The currency of the United States has been at the center of the global economy for years, but digitalization is applying pressure to its critical foundation. The traditional system of payments and exchange is being reorganized in a way that will challenge the dollar’s incumbent authority. We have explored the changing landscape of central bank digital currencies (CBDCs) in several articles and discussed the implications of a digital dollar, but now endeavor to explain the global benefits of a digital dollar. We first acknowledge the dollar’s important global role. Only through this can we gain an appreciation for both the incremental and dynamic value of the digital dollar.
From Bretton Woods to the Nixon Shock
In an attempt to stabilize the post-war global economy and prevent the destructive currency manipulation of the preceding decade, the agreement reached at Bretton Woods in 1944 established a system under which global currencies were pegged to the U.S. dollar, which in turn was pegged to gold at a fixed rate. This arrangement effectively established the dollar as the backbone of international finance. As national economies recovered from the slump, inflation concerns led to a push for greater financial autonomy and a call on gold reserves. Out of concern that the U.S. stock of gold was not sufficient to cover foreign holdings of dollars, and contemplating U.S. economic stability, President Nixon put a freeze on the dollar’s convertibility to gold (part of what is now referred to as the “Nixon shock”). Shortly thereafter, the global financial economy shifted to a floating exchange rate system.
It was during this time the term “exorbitant privilege” was coined by France’s Minister of Finance,Valéry Giscard d’Estaing, as a result of new guarantees and fail-safes provided to the U.S. from its role as the preferred international reserve currency. However, despite the dissolution of the Bretton Woods system and animus from the likes of Giscard, the dollar sustained its role as the global reserve currency and remains so today without any formal declaration or agreement. The dollar went from being the foundational currency in global finance to the de facto currency. But why? When you dig into the benefits it imparts on the global economy, it becomes quite obvious – it provides a necessary public good.In the absence of such a system, the global economy runs the risk of falling into what is known as the “Kindleberger Trap” – a vacuum caused by the absence of much needed global public goods, which results in the collapse or dysfunction of the global system. This would take us right back to the days of financial chaos that led up to the Bretton Woods Conference in 1944.
U.S. Dollar Significance
Much attention is currently given to the United States dollar and concerns regarding its preeminent role as the de facto global currency. Such status affords the U.S. certain authorities and responsibilities. This is particularly true regarding (i) the United States’ support of a global order around free markets and democracy and its role in the oversight of good global financial standards and application of sanctions, (ii) the U.S. dollar’s role in stabilizing global shocks, (iii) the U.S. provision of access to mature capital markets, and (iv) upholding the dollar’s historical role as a unit of measure, means of exchange and store of value.
The primacy of the dollar has afforded the United States leverage in shaping an allied consensus around free markets and democracy. It has also enabled the U.S. to assert global standards or impose sanctions, without threatening or utilizing military force, which is a benefit to the global financial system. Global dependence on the U.S. dollar provides the U.S. with the ability to combat terrorism, laundering, cyber fraud; and to support infrastructure such as common rules of behavior, data sharing, a legal framework, and policy coordination, strengthening the reliability and resilience of the global financial system. Recently, the Biden administration enacted a new round of sanctions on Russia as reprisal for its role in American election interference and theSolarWindscyberattacks of 2020. Iran and China, amongst others, have also been the subject of U.S. sanctions which aim to constrict the target party’s economic activity to punish or prevent nefarious activity. American sanctions policy is supported on the whole as a means to maintaining global order; however, it must be careful not to overuse this authority or use it in its self-interest, nor be insensitive to the spillover effects which impact more than just the intended recipient of the sanctions.
