Unit of Account, Store of Value, Means of Exchange - and Diplomatic Tool

The dollar’s global status is not at risk, but that doesn’t mean more can’t be done to sharpen it as a tool of U.S. foreign policy

Photo by Wilhelm Gunkel on Unsplash

Let’s be clear: if the dollar loses its reserve status in the global economy, it will be the last thing Americans will need to worry about.  Should the renminbi or some crypto alternative emerge one day as the world’s preferred unit of account, store of value and medium of exchange—the three principal uses of any currency--then much will have already gone wrong with America’s political institutions, military strength and economic vibrancy.

But if the dollar reflects America’s persistent strengths relative to the competition, it’s also a crucial tool of U.S. policy that is in urgent need of sharpening.  More transparent sanctions practices, less burdensome enforcement of anti-money laundering rules and a more welcoming embrace of emerging digital options would make U.S. financial diplomacy much more effective.

First, a quick update on the dollar’s status.  While China and Russia have been working hard to develop alternatives, the IMF doesn’t see significant shifts in dollar usage in reserves, trade finance or transactions.  True, data show the dollar now accounts for 59% of global reserves, down from 71% in 2000.  But its share was 58% in 1980 and 62% in 1960, so the long-term levels are roughly flat.  (For a cool visualization of the dynamics since 1899 (!) click here.)

The recent decline in U.S. dollar holdings mainly reflects small gains for smaller non-reserve currencies: China’s renminbi, South Korea’s won and the Australian, Canadian and Singaporean dollars.  This seems to reflect more interest in reserve diversification than fleeing America’s dysfunctional political system, runaway debt or expanding web of financial sanctions.  None of the gainers, including China, represents more than 3% of global reserves.

Many reserve managers have, indeed, boosted their gold holdings, but this trend has been underway since the global financial crisis.  A recent OMFIF survey of 73 central banks with $5.4 trillion in assets reveals that while geopolitical concerns are rising, a third of the respondents expect to increase their dollar exposure, more than any other currency.

The fact remains that if you're the finance minister of any developing or mid-sized country, the lessons of the last decade are clear. To grow your economy and tap into the world's markets, you still need to hold lots of dollars and have easy access to dollar financing. If you want to protect your country from whatever the next global crisis may bring, reserves of renminbi or euros won’t help much.

Political polarization and fiscal profligacy clearly pose risks to the dollar’s attractiveness, but consider this thought experiment.  If you had to hold all your assets in either a country with balanced budgets and civil debates or a country that consistently produces the world’s latest technologies for its leading companies, it’s not much of a choice.

Naturally, there’s still room for improvement on all the things that actually drive growth and innovation from infrastructure and education to taxes and immigration.  But if the dollar’s reserve status is a reflection of the country’s long-term political and economic attractiveness, it’s also a tool in Washington’s foreign policy kit that needs continuous upgrading. 

Above all, Washington’s deployment of financial sanctions is often reactive and poorly coordinated with other economic measures like tariffs, export controls and investment reviews.  Military leaders work tirelessly to refine doctrines that define which weapons work best under what circumstances.  But most U.S. financial sanctions are deployed as a reaction to some outrage, without a comprehensive analysis of how they can be most effective in concert with export controls, travel bans or investment restrictions.  More importantly, while Washington knows all too well how to add sanctions for bad behavior, it’s far less good at gauging when to remove sanctions as a reward for more cooperation.

Second, while dollar sanctions have been transformative in the battle against money laundering and terrorist finance, the layers of controls and regulations involved have added billions to financial industry costs without necessarily boosting effectiveness.  While the United Nations guesses that terrorist and criminal flows may reach $2-5 trillion per year, several equally heroic estimates suggest that less than 1% is actually captured.

Third, political hostility among some American politicians toward a digital dollar risks leaving the U.S. currency handicapped as distributed ledgers expand the promise of cheap, secure and direct transfers.  Worse, it keeps the dollar from incorporating new technologies that might strike a better balance between privacy and national security or reliability and innovation. 

Leveraging access to the dollar won’t change the world, but the promise of continued participation in the deepest and most sophisticated financial markets has bolstered cooperation among America and its allies.  Denying access has also punished more than a few bad actors.  What remains the most desirable global currency still offers powerful leverage if U.S. policymakers make sure to refresh how they deploy it.