There’s been some chatter lately about the dollar’s status as the reserve currency. Some (including Krugman) have tried to downplay its significance. I think any such analysis is wishful thinking at best and political pandering more likely.
Why does the “exorbitant privilege” matter? There are two crucial pieces that I credit the Richard Duncan and David Stockman books with helping me to understand. It matters because the dollar is the currency of settlement in international trade. And, relatedly, because the export/mercantilist economies need to buy dollar reserves and assets in order to keep their own currencies weaker.
For example, in the case of the former, China wants to by a barrel of oil from Saudi Arabia, but they need to go out in the market and buy some dollars in order to effectuate the transaction (all of which makes some of the recent moves by countries to conduct trade in gold or Renminbi interesting). With the latter, the Chinese peg the Renminbi to the dollar in order to keep their own exports cheaper for and more attractive to U.S. consumers. As should be clear, both create a demand for dollar assets – that presumably helps to keep interest rates lower, allowing the American government to run large deficits and sell debt, and American consumers to lever up and buy more stuff.
One can only wonder what might happen if the status quo were to change.
