Much of America’s dominance in world finance comes from the dollar’s status as international money. America’s commitment to free capital markets, the rule of law, and price stability confer credibility on the dollar as a store of value. But American spending habits have undermined the dollar’s reputation, with the excess supply of dollars on world markets depressing its price. This spring, the euro’s exchange rate against the dollar reached an all-time high, and central banks have increased the euro share of their international reserves. Is the dollar about to lose the crown of world finance to the euro?
History suggests otherwise, despite a vulnerable dollar.
American financial supremacy in the twenty-first century resembles Britain’s position in world finance a century ago. Before the outbreak of World War I in August 1914, the pound sterling served as the currency of choice for international transactions, just as the dollar does today, and the world’s borrowers visited the City of London to raise capital.
The British economist John Maynard Keynes worried that countries would not use sterling to settle trading balances with each other if the pound were not viewed as a reliable store of value. The “future position of the City of London,” according to Keynes, depended on the pound sterling continuing to serve the business world as the equivalent of gold. Britain maintained the pound’s convertibility into gold at the outbreak of the Great War to preserve its credibility as the international medium of exchange.