Clever Geek Handbook
13 June 2025

Making Sense of the Dollar

Recommendation

Marc Chandler is one of the most widely respected, prolific pundits on currency markets and foreign exchange. In this book for lay readers, he summarizes “dangerous myths” about currency markets and foreign exchange. The myths are dangerous because they can lead to the kinds of mistakes in public opinion that generate disastrous political and economic policymaking. BooksInShort recommends this accessible book and finds that Chandler does an excellent job of summarizing and countering some of the most wrongheaded, naïve or confusing blunders, blinders and bewilderments that vex discourse about the dollar, the trade deficit and the economic strengths of nations.

Take-Aways

  • Financial myths lead people to believe incorrect ideas about the dollar.
  • For instance, contrary to fiscal myth, trade deficits or surpluses do not signal national economic strength.
  • Current methods of calculating trade deficits are outmoded and mistaken.
  • Labor productivity, not market flexibility, is the backbone of U.S. economic power.
  • Though some view capitalism as monolithic, it actually manifests in many varieties.
  • In fact, America is as much socialist – or as Peter Drucker said, “postcapitalist” – as it is capitalist.
  • The dollar is and is likely to remain the world’s most important currency.
  • Globalization has helped make America stronger and more productive.
  • Dollar weakness does not help American exports.
  • While not particularly mysterious, currency markets are not suitable for individual, retail investors.

Summary

“Myth 1: The Trade Deficit Reflects U.S. Competitiveness”

Antiquated accounting methods distort the picture of the United States’s international competitiveness. When a U.S. company sends parts abroad for assembly and then brings back a finished product, trade accounts record the transaction. Because the finished product has a higher value than the parts exported, the U.S. trade deficit grows. However, the entire transaction has taken place within a single company. Does such accounting make sense?

“The system of trade accounting, no longer offers an accurate picture of how the global political economy works. It is based on a world that no longer exists.”

Trade accounting ignores much of the value that an American export creates. For instance, the trade value of services is notoriously hard to calculate. Europeans who vacation in the U.S. consume tourism services, but trade accounts do not reflect such transactions. Balance of payment accounts also do a poor job of measuring the value added by technology, specialized skill and management ability. Antiquated accounting fails to measure the right things and leads to misconceptions about what policymakers should do. The trade deficit is not a problem that needs to be corrected; the problem that needs correcting is the way trade is measured. International trade does not put American people out of work. Technology – made in America – has changed the way people work, improving productivity so much that fewer people can do more. Restrictive trade policies won’t change that.

“Myth 2: The Current Account Deficit Drives the Dollar”

The Bretton Woods system, which was based on the dollar and the value of gold, governed international monetary affairs from 1944 to 1972. However, the system proved unsustainable. With the advent of floating exchange rates in the 1970s, market transactions came to determine the value of currencies. It is true that when the dollar “weakens,” or becomes less expensive, U.S. exports also become relatively less costly compared to other countries’ products. However, this does not mean the U.S. is better off. A weak dollar means it is more expensive for Americans to buy foreign materials than producing those materials may cost.

“Despite the near-constant wailing of the alarmist claims, there is no evidence that central banks as a whole have reduced their holdings by a single dollar through the middle of 2008.”

The current account deficit measures the flow of trade, but not the flow of capital. Here, again, an inadequate metric can lead to muddy thinking about problems, policies, solutions and opportunities. To understand economic conditions, you must also consider the capital account. For one thing, dollar weakness can discourage investment in the U.S. because investors, including domestic corporations, may prefer to put assets where currencies are gaining value, not losing it. Investment flows have as much – or more – to do with the value of the dollar as trade flows.

“Myth 3: You Can’t Have Too Much Money”

The current account does not measure U.S. trade and competitiveness accurately. Because the current account position is identical to investment minus savings, its distortions call for a closer look at the question of American savings and the idea that having ample capital is always a good thing. The flip side of the alleged American savings shortfall is capital surplus. When an economy holds too many savings, problems ensue. Businesses overinvest and overproduce. Banks may make too many bad loans, because capital is cheap and profitable opportunities are scarce. The result of having too much money is deflation and economic distress.

“The activities of multinational corporations are tracked using an accounting system designed for a world where only some nations could do sophisticated manufacturing.”

Capital must be able to move freely in search of opportunities. Efficient capital markets facilitate this flow and are, therefore, critically important. For this purpose, the U.S. has the world’s best capital markets. Innovative financial technology has created new financial products and investment opportunities, while information technology makes it possible for U.S. investors to monitor investment in a Chinese company as easily as they might track a stock on the S&P 500.

“Amazingly, the movement of goods and services within the same company accounts for half the U.S. trade deficit.”

