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These completely unexpected consequences of the dominance of the dollar


In 1971, John Connally, Richard Nixon’s Treasury Secretary, told his counterparts in other major economies: “The dollar is our currency, but your problem. The background – the slow decline of the Bretton Woods monetary system – is ancient history.

But it’s remarkable that the formula still rings true after all these years. I say “remarkable” because the United States no longer dominates the world economy as it once did. In 1960, they accounted for roughly 40% of world GDP; today it is less than a quarter.

In addition, two other currencies – the euro and the yuan – now serve economies of comparable size to the US. And yet, the dollar remains dominant on the international financial markets. When an emerging market economy borrows abroad, its debt is still very much denominated in dollars. The financial dominance of the dollar seems to give the American exchange rate (see page 12) – the value of the dollar in relation to other currencies – enormous importance in the world economy. A recent paper by Maurice Obstfeld and Haonan Zhou asserts that there is a global “dollar cycle”; when the greenback is strong, it generates financial and economic stress in the rest of the world. And the dollar has been very strong in recent times.

When the greenback is strong, it generates financial and economic stress in the rest of the world.

This power of the dollar conceals three great mysteries. The first, and the least complex to break through, is the fact that it remains dominant while the American economy has lost its preeminence. The second, more puzzling question is why dollar fluctuations have such large global effects. Finally, we must understand why the dollar has appreciated so much during the recent period.

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