Talk about privilege. The dollar is not just the currency of the United States; it is what’s called the world’s “reserve currency,” where people and institutions park their money. But there’s concern that policies out of Washington could erode that status to the benefit of the euro and China’s currency, the yuan.
Among other things, the dollar’s value has been sinking: the dollar index is down 9.7% year to date.
Joining “Marketplace Morning Report” host David Brancaccio to discuss is a familiar voice on the program, Karen Petrou, managing partner at Federal Financial Analytics. The following is an edited transcript of their conversation.
David Brancaccio: One of the things that made the U.S. dollar the special world currency, the reserve currency, is, I think, a kind of predictability of governance in the United States. These days, it seems less predictable — tariffs on, tariffs off, tariffs delayed. There’s questions about the stability of the U.S. federal court system. You think that plays into the dollar as a reserve currency?
Karen Petrou: I think it does. It’s what the French once called an “exorbitant privilege.” It’s even better than special. It reduces the cost of the U.S. deficit. It reduces the amount of interest we need to pay to attract dollar investments, which helps to keep down the cost of borrowing. It makes international trade a lot more efficient for U.S. companies, because we have a lot less foreign exchange risk. It’s a really cool deal. And it gives the United States geopolitical power, because if our economy dominates the world through the financial markets, then nations really need to listen to us when it comes to issues like sanctions.
Brancaccio: We also have the independence of our central bank, the Federal Reserve, in play. That worries holders of our currency around the world.
Petrou: It really does, because the way people hold dollars is almost entirely in Treasury bonds. The United States issues $29 trillion worth of treasury bills to fund our deficit. So that’s a huge amount, and that’s one of the reasons the dollar is the reserve currency, but it is also such a big market that investors and traders really look to the Fed. And while they know the Fed isn’t always right, they trust the Fed to try to be right, and they bet based on the expectation of Federal Reserve interest rates. If these become highly political, they are more likely to be really wrong — but even more importantly, they won’t be anywhere near as predictable.
Brancaccio: Now, you’ve been speaking to groups about some of this. What are you telling them? “Keep an eye on this.” “Be very afraid.” What’s your overall message about threats to the U.S. dollar’s status as the world’s reserve currency?
Petrou: Fundamentally, currencies are confidence games. We all hold dollars, not because we think those green pieces of paper are worth anything, but because we trust the United States. Anything that threatens confidence threatens a currency’s status — and it would take a lot to dethrone the dollar’s reserve currency status — but it’s facing challenges that I don’t think were ever envisioned or thought possible just a few months ago.