American savings are larger than current tracking methods reveal. Investments by U.S. workers in defined-contribution pension plans make up a large portion of U.S. savings, but the statisticians and accountants who track national savings ignore the amount that these assets appreciate as long as pension plans hold them. The system measures money deducted from a paycheck and invested in a 401(k) tax-deferred retirement account based on its value on the date of investment. It measures money withdrawn after retirement at its value on withdrawal. Yet, while the investment stays in the plan and hopefully grows no national metric tracks its change in value.

“The trade balance is no longer a valid scorecard for America’s global sales and competitiveness.”

Technological progress also gives U.S. corporations more value for their capital investment costs. For example, because computers, trucks and air conditioners all have improved, companies that replace older models get much more functionality, often at a lower price.

“Myth 4: Labor Market Flexibility Is the Key to U.S. Economic Prowess”

Many academic commentators have praised American labor market flexibility as the reason for U.S. economic strength. Ironically, many of them are professors with guaranteed tenure. Most Americans experience labor market flexibility as a terrifying threat, manifested through downsizing, firing, and other slings and arrows of economic life. Labor market flexibility allows companies to hire and fire at will, and workers to come and go as they please. Well, it may allow workers to go as they please – or it may force them out. This, in fact, is a problem. Capital is mobile and can cross the globe instantly in search of a profitable opportunity. Labor, however, is not mobile.

“Globalization means a great deal more than outsourcing. Trade has become ‘in-sourced’.”

Actually, much of international trade occurs within corporate boundaries. For example, a German steelmaker is building plants in Brazil, Mexico and the state of Alabama. The Brazilian plant will produce steel slabs with Brazilian iron ore. The Mexican factories will make stainless steel, while the plants in Alabama will make steel for autos and other products that require high quality. Intrafirm trade does not behave like trade among unrelated parties. For example, currency shifts probably won’t change the relationship between a European car company and its U.S. subsidiary. Such a trade does not require third-party financial institutions. And, shifts in the relative value of currencies merely mean that the company is putting more money in one pocket than in another.

“The basic determinants of the value of money are supply and demand, the same as for any product or commodity.”

Since labor does not move as easily as capital, workers in Alabama, Brazil and Mexico clearly benefit from policies that allow the German steelmaker to move capital to their regions and employ their people. The ease with which entrepreneurs can open and close businesses relates to national economic strength, in that the easier opening and closing a business is, the likelier entrepreneurs are to take risks and, in turn, create jobs. Yet, overall, work is easier to move than people. Fortunately, sophisticated supply chain technology and efficient capital markets can bring work to people. The U.S. challenge is not to prevent low-skilled work from going to places where low-skill labor is cheap and abundant, but rather to ensure that U.S. workers have the opportunity and incentive to improve their skills so they can compete for the most demanding, remunerative work.

“Myth 5: There Is One Type of Capitalism”

Former “socialist” countries, such as Brazil, Russia, India and China, have adopted “capitalism.” However, in those instances, capitalism means nothing more than private ownership and a profit motive in the economy. The degree of private ownership, the relationships among private firms, and the extent of government regulation or economic involvement – all differ among “capitalist” countries. They are not following any universal definition of capitalism, since none exists.

Instead, capitalism follows different models. The Anglo-American model prioritizes efficiency and entrepreneurship. The Asian model offers vast, paternalistic corporate groups. The social democratic European model combines strong labor unions and high taxes with an emphasis on social welfare, stability and income equality. China, Russia and India follow their own distinctive models of capitalism. Culture and history are quite influential in determining which model is most appropriate in a given national context. For example, history and culture account for the significant differences between the U.S. Federal Reserve and the European Central Bank.

“Myth Six: The Dollar’s Privileged Place in the World Is Lost”

Recent concerns about the dollar losing its role as the world’s pre-eminent currency are groundless. The dollar is the currency central banks use when they intervene in markets. Most global trade is invoiced in dollars, the standard currency of oil prices and airport duty-free shops. None of this is likely to change.

“Myth 7: Globalization Destroyed American Industry”

The U.S. central bank, the Federal Reserve, provides other nations’ central banks with banking services, including holding their reserve assets. These central banks have done little to indicate any actual change in the currency composition of their reserves. No evidence indicates that they are cutting back on using the dollar at all, so it is in no danger of losing its status as a global reserve currency. On the contrary, it remains the world’s most important reserve asset, the one to which other nations turn when market shocks cause fear and flights to quality. The dollar is just as important as it has been throughout recent history, and is likely to remain the pillar of global finance. It is simply too important to world trade and international economics to be displaced. Far from destroying American industry, globalization has helped build it. The first American official to enunciate the principles behind the movement now called globalization was Secretary of State John Hay, who wrote the “Open Door Notes” in 1899 and 1900. Hay proposed ending the system of spheres of influence and replacing it with competition for economic advantage. Hay was speaking specifically of China, but the open-door concept is still recognizable in the global policies nations have implemented since World War II.

