Still the Lingua Franca: The Exaggerated Death of the Dollar

Reports of the dollar's death have been greatly exaggerated. It is of course true that the value of the U.S. currency has fallen against the Japanese yen and Deutsche mark recently. It is also true that some measures of the dollar's use as an international currency show a decline. These are long?running trends, however. There is little evidence so far of an abrupt acceleration or tipping in the use of the dollar. In particular, and contrary to widespread belief, the dollar's standing as a reserve currency has actually increased in the 1990s. Furthermore, there is little likelihood that some other currency will supplant the dollar as the world's premier reserve currency by 2020. One national currency or another must occupy the number?one position, and there is simply no plausible alternative.

There is a nice analogy with the international use of the English language. Nobody would claim that English is particularly well suited to be the world's lingua franca by virtue of its intrinsic beauty, simplicity, or utility. Yet it is certainly the language in which citizens of different countries most often converse and do business, and increasingly so. One chooses to use a lingua franca, as one chooses a currency, in the belief that it is the one others are most likely to use.

Similarly, it is not that the dollar is ideally suited for the leading role. It has some characteristics that mar its appeal. Most important, the United States is a debtor country with a large deficit and few signs that it is getting its profligacy under control. But an international currency is one that people use because everyone else is doing it. Three of the four determinants of reserve currency status--economic size, developed financial markets, and historical inertia--support the dollar. The fourth factor--confidence in the value of the currency--could in principle disqualify the dollar if the Federal Reserve launched a high?inflation strategy, but that is unlikely to happen.

THE BANKROLL

A reserve currency is one in which central banks choose to hold their foreign exchange reserves. Use as a reserve currency is one important aspect of being an international currency, or a currency used outside its home country. As a percentage of total reserves, the dollar declined gradually in the 1970s and 1980s (see graph). The mark's share increased gradually over the same period. The yen's share also increased, starting from very low levels in the 1970s.