>Is the International Role of the Dollar Changing?

Recently the U.S. dollar’s preeminence as an international currency has been questioned. The emergence of the euro, changes in the dollar’s value, and the financial market crisis have, in the view of many commentators, posed a significant challenge to the currency’s long-standing position in world markets. However, a study of the dollar across critical areas of international trade and finance suggests that the dollar has retained its standing in key roles. While changes in the global status of the dollar are possible, factors such as inertia in currency use, the large size and relative stability of the U.S. economy, and the dollar pricing of oil and other commodities will help perpetuate the dollar’s role as the dominant medium for international transactions.

By many measures, the U.S. dollar is the most important currency in the world. It plays a central role in international trade and finance as both a store of value and a medium of exchange. Many countries have adopted an exchange rate regime that anchors the value of their home currency to that of the dollar. Dollar holdings figure prominently in official foreign exchange (FX) reserves—the foreign currency deposits and bonds maintained by monetary authorities and governments. And in international trade, the dollar is widely used for invoicing and settling import and export transactions around the world.

Periodically, however, the dollar’s preeminence as a cross-national currency has been questioned. The emergence of the euro in 1999 as a major currency and global competitor fueled the debate over the dollar’s international role. More recently, the global shortage of dollars during the financial market crisis placed extraordinary strains on international firms needing to support their dollar-denominated assets and led to calls for changes in the international monetary system. Several developing countries, for example, have proposed that for certain transactions the dollar be replaced with a type of “world” currency based on International Monetary Fund special drawing rights. In addition, participants at the April 2009 meeting of the Group of Twenty finance ministers raised questions about the dollar’s preeminence as a reserve currency, and People’s Bank of China Governor Zhou Xiaochuan has pressed for a shift away from U.S. currency in various activities.

A change in the dominant role of the dollar in world markets would have consequences for the currency issuer and users alike. The dollar’s international status helps insulate the U.S. economy from foreign shocks, reduces transaction costs in trade and finance, and contributes to the international transmission of U.S. shocks and monetary policy effects. For foreign economies, broad use of the dollar in reserves and in international transactions typically results in greater sensitivity of trade, inflation, and asset values to exchange rate movements between their currencies and the dollar. Furthermore, dollar banknotes—physical bills of different denominations —used abroad provide some foreign households and businesses with a more stable store of value and a sounder transaction currency, especially during periods of turbulence overseas.

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