13. The Future of the Key Currency System
June 9, 2011
Is there any mechanism within global capitalism at present that can prevent the outbreak of a dollar crisis? The answer, unfortunately, is no. This is because of a basic dilemma at the heart of the present monetary structure of global capitalism: One country’s national currency is used as the key currency of the entire world. There is no guarantee that what is best for the US is best for the world, and vice versa . 
There is a great advantage to being a key-currency country. Even if a Japanese manages to use yen to buy something from a German, for example, those yen will probably be used right away to buy something from Japan. This is because the yen is not the key currency. If, by contrast, an American uses dollars to buy something from a Japanese or a German, at least a part of those dollars will continue to circulate around the world and not return to the United States for a considerable period. This means that the Americans as a whole have been able to purchase that amount in commodities from other countries without providing any US-produced commodities in return. This “free lunch” is nothing but the “seigniorage” that comes from being the key-currency country. According to one (rough) estimate, 85% to 90% of the US currency in circulation is held outside the United States, and since the current stock of US currency is about $750 billion, this amounts to roughly $640 billion to $680 billion.  Perhaps more importantly, the dollar’s position as key currency endows dollar-denominated securities with more liquidity than securities denominated in other currencies. This allows US financial markets as a whole to borrow short and lend long as if they were banks to the world and to earn the difference between long/short interest rates.  This is “seigniorage” in the broader sense.  I believe this broader seigniorage must be much larger than the narrower one, though there seems to have been no attempt to estimate its magnitude.
The original meaning of “seigniorage” was “king’s privilege,” originating from the chartalist theory of money dominant in medieval Europe. But privileges are the bedfellows of abuse. The key-currency country faces a great temptation—the temptation to issue its currency in excessive amounts or let its financial sector expand its leverage ratio in excessive proportions. There can be no greater temptation, since the more dollars circulate around the world and the more dollar-dominated securities are sold to the rest of the world, the more the US stands to gain in seigniorage, in both narrow and broad senses of the term. But if it ever actually succumbed to this temptation, it would trigger a dollar crisis, not only depriving the United States of its status as the key-currency country but bringing global capitalism itself to a halt.
Hence the basic lesson: being key-currency country imposes a global responsibility on the behavior of that country. Even though the key currency also acts as its own nation's national currency, it must be managed while taking the interests of the whole world into account. Though the Nixon shock was an attempt to relinquish the dollar’s key currency status for the sake of domestic advantages, the United States has gradually come to recognize the advantage of being the key-currency country. During the Cold War years, it could act with a sort of self-discipline as the leader of the capitalist camp. But as the Cold War ended in 1991, Japan suffered a lost decade during 1990s, and European countries were busy setting up the euro zone during 1990s, the US economy seemed in the eyes of many both inside and outside the country to the sole hegemonic power capable of creating a new economic order that would dominate the globe. It began to behave as such, especially during the presidency of George W. Bush. A key-currency country believing itself to be the hegemonic economic power is likely to ignore the global responsibility that comes with its key-currency country status. Never before in history has a key-currency country run a current account deficit amounting to 6% of GDP and incurred a net foreign debt amounting to 25% of GDP.  The former appears to reflect an excessive circulation of dollars as key currency outside the US, while the latter represents an excessive expansion of the role of the US financial sector as bankers to the rest of the world. The US economy has apparently overindulged in the king’s privilege, both narrow and broad, forgetting that he is only the “handsomest” at the Keynesian beauty contest.
Even if the direct cause of the current financial crisis was the meltdown of US subprime loans that triggered the collapse of the bootstrapping credit-creation process of the US financial markets, the US economy’s excessive pursuit of seigniorage from its key-currency country status has much contributed to the global scale of the crisis. It has thus invited French President Nicolas Sarkozy’s statement in November, 2008, that the dollar can no longer claim to be the “only global currency,” and the proposal made by Governor Zhou of the People’s Bank of China’s in March, 2009, for the creation of a new international currency based on a basket of a broad range of currencies. I do not believe that the present key currency system will soon collapse as a result of the current financial crisis and the consequent weakening of the US economy. But what ultimately supports the dollar as the key currency is the bootstrapping process whereby everybody believes that everybody else believes that everybody else believes…. The statements by the French president and the governor of People’s Bank of China are indications that a certain number of people have already started to fear that a certain number of people have already started to fear that the dollar may not be able to sustain its key currency status in the near future. There is always a danger that wolf-criers could turn into soothsayers if their number were to reach a critical mass.
The ongoing financial crisis is “different” from many other recent crises, because it has given us a glimpse of the real possibility of the collapse of the key currency status of the dollar for the first time since the Great Depression.
How should we deal with this impending crisis? A mere transition of the key-currency status from the dollar to the euro or the yuan or some basket of several national currencies would not be a final solution, even if by some miracle the transition took place without much global turbulence. It would merely substitute “the euro crisis” or “the yuan crisis” for “the dollar crisis. ” The basic dilemma that one currency serves as both a national currency and the world’s key currency would remain.
