Our Dollar, Your Problem: How U.S. Power Shapes — and Shakes — the World (#271)

The U.S.

dollar isn't just America's currency, it's the world's.

That dominance gives the U.S.

enormous advantages, from cheaper products to unmatched global influence.

But it also creates risks for America and for the rest of the world.

Is the dollar supremacy secure, or is its peak already behind us?

Hi everyone, I'm Lynn Toman, and this is Three Takeaways.

On Three Takeaways, I talk with some of the world's best thinkers, business leaders, writers, politicians, newsmakers, and scientists.

Each episode ends with three key takeaways to help us understand the world and maybe even ourselves a little better.

Today I'm excited to be with Ken Rogoff.

Ken is a Harvard professor, former chief economist at the International Monetary Fund, and one of the world's foremost experts on global finance and monetary policy.

His new book, Our Dollar, Your Problem, asks urgent questions about the future of the dollar and what it means for all of us.

Ken, welcome back to Three Takeaways.

Oh, Lynn, thank you for having me.

It is my pleasure.

Let's start with your book title, Our Dollar, Your Problem.

Where did that phrase come from and why does it still resonate today?

The phrase comes from 1971 when President Nixon went off the gold standard.

Yes, we were on the gold standard, although the average American might not have known it, because other countries were still able to trade their treasury bills for gold.

And Nixon said, we're not going to do that anymore.

And I think people knew that that had to run out at some point because our gold was limited, the dollar supply was growing.

But it was a shock.

And no one was more shocked than the Europeans because they were holding a lot of Treasury bills.

And they saw the inflation, which was already high.

It hadn't hit.

the 1970s, mid-70s level of 14% yet, but it was up in the 4%,

even pushing 5%.

So Connolly flies over to Rome and they're shouting at him, what are we going to do with our dollars?

And he says, well, our dollar, your problem.

And I think there are a lot of reasons that spoke to me.

One is I don't like that arrogance from Americans.

I don't actually think it serves us well in the long run.

We need friends and allies.

But also the irony of it.

Because when we got rid of the gold standard, that was our check on printing too much money.

It wasn't a firm check, but it did hold us back.

And then once that happened, the floodgates opened up and it was our problem.

But I couldn't have picked a better title because the Nixon shock is so parallel to what Trump has done.

Nixon actually that same day announced 10% tariffs and a host of other protectionist America-first kind of policies.

And in many ways, Nixon's the closest parallel to Trump.

And that was not a good decade after that for the dollar.

Not just inflation, but the centrality of the dollar in the global system, which had been put in there by design after World War II,

it collapsed.

The share of reserves held in dollars fell, I think, from 70% to 50%.

And of course, Europe was the center of the dollar system.

They were holding as many reserves as the Asian central banks today adjusted for their incomes.

And guess what?

They're not in the dollar block anymore.

So people who think these things are forever and you can survive any shock just haven't looked at history and there are other episodes too.

Most Americans think of the dollar's dominance as a given.

How dominant is it really and what benefits does that bring to everyday Americans?

Well, there are a lot of measures of dominance.

One measure is how much global central banks have dollars parked in their reserves to deal with all kinds of crises.

That's what the European leaders were complaining about to Secretary Connolly back then.

That has dropped.

So it was about 80% at one time.

It fell to 50% after the Nixon shock.

It got back up towards 75 or 80% after another 20 years, and now it's 56%.

That's showing you that something's going on.

There's been some diversification.

A measure which makes the dollar just look invincible would be foreign exchange trading.

$10 trillion a day turns over in the foreign exchange market.

And don't even ask me what exotic trades and bets and stuff, but a lot of trade gets done.

It's mostly electronic.

90%

of all trades involve the dollar.

You know, there's another side to all those trades.

So 90% of the time, the dollar is on one side or the other, the trade.

Why?

Because it's so liquid.

The dollar market, if you want to convert, say, Indian currency into Argentine currency, you could do it directly, of course, but it's actually cheaper to buy dollars with your currency and then trade it for the other currency to do two transactions.

So by that metric, the dollar looks king, but that's a very minor part of being a vehicle currency.

The part we haven't talked about is that the dollar is also the back office to the world because so much of the financial systems in dollars, and frankly, because the United States is so powerful politically and militarily, a lot of things clear through the United States.

By that, I mean, if you buy something in France from from someone in London, there's a fair chance, even though it didn't go into U.S.

borders, that we see it.

