The currency hierarchy and the role of the dollar as world money

dollar-1445476_1920There has recently been much talk that the hegemony of the United States is crumbling, from the decline in its share of world GDP to its possible submission to a new economic power such as China. However, little has been said about the fundamental pillar that sustains the power of the United States, the US dollar.

Globally, the dollar is the most utilized currency, both in trade in products and services and in cross-border financial operations. Given the continued dominance of the US dollar as the key currency of the international monetary system, it is difficult to speak of a declining US hegemony. But how to explain the power of the dollar and the apparent immunity of the United States hegemony in times of financialization?

A number of authors from a variety of schools of thought have recently dedicated themselves to elaborating explanations about this phenomenon. On the one hand, Post-Keynesian economists analyze the hegemony of the dollar using the concept of the currency hierarchy. According to Fritz et al. (2018), this notion is inspired by at least two theoretical traditions. First, the work of John Maynard Keynes (particularly his Treatise of Money (2013, [1930]) and his preparatory studies for the Bretton Woods Conference (2013, [1944])) in which he identified the hierarchical nature of the international monetary system, as well as the absolute dominance of a key currency. Second, Latin American Structuralism and its traditional center-periphery notion (Prebisch, 1998, [1949]), according to which center-periphery relations are also reproduced in the financial sphere.

The currency hierarchy notion allows us categorizing currencies based on their ‘liquidity premium.’ Following the classical Keynesian approach, liquidity represents the ability of assets to be converted in cash (the easier an asset is convertible, the more liquid it is). For Post-Keynesians, the currency hierarchy is akin to a pyramid. The US dollar is the most liquid currency and lies at the top of this pyramid. Just below the US dollar in the currency hierarchy are the elite currencies, which are the currencies of other developed countries (Cohen, 1998). Lastly, there are the dominated currencies, which are the currencies of peripheral countries and which are situated at the bottom of the currency pyramid.

Inspired by the notion of the rate of return and the liquidity preference theory of Keynes (2003, [1936]), Bortz and Kaltenbrunner (2018) identify that within the currency hierarchy, the country issuing the main currency has an ‘exorbitant privilege.’ This expression was first coined in the 1960s by Valéry Giscard d’Estaing, the French Minister of Finance at the time, to analyze the benefits that the US dollar obtained after the Bretton Woods agreements. However, the exorbitant privilege has acquired new implications in current times, given that it allows the United States to offer a lower interest rate on its financial assets compared to the one of other countries. Also, the liquidity premium of the dominated currencies is lower so that underdeveloped countries have to: a) offer higher interest rates to maintain the demand for their financial assets; b) are subject to short-term speculative operations, since foreign investors tend to prefer not to commit to long-term funds); and c) are predisposed to the possibility of a capital flight that may arise at any time and for reasons potentially disconnected from their domestic conditions. Therefore, the countries of the periphery are subordinated to US monetary policy, and any change in the international liquidity preference could send macroeconomic shocks and put at risk the future of their economies. The international liquidity preference refers to the tendency of investors to choose the most liquid assets in order to convert them easily in cash.

On the other side of the discussion, Marxist authors propose to analyze the hegemony of the US dollar and the currency hierarchy using the classical notion of world money, developed by Karl Marx in Capital Vol. 1 (2004, [1867]). According to Marx (2004, [1867]), world money functions as universal means of payment, universal means of purchase and as universal social materialization of wealth. Before the hegemony of the dollar, gold used to function as world money. This means that all the countries had to keep a great number of reserves in gold to participate in the global commodities exchange, so its hoarding and transfer were fundamental for the functioning of the international monetary system. Subsequently, with the breakdown of the Bretton Woods system of fixed exchange rates in 1971, the dollar assumed the role of world money, creating a direct link between the US financial system and the international financial system. According to Lapavitsas (2016), the US dollar has become a problematic substitute for gold inasmuch as, rather than serving as a world market coordinator, it has become an instrument of US power.

Additionally, Painceira (2011) argues that the 2007-2008 crisis that began in the United States became a global catastrophe because the financial operations at its origins were denominated in dollars. It is no surprise, then, that the financial crises faced by underdeveloped countries of Latin America in the 1980s were related to the shortage of world money they suffered during this period. The scarceness of US dollars during this period had to do with the increase of the US interest rate, and the following capital flight they suffered as a consequence, which depreciated their exchange rates, and made their external debt harder to pay.