Through the Federal Reserve and its cooperation with international financial institutions such as the International Monetary Fund and World Bank, the dollar’s role as the global reserve currency plays an important role in stabilizing the global financial system. It enables countries to weather economic shocks, purchase imports, and provides access to the world’s most liquid capital markets. Its integration with other global financial instruments allows the U.S. dollar to support other global financial institutions such as the IMF through its contribution to instruments such as Special Drawing Rights (SDRs). The U.S dollar accounts for approximately 42% of XDR, the official currency code of SDRs. In severe economic downturns, as was the case during the Global Financial Crisis (“GFC”), and more recently the Covid-19 pandemic, the U.S. stepped in directly to provide a much-needed backstop to a shortage in preferred currency reserves (i.e., U.S. dollars) in the form of currency and liquidity swap lines.According to Steffen Murrau, “the Federal Reserve’s interventions in March and April stabilized the system … allowing it to continue along its current development path. In doing so, the Federal Reserve is acting as the de facto global central bank.” Skeptics suggest that the systemic risks posed by “dollar dependence,” whereby shocks to the American economy spread throughout the globe, as during the GFC, are not worth the ties to the currency. For today, however, U.S. dollar hegemony persists, with the United States maintaining its role as the global stabilizing force in the financial system.
The U.S. dollar affords the world advantages in accessing mature financial markets offering low-cost and stable capital. According to Mark Sobel, Senior Advisor for the Economics Program at CSIS and former Deputy Assistant Secretary at the United States Treasury Department, it is imperative to remember that in conversations about the historical hegemony of the U.S. dollar, there is more than one reason for its inherent centricity and influence. He holds that “the markets chose the dollar due to the breadth and depth of the U.S. economy, its dynamism, unparalleled liquidity, and credibility of the Federal Reserve.” In addition, the U.S. has a very liberal and open capital account that provides assurance to investors that their money will not be put at risk by capital controls that support U.S. domestic priorities over free and open market principles.Lastly, the importance of the United States’ experienced, independent and prudent monetary authority, and its operation within a well-established and adaptable legal and regulatory authority that promotes security and recourse under a trustworthy rules-based system, should not be underestimated.
The U.S. dollar does a good job of satisfying the definition and the world’s expectation of a currency – that is, as a unit of account, a medium of exchange, and a store of value. As a unit of account, cash, bank deposits denominated in dollars, and ultimately a central bank digital dollar, are all understood to be interchangeable. As a means of exchange, the dollar remains the currency most used for invoicing. “The U.S. dollar is still on one side of more than 85% of the transactions in the $6.2 trillion-a-day foreign exchange market.” The largest sovereign reserves are in dollars. The dollar’s role as a medium of exchange is well established. Lastly, relative to other currencies, the dollar has been a reliable store of value. Fiat currencies, like the dollar, still are backed by the ability to tax an underlying citizenry which proceeds can be used to support the value of the currency. In reality, many countries turn to the dollar as a store of value in times of crisis. This has been particularly the case for countries facing hyperinflation, currency devaluation, or capital controls such as in Venezuela or Argentina.
As we move into a more multipolar world and as emerging powers assert alternatives to the dollar, we should consider the benefits it has afforded the global economy thus far and acknowledge that it has served the global community well. It should be noted that the U.S. stewardship of the dollar as a leading currency provides many benefits but comes with certain domestic tradeoffs as well. Creditors purchase U.S. debt with the comfort that it carries low risk and easy convertibility. Foreign demand bids up the value of the dollar and renders U.S. exports less competitive, impacting jobs and depleting important sectors of the economy. The U.S., nevertheless, provides this global function as it derives reserve currency benefits and honors its obligations to the many countries unable to borrow money or pay for foreign goods in their own currencies (much of international trade is done in U.S. dollars). In summary, the dollar has far- ranging positive effects, and the global economy should be wary about rising criticism regarding its replacement. There are few, if any, other currencies that can offer its full suite of advantages.
