the payments. They have to use the proceeds to buy gold, oil and such essential commodities from the foreign markets. Since these commodities are traded in dollars, all balance of payment differences are settled only in dollars.

Now, if the United States wants to settle its current account deficits, it faces many advantages as compared to other countries:

  • Firstly, it can just keep on buying whatever it wants and when the time comes to pay the proceeds, United States can print up dollars and make the payments. While doing so, they are essentially stealing value from anyone who holds the United States dollar. Secondly, other countries around the world cannot simply create money to settle their current account deficits. This is a privilege that accrues to United States because of the dollars status as the reserve currency.

  • Secondly, the money that is paid out to settle the debts, more or less ends up with the United States central bank again! One country settles its debt with another and so on till the dollar finally returns to its true home i.e. the Federal Reserve.

  • Lastly, since the dollar is a reserve currency, everyone needs them. This creates an artificial demand for dollars. Also, when people have dollars they try to invest it in the safest dollar denominated asset there is i.e. the United States treasury bonds. Since so many investors want to invest in the United States treasury bonds, the yields of these bonds are reduced and as a result the United States government can borrow money much cheaper from the world than it otherwise could. The American government has taken full advantage of the hegemony as they currently borrow to the tune of more than $2 billion daily.

Repercussions

Since the United States dollar enjoys this privilege, there are many advantages that accrue to it as a result.

  • For instance, the United States has no requirement to devalue its currency and make its exports attractive. It can continue importing without needing to ever resolve its balance of payment deficits.

  • The United States also does not face the inflation that comes as a result of printing more currency. They can buy the goods. However, the currency they print is held by their own central bank or the central banks of foreign countries.

  • Also, the United States government has no need to rationalize its spending. This is because it can obtain artificially cheap credit as a result of the dollar being the reserve currency. This may not be such a good thing as it has encouraged the government to get in debt up to their eyeballs.

Why Does the Privilege Continue ?

Now, the question arises that the world is aware of the exorbitant privileges being awarded to the United States, then why is it not stopped?

Well, the answer lies in the fact that the dollar has not faced any significant competition. Currencies like the Japanese Yen and the Great Britain Pound are weaker and have worse economic fundamentals as compared to the dollar. The Euro has only emerged in 1999 and the crisis that has followed ever since makes it a very weak competitor for the dollar.

The Special Drawing Rights (SDR) system launched by the International Monetary Fund (IMF) also has not gained much traction. Therefore, at the moment the world does not seem to have a viable alternative.

However, many experts have predicted that the current system is skewed in the favor of the United States and is unsustainable. Therefore, sooner or later an alternative will have to emerge to correct this imbalance that has been continuing since the Nixon shock in 1971!


❮   Previous  Article Next  Article   ❯

Authorship/Referencing - About the Author(s)

MSG team comprises experienced faculty and professionals who develop the content for the portal. We collectively refer to our team as - “MSG Experts”. To Know more, click on About Us. The use of this material is free for learning and education purpose. Please reference authorship of content used, including link(s) to ManagementStudyGuide.com and the content page url.

Forex Markets