In 1971, John Connally, Richard Nixon’s Treasury Secretary, told his counterparts in other major economies: “The dollar is our currency, but your problem.” When the dollar is strong, it creates financial and economic stress on the rest of the world.
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 used to. In 1960 they represented approximately 40% of world GDP; today it is less than a quarter.
In addition, two other currencies, the euro and the yuan, now serve economies comparable in size to the United States. And yet, the dollar continues to dominate international financial markets. When an emerging market economy borrows abroad, its debt is still largely denominated in dollars. The financial dominance of the dollar seems to give the US exchange rate (see page 12) – the value of the dollar relative to other currencies – enormous importance in the world economy. A recent article by Maurice Obstfeld and Haonan Zhou asserts that there is a global “dollar cycle”; when the dollar is strong, it creates financial and economic stress in the rest of the world. And the dollar has been very strong of late.
When the dollar is strong, it creates financial and economic stress on the rest of the world.
This power of the dollar hides three great mysteries. The first, and the least complex to break, is the fact that it remains dominant while the US economy has lost its pre-eminence. The second, more perplexing question is why the fluctuations in the dollar have such large global effects. Finally, it is necessary to understand why the dollar has appreciated so much during the recent period.
As for the first question, part of the answer lies in the role of history. Once a coin has reached[…]