“When a nation chooses to peg its currency to another, it turns its monetary policy over to someone else.”

One feature of globalization is local production to serve local markets. When U.S. corporations put factories in foreign markets, usually their motive is not to generate a price advantage over production at home but rather to produce for local sale. America, the world’s largest market, has benefited from investments by European and Asian firms hoping to serve U.S. customers. A myopic focus on the trade account by Washington policymakers could be very harmful to America’s real economic interests. The trade deficit is not nearly as important as people make it out to be. As noted, the very metrics statisticians use to calculate the trade deficit are flawed and inadequate. America has the most productive economy on earth, with the most efficient and innovative capital markets. The ability to manage far-flung global supply chains is an important competitive advantage for American businesses.

“Myth 8: U. S. Capitalist Development Prevents Socialism”

The United States is not really a “capitalist” country. Through pension funds, mutual funds and other intermediaries, America’s workers own its means of production. However, the state is quite heavily involved in the economy. Anyone who doubts this need only look at the programs the government launched in 2008 to cope with the financial crisis.

“Perhaps it is the uncertainty and pace of change that contributes to people’s anxiety, even though they are doing better by objective measures.”

Thanks to technological advances, U.S. productive power is so immense that production outstrips demand, which can lead to economic catastrophe. The government has a role in allocating and balancing production. While the U.S. may not be socialist, it is, in the words of Peter Drucker, “postcapitalist.” The 2008 credit crisis is likely to result in a bigger, enduring role for government and regulators in the U.S. economy.

“Myth 9: The Weak U.S. Dollar Boosts Exports and Drives Stock Markets”

This is false because, as noted, the dollar has many roles. A weak dollar does make American-made goods cheaper in terms of international currency, but currency rates are so unpredictable that many American manufacturers have preferred to neutralize them by hedging and by locating production of goods for foreign markets within those markets themselves. A weak dollar may actually work against the U.S. stock market by leading investors to keep their capital abroad until they are reasonably sure American investments will not lose value in home-currency terms due to a weakening dollar.

“Myth 10: The Foreign Exchange Market is Strange and Speculative”

The same factors that determine the price of any commodity – supply and demand – determine the price of the dollar or any other currency. However, retail investors should not speculate in currencies, because they do not have the information available to the major institutions in the market – most notably information about what those parties are buying or selling, and why.

About the Author

Marc Chandler, chief foreign exchange strategist at Brown Brothers Harriman, is the former chief currency strategist for HSBC Bank U.S.A. He has contributed to many financial publications, and teaches in New York University’s School of Continuing and Professional Studies.

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Making Sense of the Dollar

Book Making Sense of the Dollar

Exposing Dangerous Myths about Trade and Foreign Exchange

Bloomberg Press,
 


13 June 2025

Streetlights and Shadows

Recommendation

In 1998, Gary Klein gave readers Sources of Power, a thoughtful, innovative consideration of how to make decisions in complex situations. Here, he returns to the same subject in even greater depth. Klein has spent decades studying and interviewing people, such as firefighters, soldiers and pilots, who make decisions in complicated, shifting, high-stakes circumstances. He discusses what most people believe about making decisions, and shows how they err...some of the time. In ambiguous, unknown settings or under complex conditions, people tend to simplify until their beliefs become dangerous. This entertaining book grapples with many of life’s more challenging situations. As a result, BooksInShort recommends Klein’s insights to leaders, trainers and anyone who must make more effective decisions in crises.

Take-Aways

  • Most common beliefs about decision making are wrong or incomplete.
  • Decision making functions differently in complex, chaotic circumstances than in clearly defined, well-known situations.
  • Formal guidelines can get in the way of good decisions and learning.
  • You can’t eliminate risk, establish true common ground or set definitive goals. You must adapt as you go.
  • More information helps decision making only when lack of data is a problem.
  • Communication is always difficult, and feedback is easily misunderstood.
  • Make sense of a situation as best as you can, adapt to it and make a decision. Blend intuition with logical analysis, and always engage your expertise.
  • People overemphasize “explicit knowledge,” such as procedures and guidebooks.
  • “Tacit knowledge,” which includes intuition, is the source of pattern recognition and “mental models.”
  • Any systems or tools designed to help people make better decisions must take into account individual expertise and how the mind functions.

