The dollar has endured repeated crises since 1960, when
economist Robert Triffin postulated his famous dilemma: The
U.S. needed to run balance of payments deficits to supply the
world with greenbacks, but those deficits would ultimately
undermine confidence in the currency. Yet more than five years
after a global financial calamity that originated in the U.S.,
the dollar remains as central as ever to the financial system.
In his new book, The Dollar Trap: How the U.S. Dollar Tightened
Its Grip on Global Finance, Eswar Prasad, a Cornell
University economist who previously headed the International
Monetary Funds China division, argues that the
dollars fragility has actually entrenched its pivotal
role. Prasad, 48, recently spoke with International Editor Tom
The dollar seems to have been in crisis for decades.
Whats different now?
The financial crisis has been a very interesting game
changer, but in the opposite direction of what had been
expected. Before the crisis, with the U.S. current account at
very high levels, it seemed very likely that with Europe
looking strong and China growing strongly, the stars were
aligning for the dollar to be knocked off its perch.
Then the crisis came along, and it led to a substantial
increase in the demand for financial safe assets, from
emerging-markets economies in particular. U.S. policies
themselves are adding to capital flow volatility, with
quantitative easing pushing a lot of capital out and now the
hint of a taper pulling capital out of
emerging markets. So emerging markets want more protection
in the form of reserves. And where do they go to put the
reserves? In the U.S.
Is that good for the U.S.?
At one level, having the dollar be the dominant world
currency is good. There is the aspect of prestige. There is
seigniorage revenue because it costs the government nothing to
print the money but they can buy real goods and services with
The big paradox here is that the rest of the world comes to
the U.S. for protection, and the rest of the world gets lousy
returns on its money because Treasury securities are paying
nothing. And the other curious thing is that although the
dollar is very strong in its role as a global currency, the
actual value of the dollar has been falling over the past
decade and a half by 1 percent a year on average. Everybody
knows the dollar has to depreciate some more in order for the
U.S. trade deficit to continue declining, but because the rest
of the world wants dollars so much, that keeps the dollar from
depreciating as much as it otherwise should.
Things dont change, until they do. What could
prompt a sea change in the dollars role?
In the book I talk about various tipping-point scenarios.
One could be where China says, Yes, it is going to hurt
me if I sell down some of my U.S. Treasuries, but the U.S. has
been doing crazy things, so were going to do this
anyway. Another possibility is that the yield curve could
shift up very sharply, causing panic in financial markets. But
heres the thing: Any of these scenarios is going to lead
to a lot of turmoil. And when there is turmoil, what do investors
do? They look for safety. And when you look for safety, where
can you go? The U.S. dollar.
How big a factor is the lack of
Thats the key issue. Lets say the Europeans got
together, reformed their macroeconomic position and put in
place institutions to make the euro zone hang together well.
The euro could become a viable competitor, but the markets are
not deep enough to sustain the amount of debt that the U.S. is
able to provide.
China is almost certainly going to become a competitor in
one sense, that the renminbi will become more accepted
internationally for trade and financial transactions. Countries
like Nigeria and Chile have indicated that theyre going
to hold maybe 5 to 10 percent of their reserves in renminbi.
And that, I think, is where well end up. But China is
not, with its present political and legal structure, going to
be considered a safe haven. The Chinese themselves dont
trust China. A lot of Red Chinese have much of their money
offshore because they fear it could be expropriated. And
foreign investors have a similar fear.
Americas political hegemony has eroded
dramatically. Will that have an impact on the
Logically, it should. I think the problem has become the
very flawed structure of the international monetary system.
Emerging markets have become much more open to capital
flows, so they want more protection. There is a lot more
turmoil in financial markets, so ordinary investors
want more protection. All those factors that have led to the
demand for safe assets increasing are not being met on the
other side. In international finance everything is relative.
And relatively speaking, the U.S. still remains very