Managing the World's Dollar Dependency

The global financial crisis has exposed a weakness in the international monetary (non-)system. Desired levels of currency reserves in emerging markets have jumped over the past decade. The dollar's unique reserve-currency status has caused the bulk of these reserves to be parked in the United States, and the resulting capital flows have contributed to the underpricing of risks in the world's leading financial center. This underpricing formed part of the backdrop for the global financial crisis and may set the stage for the next one. To prevent a repeat of the past, policymakers must establish mechanisms to avoid excess reserve accumulation in surplus nations. In the early 1970s, U.S. treasury secretary John Connally could tell Europeans that the dollar was "our currency, but your problem." Today the world's dollar dependency is a problem for the United States, too.

Kiel Institute Expert