And this is a big part of our power, of the power of the dollar.

And it's actually why we're able to use it to punish other countries when we cut them off and we spy on everyone that way.

And we love it, but the rest of the world hates it.

What risks does dollar dominance create for other countries?

And how do they feel about the dollar?

One risk for other countries is simply that the Federal Reserve, our central bank, chooses interest rates that look at the U.S.

economy.

They are, by law, proscribed from caring.

about what happens to Latin America, about what happens to Europe.

They're able to say, well, if our policy puts Europe into crisis, it'll boomerang on us.

But it's really second and third order.

We really don't care that much.

When I worked at the Federal Reserve in the early 1980s, Paul Volcker, a great man, was chair, and he was the one who raised interest rates.

They got to near 20%.

And that just crushed Latin America because they were basically borrowing at variable rate mortgages.

variable rate interests and they borrowed at 7% and suddenly it's 18%

and we got a huge debt crisis.

I mean, he felt bad for them, but he didn't care.

So certainly there are times where we're just doing our thing.

They have to dance to our tune.

The other thing they don't like, which is below the surface, is the fact that we collect so much information on them, that we have so much power.

Lastly, an area which I wouldn't describe as a problem for everybody else, but they're jealous of it, is that whenever we have a crisis, the global financial crisis in 2008, 2009, we raised our debt by 30%.

In the pandemic, by 20%,

everybody else tried to do the same thing, but they couldn't because the dollar is in such a unique position of being in such demand.

So I think China would like a piece of that.

Europe would like a piece of that.

They would like to share this, it's sometimes called exorbitant privilege that the U.S.

has.

But that's more on the jealousy side side and less on the what makes them unhappy side.

We've had a period of low inflation, at least until recently, as well as low interest rates and fairly stable exchange rates.

What do you see ahead?

I see a much more volatile period ahead with higher average interest rates, higher average inflation rates, probably a return to financial crises in some places.

One of the things that drove me to write my book was that so many people would sort of get a lot of attention by extrapolating a trend, 10-year trend, sometimes 15, 20-year trend.

But nevertheless, when you look at longer periods of history, you often realize that these trends tend to dissipate.

Interest rates have been low before, until they weren't.

Inflation had been low before, until it wasn't.

And to just say, we live in a new world, world, this time is different, it's very naive.

And so the interest rates have gone up, I think, to stay for a long time.

My guess is they're more likely to go up than down.

And that also puts pressure on central banks.

When interest rates are low, and everybody's kind of happy with them and they're not squeezing them.

When interest rates go up, it puts a lot of pressure on the government budget, puts a pressure on businesses.

They don't like it.

There's pressure to bring the interest rates down.

In this period of low interest rates, the central banks could kind of do their thing.

Nobody was bothering them.

But we're not in that world anymore.

At the end of the day, if the government's putting a lot of pressure on you, it's very tough to resist.

What happened to the last few reserve currencies and what lessons should the U.S.

take from their decline?

I mean, they lost wars.

You know, some of it from arrogance.

I mean, the British wouldn't argue that.

The British actually won World War I and World War II,

but the U.S.

was the big winner because the U.K.

lost percentage-wise of their population, of their income, much more of their industrial base, much more of their young men.

I wouldn't take too much solace from that because we live in a big world and it's not just a matter of what we use in New York.

It's a matter of market share.

Ethan Hilzetsky and Carmen Reinhardt argues that the dollar peaked in 2015.

It had fallen off after Nixon.

It had come back and back and back and hit, I think, an all-time peak in 2015, but it's been coming down.

So you think the dollar, which has been on top for over a century, is essentially in its twilight years of dominance?

It's peaked.

And it's in decline, but it's not going away.

Think of a world where the dollar is king, but of a smaller hill, and it has to share the space more.

People, the Euro is going to rise in its share.

Crypto is already taking a share from the dollar in the underground economy, which is a huge part, maybe $20 trillion a year, $25 trillion a year.

The dollar used to own that.

Now it doesn't.

The RMB will certainly take part of Asia.

We've been lucky at times.

We're good, but we've been lucky and and we can't always count on that.

What mistakes have other countries made that has essentially made the US dollar more dominant?

One is the fact that the Euro took Greece into the Eurozone, but their income level, their economic and social development was not ready.

And had the Euro crisis happened without Greece, it would have been much less and the Euro would already be a much more important currency, not as important, but it lost a lot of market share.

The dollar gained it.

The yen has no market share.