Summary

Common Beliefs About Decisions

The human eye sees in light and shadow, but uses different systems for daylight and darkness. In daytime, “cone cells” take in a lot of light, and you see the world in detail. When night falls, “rod cells,” which are more sensitive to faint light but poor at picking up details, take over. You need both systems to see well. Vision functions as an analogy for decision making. Approach decision making one way when the situation is well-known and clearly defined, and another way in unknown or ambiguous circumstances.

“Logic and statistics are useful, but they aren’t sufficient for making good decisions, and they sometimes result in worse decisions.”

Most common beliefs about decision making work in “bright and clear conditions.” People don’t know how to respond to more opaque situations, and most guidelines interfere with complex problem solving. Familiar rules of thumb don’t apply; an emphasis on directives and formal procedures can be limiting or even dangerous. A majority of the leaders and professionals surveyed supported the following incorrect beliefs about making decisions:

  • If you teach people a specific procedure, they perform assigned tasks better – Routine tasks evolve over time, but published procedures usually stay frozen. Procedures are abstract and do not take local conditions into account. They don’t allow for learning, growing expertise or focus. When people follow a procedure, they often don’t pay attention to what they’re doing; the procedure replaces their judgment. Procedures are useful during training, to jog your memory, to guide you when your attention wavers or for routine tasks. In complex situations, procedures are dangerous.
  • Bias distorts your thinking – When someone in a decision-making situation introduces a number, people often “anchor” their estimates to that number. Mentioning a number when asking a question produces answers closer to that number. Other common biases are the “framing heuristic,” in which people view information differently based on how the presentation frames it, and the “representativeness heuristic,” in which people make choices depending upon whether they find that a sample represents the situation or not. Cognitive biases exist, but they don’t pose the risk to decision making that common belief claims, because people don’t use these cognitive factors irrationally. They apply frames or examples when they find it necessary to think about choices. To help people use these focusing factors more effectively, give them useful frames, help them develop expertise and design their choices to support the right actions.
  • Use logic, rather than intuition, when making decisions – Many common decision-making models tell you to collect hard data, such as statistics, and weigh it rationally. Other studies show that deciding quickly, without too much information, produces better decisions. People may overthink and back away from strong initial decisions. People who have brain damage that eliminates emotions from their decision-making process tend to make much worse decisions, indicating that sound decision making requires both intuition and logic.
  • When making decisions, block out several choices and compare them – Many schools teach that people consider more choices when they gain more experience, that novices hurry while experts weigh options, that analyzing your choices works best in decision making, and that people decide by applying the same set of criteria to each option. Analytical methods are attractive, because employers can universalize and teach them, and they offer evidence to justify decisions. But this matrix takes too long to be useful in making most decisions. In emergencies, no one has time to apply a matrix. Many different options, or choices that differ considerably, obviate methodical thinking. In time-sensitive situations, experts read situational cues and react. If one choice doesn’t work, they shift tactics.
  • In ambiguous situations, you can “reduce uncertainty” if you get more information – This belief is true when the situation is uncertain because of a lack of information. However, you might have information that you distrust or reliable data that contradicts your values. Perhaps you possess the relevant facts, but you do not understand what to do with them or how to act on them. This belief treats all problems like puzzles: You could solve them if only you possessed the right clues. However, some problems aren’t puzzles; they are mysteries. Their solutions require analysis and action, not information. Beyond a certain amount of data acquisition, for instance, meteorologists get worse at predicting storms. However much data you have, you need to understand it.
  • Don’t jump to conclusions; wait until you have all the evidence to act – You’ve probably seen an early news report that says one thing and a later story that contradicts the first report. That turnabout might cause you to freeze in fluid situations. And that will lead to poor decisions. Draw conclusions and test them. Actively speculate about what might resolve a situation instead of passively waiting for new data.
  • Giving people “feedback on the consequences of their actions” helps them learn better – Employees can misinterpret feedback, and your input may not address their actions. Giving feedback is easier in well-ordered, well-understood situations and more difficult in complex, shifting circumstances. Complexity can create crises just when you most need to improve your performance. You might not have time to give feedback, and employees might not be in a position to receive or even detect it if they are, for example, overwhelmed. Make your feedback understandable, and shape it to the moment.
  • You make sense of events by drawing “inferences from data” – The metaphor for this rule is the “assembly line”: You get data and develop it into information; you assemble that information into knowledge and you then use reasoning to understand it. Problems arise when you can’t connect the dots because you don’t know what a dot is. Data and relevance are not self-evident; making an educated judgment requires accumulated expertise. Create narratives early in a situation and revise them as new dots of data arrive.
  • To start a project, clearly describe your goal – More people agree with this rule on decision making than any other. People like to define goals before they start, so try to provide those objectives when you can. But the world is both complex and shifting, so insisting on satisfying this rule can stall progress. What do you do with “goal trade-offs” when two values clash? Or in situations with “emergent goals,” such as when you’re developing a new technology? For example, when Xerox first marketed copiers in the 1950s, it tried several methods to promote its business before developing one that worked. This rule also pushes you to set goals you can measure “objectively.” Thus it’s of little use if your goals are qualitative. Try to establish objectives, but in complex situations, redefine your goals as you move forward. This is “managing by discovery”: Set goals, pursue them, gather data and redefine your objectives as suggested by the data and the situation.
  • Your plans will work better if you “identify the biggest risks” and get rid of them – This rule works in a “mature industry” or with a well-known activity. But if you’ve never done something before, accurate evaluations can prove elusive. The most devastating risks are “black swans,” risks you don’t know how to look for or identify, let alone eliminate. Many “risk-mitigation plans” become part of the problem because they are rigid and allow organizations to develop blinders. Practice “resilience engineering,” and work on an “adaptive mind-set” to respond quickly and effectively.
  • As a leader you should assign roles and write “ground rules” – Setting up roles in advance lets you define “common ground.” The problem with this rule is simple: Communication is always difficult, and people’s perceptions spring from their individual experiences. Recognize how “fragile” common ground can be, and how much effort, shared experience and training it takes to produce and maintain it.

