The U.S. dollar has been the dominant currency of the world since the Bretton Woods Agreement of 1944 established it as the reserve currency and considering how the U.S. became the largest and most stable economy in the world after the Second World War. However, while the dominance of the U.S. dollar has afforded both the American economy and government several advantages and privileges, it also contributes to the persistent U.S. trade deficit.
U.S. Dollar Dominance and the U.S. Trade Deficit: How the Global Dominance of the U.S. Dollar Hurt American Trade
Universal Currency Status Creates Persistent High Demand and Further Keep the Value of the United States Dollar Elevated
There is a consistent demand for the U.S. dollar among central banks because it is the primary global currency reserve. Data from the International Monetary Fund showed that it made up more than 50 percent of the global foreign currency reserves in the last five years. This currency is also used in international trade and other cross-border financial transactions.
It is also considered a safe haven asset and investors tend to flock to dollar-denominated assets like U.S. stocks and bonds issued by U.S. corporations and U.S. federal and state governments. Nevertheless, because of persistent high global demand, its value also remains elevated relative to other currencies. This follows the general principles of supply and demand.
Supplying dollars to the world provides the U.S. with several critical benefits like low borrowing costs, reduced exchange risks, enhancing the liquidity of U.S. financial markets, and maintaining geopolitical influence. However, to supply this demand, the U.S. may need to run persistent current account deficits, of which the trade deficit is one of the main components.
The particular current account deficit of a country is a broader measure of all transactions with the rest of the world. It includes not only traded goods and services but also net income from abroad and net current transfers. The U.S. runs a current account deficit to supply the world with U.S. dollars by importing goods and services and accepting foreign investments.
High U.S. Dollar Value Relative to Other Currencies Essentially Makes Import to U.S. Inexpensive and American Exports Expensive
Nevertheless, trade deficit is a consequence of a strong U.S. dollar. This is because it makes U.S. exports more expensive for consumers using other currencies. This further makes U.S. goods and services becoming less competitive and attractive in the global market and results in reduced global demand for U.S. exports. The overall result is lower export volumes.
A strong U.S. dollar also makes imports to the U.S. cheaper. The elevated value of this currency increases the purchasing power of American consumers and businesses. This means that they can purchase more foreign goods and services at relatively lower value. The situation increases further the domestic demand for imports. The trade deficit then widens as a result.
Further Theoretical Groundings and Explanations Based on the Concept of Triffin Dilemma and the Exorbitant Privilege Phenomenon
Belgian-American economist Robert Triffin introduced the Triffin Dilemma during the 1960s to describe a conflict of economic interests that arises for countries whose currencies serve as global reserve currencies. It explains that the country that prints the dominant currency needs to ensure its sufficient supply to maintain international trade and international finance.
However, as a consequence of its role, the issuing country often runs persistent trade deficits since it needs to spend more abroad than it earns through importation, thus effectively exporting its currency. The continuous trade deficit can lead to a build-up of debt as it spends more and a potential weakening of the value of the reserve currency over the long term.
French politician Valéry Giscard d’Estaing also coined the term “exorbitant privilege” in the 1960s to describe the advantages held by the United States due to the dominance of the U.S. dollar. He notes that the U.S. can finance its trade deficit by issuing debt that is in high demand globally. This essentially removes the pressure to resolve the persistent trade imbalance.
The Triffin Dilemma highlights the inherent tension for a reserve currency issuer stemming from its need to run a persistent trade deficit to fulfill its role as a global supplier. The exorbitant privilege is the reward for undertaking this risky role. The U.S. can consume more than it produces without facing currency penalties. It can finance its deficits through debt issuance.