After the dollar
It’s unclear whether we are bound for a Post-American World in the near future, but it seems pretty clear that we are bound for a world in which the US dollar is no longer the unique ‘reserve currency’. The combination of chronically large trade and budget deficits and willingness of the US monetary authorities to tolerate sustained inflation means that decisions by national central banks to hold US dollar reserves are now driven by a desire to preserve the existing order rather than by calculations of risk and return. In the long run this can’t be sustained.
If the US dollar can no longer satisfy the requirements of a reserve currency, what are the alternatives? I can see two possibilities.
The first is the euro. At current exchange rates, which seem likely to persist for some time, the eurozone is the world’s largest economy. And the euro share of reserves has been growing. Still, neither of these, in isolation, would be enough to allow the euro to achieve the kind of dominance that characterized the dollar in the early postwar period (or, before that, the pound sterling). In each case, these currencies combined economic hegemony with imperial power.
The eurozone may be the worlds largest economy, but the EU is not an economic hegemon. Europe is a postmodern kind of empire, so the possible rise of the euro would not follow the flag as om the past. What’s more likely is the euro equivalent of dollarization, with the eurozone potentially expanding beyond the EU, along with a growing penumbra of currencies pegged to the euro or targeting a euro exchange rate. This would in turn encourage countries outside the euro area to hold euros as foreign exchange reserves. All of this would be of a piece with the differentiated expansion that has characterized European institutions of all kinds.
The second possibility is a world without a reserve currency. If the decline of the US dollar continues, we might see gradual diversification into euros and pounds, renewed holding of the yen as Japan recovers and, with the relaxation of exchange controls, increased holdings of rupee and yuan. In principle, given modern computing resources, there should be no problem in quoting prices in six different currencies simultaneously, or in one or more baskets of currencies.
Update Much the same thoughts from Peter Goodman in the NYT