How to Make Better Decisions in Complex Situations

To make better decisions in the complicated, changing, ambiguous circumstances that you encounter in times of great crisis, start by shifting your mind-set. Rather than viewing your mind as a “mental storehouse” stocked with information and guidelines – a view that assumes you can organize your mind in a stable, consistent fashion – you must practice “unlearning.” See this process in the context of the useful “snakeskin metaphor.”

“We need both intuition and analysis. Either one alone can get us in trouble.”

As you move through life, you develop, change and shed your skin, casting off parts of yourself that are no longer functional. Accepting this premise allows you to make other broad, related shifts in your approach, such as giving up a “fixation” on any specific view, goal or procedure. Adopt a mind-set that allows for continual change and growth. Consciously pause in the midst of decision making and ask what it would take to get you to change your mind about a primary issue. Pay particular attention to evidence that contradicts your position; consider how hard you would have to work to explain it away. Studying other similar cases or bringing in outsiders who are free from your specific history might help you to modify your perspective.

Make a Circle

Another broad shift in approach is to move from linear decision making to a circular, complex process. Imagine a circle with expertise in the center, and three points along the outer edge: “adapting,” “sense-making” and “decision-making.” You can start a circle at any point, and you can move in any direction along it. Making sense of a situation will lead you to making a decision that you adapt as you act on it. Or you can start by adapting to external changes as you make sense of them, progressively learning what’s required to make a functional decision. Set up your actions and your organization’s activities to draw on the accumulated knowledge of those involved.

“Explicit” and “Tacit” Knowledge

This change involves a switch in processing from explicit knowledge, such as procedures and guidebooks, to tacit knowledge. Explicit knowledge has worth, but organizations often overvalue it, though it’s only the tip of the iceberg. To understand a situation, especially one that involves making sense of complexities, look beneath the surface and call on the broad array of factors that make up tacit knowledge: your ability to recognize patterns, the “mental models” you bring to bear on a situation, your perceptions, your skills and the judgment you’ve developed to address an issue’s specific challenges. You can develop each factor that builds your tacit knowledge. For example, you can learn to build better mental models or to use your senses more skillfully.

“Too much information can make things worse.”

Explicit knowledge can exist independently of expertise. It resides in a book or computer. It may or may not be accurate, and it remains fixed until someone changes it. Tacit knowledge, on the other hard, depends on experience; how well that tacit knowledge functions depends on your level of know-how and your willingness to embrace your experiences. These two knowledge categories are not fixed. You can convert tacit knowledge to explicit knowledge. Internalizing explicit knowledge integrates it with the deep well of your tacit knowledge.

Mental Models

You become expert in your field by drawing lessons from your experience and by developing better and more sophisticated mental models about your arena of capability. Expertise doesn’t keep you from making mistakes, but can help you recognize your mistakes more quickly. As you pick up cues that something is wrong, you can match your actions and outcomes against accumulated patterns and mental models with greater skill and fluidity. Expertise allows you to notice details at all levels of performance. It enables you to judge how well someone executes a task, the pivotal elements in a skill, and the signs of failure or struggle.