In the long run, there is only one solution: to cut the causal chain from the presence of seigniorage to the temptation to excessive creation of money and credit. There is no other way but to set up a global central bank that issues and controls a new key currency, similar to the Bancor that was part of the ill-fated Keynes plan presented to the Bretton Woods conference in 1944 or the latest version suggested by the governor of the People’s Bank of China. With all due respect to Keynes and the governor, I do not believe (and in fact nobody believes) that such system will emerge in the foreseeable future. In the first place, the US government would do everything to maintain the dollar’s status as the sole key currency in order not to lose its seiniorage-derived free lunch. More fundamentally, the nature of global capitalism is totally different from that of a nation state, which can be characterized as an imagined community that presupposes the presence of other nation states and is unified through feelings of rivalry with them. With no global government, weak international law, and no rivals to fight against, it would be next to impossible to create a global institution recognized by all countries, which would give up at least part of their right to govern their own monetary affairs. This is even more the case now than in 1944, the year of Bretton Woods Conference, because the rise of the emerging economies has greatly increased the number of countries whose economic weight entitles them to a say in international monetary affairs. Even Europe, with its shared cultures, regional proximity, and relatively small disparity of economic conditions, took half a century to set up its own central bank. Even if a global central bank of some sort were created, possibly as a vastly expanded version of the IMF both in scale and functions, there would be little common ground among contributing countries to guarantee its independence and freedom to control the supply of the key currency and to regulate international finances in a way that would transcend conflicting interests. Money is a living thing and credit is even more so. It is hard to imagine a currency issued by a committee-like institution amassing sufficient confidence among the world’s decision-makers in terms of money, commodities, and finances.
We are, however, all dead in the long run. In order to cope with the problem of an impending crisis in global capitalism, we cannot afford to sit around waiting for the appearance of a global central bank. In the short run, we have no other option than to be practical. This means starting by recognizing the fact that, whether we like it or not, the key-currency country and the non-key currency countries together form a community sharing a common fate within this blatantly asymmetric structure. The United States, as a beneficiary of its status as the key-currency country, has an obligation to behave with an awareness of its global responsibility as the key-currency country. Equally importantly, the non-key currency countries have a joint obligation to keep watch over the key-currency country that has a tendency for ignoring its key-currency status, to remind it constantly of its global responsibility, and to cooperate with it whenever necessary. We have been accustomed to perceiving international order either on the basis of the traditional mental framework according to which every asymmetric relationship was a ruler/the ruled relationship, or on the basis of a politically correct tendency to paint all international relationships as being a league of equals. But the key/non-key relationship fits neither of these categories. Although the asymmetry does not satisfy anyone's desire for domination or demands for equality, the stake that the 21st century has in carefully balancing this asymmetric relationship is by no means low, given the fact that the collapse of a key currency system has always triggered a global crisis in the past,.
 This is the well-known “Triffin Dilemma,” recently referred to in a widely cited speech made by Governor Zhou of the People’s Bank of China (http://www.pbc.gov.cn/english/detail.asp?col=6500&id=178). This dilemma was first pointed out by Robert Triffin, Gold and the Dollar Crisis: The Future of Convertibility , New Haven: Yale University Press, 1960.
 This figure is taken from Robert Mundell, who attributed it to a study by an IMF staff member. See Robert Mundell, “The International Monetary System in the 21st Century: Could Gold Make a Comeback?” Lecture delivered at St. Vincent College, March 12, 1997. The basic idea is that, since the currency/GDP ratio of the Canada is only 10-15% that of the US, if American and Canadian currency preferences are the same in relation to their GDP domestically, the remaining 85%-90% of the US currency must be used as the key currency outside of the US. Another estimate made by Federal Reserve staff, as reported by Alan Blinder based on the shipments data of $100 bills by the Federal Reserve Bank of New York, is much smaller but still substantial, at around 50-70%. See p. 130 in Alan Blinder, op. cit. Blinder then calculated the imputed interest earning of the US as $11-15 billion per year, using the average interest rate of US Treasury securities.
 See Emile Despres, Charles P. Kindleberger and Walter S. Salant, The Dollar and World Liquidity: A Minority View , Washington, D.C.: Brookings Institution, 1966.
 Portes and Rey called a saving of interest payments on US government securities because of their greater liquidity as the issuer of the key currency a “neglected source of seigniorage to the issuer of the international currency,” and suggested that it could amount to at least $5-10 billion a year. Portes, Richard and Hélène Rey (1998), “The Emergence of the Euro as an International Currency,” in David Begg, Jürgen von Hagen, Charles Wyplosz, and Klaus F. Zimmermann, eds., EMU: Prospects and Challenges for the Euro (Oxford, UK: Blackwell), pp. 307-343. I believe that a similar argument can be applied to most of the dollar-denominated securities issued by private financial institutions in the US.
 Eichengreen, “Sterling’s Past,…” p.1.