Furthermore, it is commonly accepted that all countries that participate in the world market have to maintain a certain part of their wealth in dollars to exchange the goods they produce. Besides, most of the financial assets are also denominated in the US currency. Under these conditions, countries that cannot issue dollars are subordinated to the world money issuing country. Consequently, underdeveloped economies need to accumulate a large amount of foreign exchange reserves, largely denominated in US dollars, to protect themselves from external imbalances and capital account reversals (Painceira, 2011: 326-330).

For Marxist scholars, the accumulation of US dollars as international reserves is a contemporary manifestation of imperialism. Given their specific position in the world market, as well as their role in the international financial systems, emerging economies present characteristics of subordinate financialization, a phenomenon similar to the financialization presented in developed economies, but limited and shaped by their peripheral position in the world market. The notion of subordination was first proposed by Powell (2013) and later developed by authors such as Lapavitsas (2013) and Alami (2020).

Following this approach, Alami (2020) argues that the accumulation of reserves denominated in US dollars is a manifestation not only of subordinate financialization but of imperialism as a whole, given that this implies a continual transfer of a share of the surplus-value created in the periphery toward the developed countries, mainly the US, who constantly benefit from the subordinate financial conditions of underdeveloped economies, given that the resources that could be used to promote development policies are used to invest in low-interest US treasury bonds, and other types of US debt financial assets (Alami, 2020: 45).

To sum up, the role of the US dollar as world money has granted the United States several privileges such as its complete autonomy in terms of monetary policy and the possibility of accumulating trade deficits. This brief essay intended to present two approaches that invite us to unpack the role of the US dollar as a pillar of the United States hegemony. On the one hand, Post-Keynesians analyze the power of the dollar with the notion of the currency hierarchy. On the other, Marxist authors analyze this phenomenon with the notion of world money. It is worth concluding by saying that, irrespective of the tradition or approach one chooses to start from, it is crucial to continue analyzing this pressing issue.

References

Alami, Ilias (2020), Money Power and Financial Capital in Emerging Markets: Facing the Liquidity Tsunami, RIPE Series in Global Political Economy, Routledge, Oxon and New York.

Bortz, Pablo; Kaltenbrunner, Annina (2018), “The International Dimension of Financialization in Developing and Emerging Economies”, Development and Change 49:2. pp. 375-393.

Cohen, Benjamin (1998), The Geography of Money, Cornell University Press, Ithaca, NY.

Fritz, Barbara; De Paula, Luiz Fernando; Prates, Daniela (2018), “Global currency hierarchy and national policy space: a framework for peripheral economies”, European Journal of Economics and Economic Policies: Intervention, vol. 15 No 2. pp. 208-218.

Keynes, John Maynard 2013 (1930), “The Treatise on Money, II: The Applied Theory of Money”, The Collected Writings of John Maynard Keynes, vol. VI. Cambridge University Press, Cambridge, UK. pp. 189–367.

Keynes, John Maynard 2003 (1936), Teoría general de la ocupación, el interés y el dinero. Fondo de Cultura Económica, México.

Keynes, John Maynard 2013 (1944), “Activities 1941–46: The Clearing Union”, The Collected Writings of John Maynard Keynes, vol. XXV. Cambridge University Press. pp. 1–238.

Lapavitsas, Costas (2016) Beneficios sin producción. Cómo nos explotan las finanzas, Traficantes de sueños, Madrid.

Marx, Karl 2004 (1867), El Capital. Siglo XXI, México.

Painceira, Juan Pablo (2011), “Los países en desarrollo en la era de la financiarización: de la acumulación del déficit a de reservas en divisas”, Carlos Morera y Costas Lapavitsas (coordinators), La crisis de la financiarización. UNAM, Instituto de Investigaciones Económicas, Consejo Latinoamericano de Ciencias Sociales, México. pp. 309-358.

Powell, Jeff (2013), Subordinate financialisation: a study of Mexico and its nonfinancial corporations. PhD Thesis. SOAS, University of London.

Prebisch, Raúl 1998 (1949), “El desarrollo económico de la América Latina y algunos de sus principales problemas”, Cincuenta años del pensamiento de la CEPAL: textos seleccionados, Fondo de Cultura Económica/CEPAL, Vol. I, Santiago, Chile. pp. 63-129.

Giovanni Villavicencio has a degree in Economics from the Universidad Nacional Autónoma de México. @giomvill.

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