“Support Systems”

Many people push for having automated systems make decisions. They try to shape “decision-support systems” to help people make choices. Many of these systems “are rejected or fail.” Valid reasons for rejecting such systems exist, particularly if they are based on faulty beliefs or lack sensitivity to tacit knowledge. Some systems substitute algorithms for individual expertise. Algorithms can help if you apply them well, but too often, these systems undervalue the processing power of human insight. People don’t think like computers, and that’s a good thing. Computers process information quickly. The human mind, on the other hand, works with far less information, but it excels at identifying and applying patterns. To make better decisions, foster this unique human cognitive “magic.”

About the Author

Research psychologist Gary Klein, author of Sources of Power, is a senior scientist at Applied Research Associates.

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Streetlights and Shadows

Book Streetlights and Shadows

Searching for the Keys to Adaptive Decision Making

MIT Press,
 


13 June 2025

The Future of the Dollar

Recommendation

The dollar is dead; long live the dollar. That’s the message from this insightful look at the greenback’s future as the world’s reserve currency. Edited by Eric Helleiner and Jonathan Kirshner and including essays by half a dozen other academics, this overview plays out as a polite debate among professors. They offer useful historical and economic perspectives that will help readers understand the forces that make one currency a winner and another a loser. With a variety of contributors, however, the study suffers from a good deal of repetition of background material from one essay to the next, and an unevenness in writing styles that veer from clear to cloudy. While the book promises a spirited debate between “dollar optimists” and “dollar pessimists,” a close reading reveals that most of the contributors tend to fall into both camps simultaneously. BooksInShort recommends this book to readers seeking an erudite review of the US dollar’s past, present and future in world currency markets.

Take-Aways

  • The 2008 financial crisis has renewed a decades-old debate about the US dollar’s role as the world’s dominant currency.
  • The US’s huge economy, vibrant capital markets, robust growth and political stability have ensured the dollar’s prime position.
  • The greenback still acts as “a medium of exchange” for most international trade.
  • International investors consider the dollar “a store of value” for investment purposes.
  • Nations that link their own currencies to the dollar use it as “a unit of account.”
  • The euro, the dollar’s most obvious rival, presents a qualified test to dollar hegemony.
  • The Japanese yen and the Chinese renminbi may battle for regional dominance in Asia.
  • Intriguingly, the dollar gained against most other currencies during the financial crisis.
  • No single currency is likely to replace the dollar entirely, which will coexist alongside other major currencies.
  • This “leadership vacuum” could lead to currencies battling for financial supremacy.

Summary

Another Day, the Same Dollar

Is the US dollar on the verge of a permanent decline? Will the euro or another currency surpass the almighty dollar to become the world’s reserve currency? Those questions gained particular urgency after the 2008-2009 US-led global recession. While no clear answer yet has emerged about its staying power, predictions of the dollar’s demise are nothing new. Since the 1960s, skeptics have anticipated the greenback’s tumble from the top, but the dollar hasn’t given up its pole position among global currencies quite yet. Consider that it serves on one side of 86% of all foreign exchange transactions, compared to the euro’s 37% and the yen’s almost 17%.

“The greenback has provided the monetary foundation for the international economy and its worldwide role has both reflected and reinforced America’s global pre-eminence.”

The dollar’s popularity arose for a number of reasons: The US is the world’s largest economy, and its traditionally vibrant capital markets, robust growth and political stability have made the dollar an easy choice for most favored currency. The greenback acts as “a medium of exchange” for transacting international business, as “a store of value” for investment purposes and as “a unit of account” to which other nations can link the values of their own currencies.

“The primary attraction of the United States as a destination for capital movement is the unique depth of its markets...and the political and security position of the country.”

The US government gains from issuing the world’s most viable money. Foreigners who own dollars, either as Federal Reserve notes or US Treasury securities, essentially offer the US an interest-free or low-interest loan. For private sector firms in the US, the dollar’s stability reduces exchange rate risks. In the public sector, the dollar’s prominence helps the US finance its deficits. The dollar’s key role becomes self-perpetuating: Investors and traders find it easy to use dollars because everyone else uses them, too.

“The US dollar will be the major international currency as long as the United States remains the world’s largest concentration of political and military might as well as of economic potential.”

Intriguingly, even the global financial panic of 2008 couldn’t displace the dollar. Demand for US Treasury securities was so strong then that yields fell to nearly zero. Evidently the dollar remains the ultimate “safe haven”: During the crisis, the dollar gained against most major currencies, climbing 25% against the euro; only the yen rose compared to the dollar.