The Dollar is the Global Market’s Preferred Option
Dollar primacy has been sustained due to the size and stability of the U.S. economy; global confidence in U.S. leadership; U.S. adherence to an independent court system; the size and depth of U.S. capital markets; the ability to freely invest and liquidate assets domestically and globally and to transfer proceeds domestically and globally when desired. The dollar’s preeminent role in the global economy is evidenced by the numbers as well. As it stands today, the dollar accounts for close to 60% of total official foreign exchange reserves. While the U.S. economy represents around a quarter of total global economic activity, roughly half of cross border bank loans and international debt securities are denominated in dollars, about half of all international trade is invoiced in dollars, 40% of international payments, and 85% of foreign exchange transactions occur against the dollar. As noted, the dollar has obtained its role as a product of the robustness of the U.S. economy, and the maturity of its financial and legal institutions. The U.S. should not take its reserve currency status for granted, however. The rapid creation of an approximately $1.75 trillion cryptocurrency market; the sale by foreigners of over $1 trillion of bonds in response to the CARES Act stimulus in March 2020; and the flight observed in many South American countries to cryptocurrency rather than U.S. dollars in April 2020 each suggest that the U.S. dollars enduring attractiveness is uncertain while the fluidity of sovereign, institutional and consumer choice remains quite certain. Today, the whole of the U.S. economic system provides a much-needed public good in the form of an efficient and trustworthy financial infrastructure that supports a functioning global economy.Maintaining the dollar’s value and centrality in the global financial systems will require leadership, flexibility, and innovation.
The Emergence of a Digital Dollar
The financial world was impacted by at least eight material events which have led to the birth and growth of digital currency:
First, the 2009 Global Financial Crisis changed the financial landscape and people’s trust in the banking system and centralized authority.
Second, the advent of blockchain technology provided the capability to move away from the banking system and provided independence from a centralized authority.
The third material event leading to the birth of the digital currency ecosystem was the creation of Bitcoin, where an individual or a group writing under the pseudonym Satoshi Nakamoto laid out a framework in a document titled “Bitcoin: A Peer-to-Peer Electronic Cash System.” Satoshi wrote, “The root problem with conventional currencies is all of the trust that is required to make it work. Banks must be trusted not to debase the currency, but the history of fiat is full of breaches of that trust. Banks must be trusted to hold our money and transfer it electronically, but they lend it out in waves of credit bubbles with barely a fraction in reserve.”
Fourth, in 2014, the Ethereum blockchain launched, which is helpful to understand culturally. Ethereum supporters were inspired by Bitcoin’s ability to deliver a scarce and decentralized currency no longer dependent on a centralized government. Ethereum broadened the application of decentralization beyond money to a decentralized internet offering trusted transactions and smart contract capabilities which enabled commerce and exchange without centralized intermediaries. According to Joseph Lubin, a founder of Ethereum, “this is a paradigm shift …that moves us in the direction of digitization of the entire economy and digitization on top of a new trust foundation represented by decentralized protocol technology.” He further stated, “we can build a new economy that moves from subjective trust to objective trust over the coming decades.”
Fifth, the COVID-19 pandemic greatly accelerated the digital transformation and shift towards a cashless economy.
Sixth, as decentralized cryptocurrencies became popular, the world’s central banks grew concerned about the implications of new participants and technologies in their traditional domain. Certain proposed cryptocurrencies like Diem, Facebook’s proposed currency, posed a threat to the core mandate of central banks, which is to ensure economic and financial stability. In response, developed central banks intensified their research regarding the provision of a digital alternative to private cryptocurrencies. This alternative is central bank digital currency, or CBDC. CBDC is the government’s response to the decentralization, libertarian cryptocurrency movement.
Seventh, the advent of digital technology platforms restructured currency competition. Once on a platform and with the use of digital tokens (a form of currency), value can be readily transferred throughout a network. Furthermore, the capabilities of the network provide additional value beyond the transfer itself. A platform may provide credit information validating the creditworthiness of a counterparty. A global platform with a good communications infrastructure can assist in accessing a previously unreachable set of transaction counterparties. A platform that includes foreign exchange capability can assist in making multiple currency conversions behind the scenes to facilitate a multi-country supply chain transaction. According to Eswar S. Prasad, a senior fellow at the Brookings Institution, “a company such as Amazon could conceivably issue electronic tokens for trading goods on its platfom. The backing of such a large company could ensure the stability of its value and make it a viable medium of exchange, reducing the demand for central bank money for commercial transactions.” Data ownership, privacy, transparency, security, and the ability to uphold value, are all examples of important variables that will make up the attractiveness of a platform and a currency. The implications are that a currency’s discrete functions as a store of value, medium of exchange, and unit of account can be unbundled and repackaged with other platform features and functionalities offering institutions and consumers a menu from which to move seamlessly back and forth depending upon objective. “Currency competition will effectively be competition between bundles of information and networking services.” Furthermore, according to BIS, “the centrality of payments and data on social and commercial platforms may lead to an inversion of the current industrial organization of financial activities…Consumers’ point of contact would be the entity that owns the platform rather than a bank. Financial services would be subordinated to payment services.” The possibility of unbundling and repackaging the components of a currency’s value and recognizing the strategic value of payment services serve to explain why governments seek to remake their currencies as digital currency platforms and seek to maintain access to strategic payments information.
