The Unloved Dollar Standard

The US dollar's role as international anchor is faltering, as emerging markets become frustrated by the Fed’s near-zero interest-rate policy and the US protests other countries' exchange-rate policies, especially China's. But such conflicts are generating ill will, while shrouding the real problem: America's huge fiscal deficit.

PALO ALTO – Since World War II’s end, the US dollar has been used to invoice most global trade, serving as the intermediary currency for clearing international payments among banks and dominating official foreign-exchange reserves. This arrangement has often been criticized, but is there any viable alternative?

The problem for post-WWII Europe, mired in depression and inflation, was that it lacked foreign reserves, which meant that trade carried a high opportunity cost. To facilitate trade without requiring payment after each transaction, the Organization for European Economic Cooperation created the European Payments Union in 1950. Supported by a dollar-denominated line of credit, the EPU’s 15 Western European member states established exact dollar exchange-rate parities as a prelude to anchoring their domestic price levels and removing all currency restrictions on intra-European trade. This formed the keystone of the hugely successful European Recovery Program (the Marshall Plan), through which the US helped to rebuild Europe’s economies.

Today, most developing economies, with the exception of a few Eastern European countries, still choose to anchor their domestic macroeconomic arrangements by stabilizing their exchange rates against the dollar, at least intermittently. Meanwhile, to avoid exchange-rate conflict, the US Federal Reserve typically stays out of the currency markets.

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