Thumbs Up, Down and Sideways

Experts pontificating on the future of the dollar fall into three schools of thought: the “dollar optimists,” the “uncertain” and the “dollar pessimists.” The currency’s fans say it will continue its dominance because American economic power will stay strong while inflation remains in check. For the dollar to sustain itself, it must remain attractive, based on “confidence and liquidity,” compared to other currencies. While few predict a sudden collapse of the US currency, most dollar pessimists anticipate a fairly steady decline. They forecast that US debts and deficits will affect monetary stability; growing inflation and depreciation of the US economy could lead traders and investors increasingly to turn from the dollar as the markets’ main exchange mechanism. Those who remain uncertain take a middle-of-the-road stance, weighing both sides of the argument. Yet all three schools agree that the dollar’s place at the summit could be under threat.

“If the dollar was not playing this invaluable role in today’s international economy, the markets would have chosen some other national money to be the world’s key currency.”

With the dollar’s role so prominent, critics in other nations long have targeted what they see as US irresponsibility and profligacy. More than 40 years ago, French president Charles de Gaulle called the US government’s deficit spending “poor management”; he chastised the US’s “exorbitant privilege.” And while popular opinion holds that Americans’ “conspicuous consumption” causes the US’s current account imbalance, in fact more spending goes primarily to cover rising costs for education and health care than to big cars and luxury items. Recent concerns about the dollar have centered on America’s growing reliance on China both as a trading partner and an investor. China has emerged as the US’s largest creditor, with unbalanced trade between the two nations. Worries over US deficits and mounting debt lead the world to consider which currency might take on the dollar’s current role.

A Replacement for the Dollar?

If the dollar were to slide out of the spotlight, which currency would replace it? The euro has emerged as a credible competitor, thanks to Europe’s cautious management of its currency. The Maastricht Treaty constitutionally mandates the region’s conservative monetary approach. The relatively new euro-denominated government securities also have the potential to compete with US Treasury bonds as reliable storehouses of capital.

“China is the largest creditor of the United States, nervously holding huge stocks of dollar claims.”

The euro faces challenges, however, including a rocky relationship between the European Union (EU) and the European Central Bank (ECB), and a patchwork of country-by-country financial regulation. Strict labor laws, rigid rules and a quickly graying populace all conspire against growth in European economies, while the ECB’s charge is to fight inflation, not to stimulate growth in employment and business. Euro securities – a hodgepodge marked against “the German Bund at ten years, the French bond at five years and the Italian bond at two years” – still are weak competitors to the handily liquid US Treasury bill. The Maastricht Treaty’s failure to specify exactly how the EU should respond to financial crises strikes another blow against the euro.

“As amazingly robust as the dollar standard under stress seems to be, the United States has been gravely weakened in its ability to mount a countercyclical policy to offset the global recession.”

Although finance experts consider it a long shot, the yen could be in contention to usurp the dollar, because Japan enjoys political stability, low inflation and a large economy. Financial reforms, which began in the 1990s, opened up the Japanese financial system, but the nation’s low growth, aging population and huge public debt have tempered the yen’s chances to serve as the world’s reserve currency. Its usage in foreign exchange transactions dwindled from 27% in 1989 to less than 20% in 2004, reflecting the yen’s tapering influence. At best, the yen could work as an Asian regional currency.

“Housing turbocharged the US economy and in turn bolstered the dollar’s position.”

Despite China’s soaring economic power, the renminbi (which means the “people’s money”) is not in the running to become a global currency for at least the next few decades. The country’s embryonic economic infrastructure, its limited protections for creditors and its strictly regulated currency flows all impede the renminbi’s acceptance in global money markets.

The Housing Market and the Dollar

The price of a US home, on the surface at least, seems irrelevant to the fluctuations of the world’s dominant currency. After all, money is “universal, abstract, [and] delocalized,” while a house is “local, material and specific.” But the US housing market has been an important factor in the dollar’s value for almost two decades. From 1991 to 2005, low interest rates allowed the US mortgage market to create an above-average rate of economic activity. That engine of growth propelled the US dollar to even greater prominence as more investors and traders clamored for dollars and dollar-denominated assets. The more-restrained mortgage markets in Japan and Europe, on the other hand, generated less robust growth than the US.

“Sooner or later, confidence in the dollar is bound to be undermined by the chronic payments deficits of the United States, which add persistently to the country’s looming foreign debt.”

If Europe and Japan’s economies could advance faster than the US’s, the euro or the yen might take a run at displacing the dollar from its top spot. But in 2008 and 2009, Europe and Japan saw even weaker growth than the US did, and Europe didn’t escape the effects of the mortgage meltdown and bank failures. As long as the US performs relatively better than Europe or Japan, the dollar probably will “muddle through” the aftereffects of the housing crash.

A Currency Oligopoly?

