The dollar dominance has been a matter of controversy since the last decades of the 1900s. IMF reports show that the Dollar's share in the global foreign exchange reserve fell from 70% in 1999 to 59%. This article will cover Paul Krugman's (noble economics laureate) interesting comments about dollar dominance. He states that firstly, the dollar dominance will remain due to specific feedback loops and secondly that even if the USA dollar declines, it doesn't matter. Both extremely controversial statements said with an assertiveness that we will investigate cautiously.
Firstly, what feedback loops maintain USD dominance even when the USA's economic commanding position has been declining for a while? The first feedback loop is that it's easier for countries to exchange using the Dollar. For instance, for Malaysia and Bolivian, many more people want to exchange bolivianos and ringgits for dollars rather than vice versa. So, it's easier and much cheaper to do bolivianos and ringgits transactions indirectly using the Dollar, avoiding having to exchange currency multiple times. This set of indirect exchanges Krugman says reinforces the USA dollar advantage. Another feedback loop is that many goods are priced using the Dollar, "dollar assets have predictable purchasing power. This reinforces demand for these assets, making it cheaper to borrow in dollars than in other currencies". This also sets another feedback loop: businesses will start pricing goods using the Dollar to reduce risks reinforcing the currency advantage.
The first feedback loop is shaky. As professor Eswar Prasad mentioned in his famous book, the 'dollar trap' is that cross-border transactions are ever becoming easier due to technological development. As such, the use of the Dollar as a means of exchange will probably further decline. However, the second feedback loop is valid as many goods such as USA government securities are priced using dollars which investors often use to safeguard investments. In addition, export-led Emerging economies continually use the Dollar to protect themselves from volatile capital flows allowing the US dollar to maintain dominance.
However, as stated by Professor Eswar Prasad, we must understand that complex politics drives financial currency more than sheer economics. As such several political scenarios can lead to the decline of USD dominance even if the US dollar is considered a safeguard for economic interest. For instance, the belt road initiative or future alliance by major financial players, etc, could quickly diminish the US dollar's role, power, and dominance.
Krugman's last statement that even if US dollar dominance falls, it doesn't matter is entirely erroneous. As we have seen, having your currency as the dominant one is a highly lethal weapon that is constantly used for political gains. Read "America's Misuse of Its Financial Infrastructure" by the national interest for more. In addition, it gives the US what is labelled as 'exorbitant privilege' such as not having to pay exchange fees, allows the US to finance large current account deficits, the seigniorage it gains from circulation etc.
