The dollar system

Somewhere around 58% of the world's allocated foreign exchange reserves are held in dollars, down from about 71% at the start of the century. Roughly half of world trade is invoiced in dollars, which is several times America's share of world trade. And the United States has run a current account deficit every year since 1991. Those three facts are connected, and the connection runs in the direction most people assume it does not.

The world wants dollars, which means it wants American debt

A dollar is a liability of the United States. So is a Treasury bond. When a central bank in Asia decides to hold reserves, or an exporter decides to invoice in dollars, or a company in Brazil borrows in dollars, each of them is choosing to hold a claim on America.

There is exactly one way for the rest of the world to acquire more of those claims in net terms: sell America more than it buys. The dollars go out as payment for imports and come back as purchases of American assets. That is the current account deficit and the capital account surplus, which the trilemma lesson works through as one transaction counted twice.

So the reserve issuer runs deficits. Not through incompetence and not by choice. The world's demand for its currency is a demand for its liabilities, and a liability only reaches somebody else's hands by being issued.

The bind, projected forty years

Below is a world where the issuer is a quarter of world output, grows more slowly than everybody else, and everybody else wants to hold a fifth of their own output in its currency. There is no policy in this model and nobody makes anything.

Now drag the issuer's growth up to match the world's. The deficit stops rising and holds flat forever, and the claims stop piling up. Nothing about the deficit changed.

Reserve composition is the IMF's COFER database, published quarterly and free. Invoicing shares are in Gopinath and others' work on dominant currency pricing. Triffin's argument is in Gold and the Dollar Crisis, 1960. The projection above is the model on this page, which is unit tested.

ConventionExorbitant privilegeis Valéry Giscard d'Estaing's phrase from the 1960s, and it is worth being precise about what it buys. The issuer borrows in a currency it prints, so it cannot be forced to default in the way Argentina can. It pays lower interest than its numbers alone would justify, because the world has to hold something. And it earns more on its foreign assets than it pays on its foreign liabilities, which is why America has run a large negative investment position for years while still earning net income on it.

What the privilege costs

The bill is not paid by the country evenly. Persistent demand for dollar assets keeps the dollar stronger than trade alone would make it, which makes American exports dearer and imports cheaper. That is pleasant if you buy things and unpleasant if you make them, and the people it is unpleasant for are concentrated in particular places.

The second cost is that the issuer's monetary policy becomes everybody's. When the Federal Reserve raises rates, every borrower in the world who owes dollars gets a tightening they did not vote for, delivered by a committee with no mandate to consider them. The trilemma lesson names this from the other side: countries with open capital accounts and managed rates are following the Fed whether or not they say so.

What to do with this

When you read that a country is trying to move away from the dollar, ask what it is moving into and whether that issuer is willing to run the deficits and open the capital account the job requires. Almost every announced alternative fails on the second point, and the countries most eager to displace the dollar are the least willing to do the thing that would.

And when the trade deficit comes up, hold both halves of it at once. It is the mechanism that supplies the world with dollars, and it displaced real industries in real towns. Those are both true, they are the same transaction, and any argument that only mentions one of them is not finished.