And had it not let us pressure them so much in the 1980s to devalue their exchange rate and do a host of financial liberalization, the yen would also have a role.

I would also point to the mistakes that the Soviet Union made, where we all take as given, that it always was going to do terrible.

But of course, you know, as someone of my age knows, we didn't know that.

And I think there was a moment when they could have done more Chinese-style reforms in the mid-1960s.

The Brezhnev, Koseygin reforms, had they been started and followed through.

You know, Russia could look more like China does today and long ago become a competitor.

There are other stories, but those are some of the major ones where things could have gone differently and they didn't.

What would it take to keep the dollar dominant?

And what forces, inflation, sanctions, debt, crypto, could further undermine it?

The things to keep it on top were first and foremost, this independence of the Federal Reserve.

Because let's remember when we took away gold, why should anybody trust the dollar?

Okay, because we say we're going to be good, but everybody knows we won't be when it's important.

And the independence of the Federal Reserve, which is not an absolute, is very, very important.

I actually think I wrote the first paper on this in the early 1980s when only the U.S.

and Germany had independent central banks, and it's become a gold standard, so to speak, in the world.

But a lot of countries think, oh, that was too much.

I don't want them to be that independent.

I don't like having them have that much power.

What you're seeing Donald Trump say and do is actually not so different from many other countries.

I mean, he has his own personality, idiosyncratic ways of doing things.

But my book, which remember was written before the election or we knew what he would do, I was just as worried about the progressives who breathe fire on this issue.

They don't like the independence of the Federal Reserve.

They don't like the financial sector in general.

And that's true in many places in the world.

So there are people who argue we're in the twilight of central bank independence.

I hope not.

If we do have it reduced in the U.S., the president assumes more power, that will not be good for the dollar.

I think the smart players in the rest of the world will realize long run, you're going to get more bursts of inflation.

You can get defaults, partial defaults in the United States in this new world.

Again, that's a, this time is different.

We never default on our debt.

It ain't never going to happen.

We did in the 1930s.

Roosevelt defaulted on our debt.

All these things are possible just because they haven't happened in 20 years or 30 years.

If you not just look at our history, but other countries, look at how people behave in difficult situations.

I mean, this would take a shock to have it happen.

It wouldn't just happen because our Congress decided to shut down the government and default on its debt.

But some mix of inflation, forced saving into government debt, which we call financial repression and partial default are all on the table over the next few years if we run into problems.

And how about sanctions?

Sanctions undermine many countries from wanting to use the dollar.

China is our biggest fan in a way.

By the official numbers, they're only holding $800 billion right now in treasuries.

But I had a student do work on this, getting an important paper, where he says, no, no, no, no, you can look at other things to show that they actually hold $2 trillion.

A lot of it's through proxies and indirectly, because of course, they don't want us to know.

And China's our biggest fan.

They're looking at what we did to Russia, and they are wanting to reoccupy Taiwan.

Again, that's another debate, what'll happen.

But a lot of people I talk to say it's more likely than not that they'll at least blockade Taiwan.

And they know that when they do that, we will retaliate.

We're not going to bomb Shanghai, but we'll probably put on financial sanctions.

They know that.

And they're trying to prepare their economies for that, have their own back offices, their own ways of doing trade, and hold less dollars.

Ken, what are the three takeaways you'd like to leave the audience with today?

First of all, investors and policymakers get mesmerized by trends, something lasting a decade, sometimes even 20 years.

But to have perspective on whether this time is different, you need to look at longer periods.

I think people need to understand

that the dollar brings incredible advantages to the United States.

Lower interest rates, as you and I have been discussing, Lynn, but many other things, particularly our ability to spy on everyone as the the back office to the world, our ability to put sanctions on everyone.

And number three, people always think that the United States is great.

I was a professional chess player in my youth, and I quote a great chess player who was asked, would you rather be lucky or good?

And he thought for a second, great Danish player Vent Larson, he said, well, both.

And Americans forget we've been lucky.

And if you go through the history, you'll see we made some terrible mistakes.

We went down but came back.

But importantly, our potential competitors did a lot of dumb things that had just they done a little differently.

We would already be in a multipolar world.

We would already be paying higher interest rates.

We have been good.

We've also been lucky.

Ken, this has been great.

Thank you so much.

I very much enjoyed both of your books.

This time is different

and our dollar, your problem.

Thank you so much.

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I'm Lynn Toman, and this is Three Takeaways.

Thanks for listening.