The recent global currency environment bears some resemblance to that of the pre-World War I era, in which Great Britain – then the world’s dominant economic power – faced challenges from the US and Germany. The pound sterling gradually ceded its position – first to gold and then to the US dollar. But for many years, the greenback and the pound coexisted as the top currencies. Indeed, as late as 1965, the pound still accounted for 20% of global monetary reserves; that share now has dwindled to 5%.

“With the rise of China and the growth of the euro, we may now be moving toward a competitive oligopoly.”

The US’s abrupt burst of economic activity prior to the 1930s, fueled by machine and worker productivity, parallels that of the latter-day emergence of the BRIC nations, Brazil, Russia, India and China. These nations pursue a largely mercantile agenda, placing them as major trading counterparties to the US and thus contributing to the dollar’s continued importance. None of the BRIC currencies pose an imminent threat to the US dollar.

“Nothing enhances a currency’s acceptability more than the prospect of acceptability by others.”

An oligopoly consisting of the euro and the dollar is most likely to unfold in foreign exchange markets over the next several decades. Because the US buys 15% of the world’s imports but sends out only 7% of the globe’s exports, the dollar will continue to play a major part. It still makes up two-thirds of all the world’s currency reserves, followed by the euro, which accounts for less than one-third. China remains a key player to watch: Its foreign currency reserves include $1 trillion. China began switching out of dollars into euros in 2002, a course it ended in 2004.

“A Leaderless Currency System”

Dollar pessimists, who posit that the dollar’s position clearly is weakening, recognize that even if the dollar is toppled from its summit, another currency is unlikely to eclipse it wholly. Just because the dollar is lagging doesn’t mean that another currency is poised to take its place.

“In effect, Americans have outsourced their saving to the rest of the world.”

Legal tender that aims to become a global reserve currency must maintain its purchasing power and have at its back a nation that is politically and economically stable. The currency must be liquid, convenient and widely used. All these factors create “stickiness”: Once a currency becomes the top choice, inertia works to keep it in place. The dollar’s dominant position in so many areas – trade, capital markets, bank reserves – illustrates that stickiness. So the dollar is unlikely to drop off the currency map suddenly; it’s more apt to enter a long, gradual decline.

“The euro is the expression of the joint sovereignty of a group of governments and therefore can be considered only as good as the political agreement underlying it.”

In that scenario, a “fragmented” scheme occurs, in which the dollar loses some of its luster and the euro gains momentum. The absence of a single hegemonic currency could create a “leadership vacuum,” resulting in financial uncertainty and economic struggle. The Middle East is one obvious battleground: Countries there conduct oil transactions almost entirely in dollars, even though the region maintains closer commercial links with Europe. Leaning on Middle Eastern countries to use euros in place of dollars in Europe-directed trade would give the EU currency a huge boost but would invite US resistance. And geopolitics could creep into the currency wars, if it hasn’t already done so. For example, in 2003, Saddam Hussein insisted on receiving payment in euros for Iraqi oil exports. Some say the US’s subsequent invasion of Iraq had much to do with retaining US dollar hegemony in the region.

“Dollar diminution would significantly affect international power politics...by presenting new and underappreciated restraints upon American political and military predominance.”

In East Asia, meanwhile, the dollar, the yen and the renminbi are likely to fight for top billing in the region. No matter how these battles play out, decades will pass before a clear winner emerges. Japan’s interest in furthering the yen comes up against its need for American military protection, particularly against China. Meanwhile, China could force out the dollar if it chose to do so, but it risks damaging its own American investments should the dollar decline precipitously.

Dollar Power

Since the 1960s, the US military’s pursuit of geopolitical goals gave the rest of the world an incentive to keep the dollar strong. Amid Cold War threats, nations under the US umbrella believed buying dollar assets was a small price to pay for US protection. With this fiscal wind at its back, the country’s politicians became “addicted to managing the world.” With the fall of the Soviet Union, however, the US turned away from large-scale military incursions and used its “peace dividend” to promote productive investment in technology, driving down its deficits. But post-September 11, 2001 military expenditures soon outpaced those of the Cold War, and armed forays, along with spending on social services, again drove the US into massive deficits.

The standard prescription for what ails the US would be more saving and less borrowing, but that medicine would come at the expense of robust growth and military might. Europe’s more disciplined approach to monetary policy could serve as an example for the US. Europe is less likely to become engaged in military conflicts because it lacks the resources to do so. US spending is nothing new, but now the dollar’s support has weakened: The fall of the Soviet Union and the up-and-coming euro may have paved the way for the dollar’s decline.

About the Authors

Eric Helleiner is a professor of political science at the University of Waterloo, Ontario. Jonathan Kirshner is a professor of government at Cornell University.

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The Future of the Dollar

Book The Future of the Dollar

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