Eighth, global Big Tech companies leveraged the value of their platforms and trove of individual user data to push traditional boundaries and, in cases, wade into the political arena highlighting their willingness to encroach upon the traditional domain of governments. Also, burgeoning private company success in building payment system ecosystems further neutered traditional government levers of power. Governments, desiring to keep Big Tech out of the public domain and reclaim oversight of valuable payments data, took various responsive actions. China responded earliest and most aggressively in launching a digital Yuan (“DCEP”) while tightening restrictions on the use of cryptocurrencies. Further, AliPay and WeChat, were reigned in and access to their data and systems quickly found its place in an overarching CCP oversight infrastructure. In the West, the alignment between the U.S. government and Big Tech is evolving and differentiated by company. Regulators have repeatedly stifled Facebook in its efforts to launch a global digital currency as the U.S. and the EU conduct research to launch a CBDC. Today, over 80% of central banks are involved in researching the launch of a central bank digital currency, and are in various stages of regulating cryptocurrency.
A Digital Dollar Strictly Defined
While the bulk of transactions today are digital – banks store and transmit dollars in digital form – a true digital dollar is a liability of the Federal Reserve and is a direct call on its balance sheet. While some have described a CBDC as having similarities to crypto-backed assets as a whole, CNBC author Jeff Cox notes that there are several important distinctions: “Rather than be a tradable asset with wildly fluctuating prices and limited use, the central bank digital currency would function more like dollars and have widespread acceptance. It also would be fully regulated and under a central authority.” This quotation denotes the most critical difference between the two – the use of centralized vs. decentralized systems of operation. This highlights another essential component of CBDCs and their development, which is the role of the central bank in determining the regulations, standards, and oversight of the currency’s use. The concept stated broadly here is why we have placed such emphasis in past articles on leading the CBDC race and assuring favorable economic, ethical, and privacy outcomes in the emerging digital currency world.
The Role and Benefits of a Digital Dollar
A U.S. digital dollar should aspire to (i) reassert American standards and values, (ii) offer the world greater transaction efficiency, (iii) drive policy efficacy, (iv) ensure accountability, (v) enhance economic growth and (vi) offer the greatest safety of funds. Lastly, it should complement the existing strengths and benefits of the U.S. dollar discussed earlier -- that is, it should assist in enforcing good global order and standards, stabilizing global shocks and providing access to mature capital markets, and upholding its historical role as a unit of measure, medium of exchange and store of value.
The launch of a U.S. CBDC is an opportunity to reassert the standards and values of America and its allies. In constructing a digital currency platform, concepts such as preserving financial stability, the rule of law and privacy are policy considerations that can be built to varying degrees into the digital currency platform and its use and oversight. In a burgeoning atmosphere of cryptocurrencies and stablecoins, a central bank digital currency offers stability by reducing market manipulation risk, counterparty risk, fraud and offering the consumer protections attached to the U.S. dollar. Clarity in the rule of law and regulatory environment that would accompany a U.S. CBDC would set it apart from the fraud, graft and autocratic decisions in other parts of the world that create and destroy value unpredictably. Regarding privacy, governments and private companies have begun to merge big data, blockchain, digital payments, and artificial intelligence to produce significant amounts of meaningful information. The central digital system implemented in the future will have the potential to support some private information, some information used to generate good public policy, and some that could be used for surveillance. Balancing the transparency inherent in Know Your Customer (KYC) and Anti-Money Laundering (AML) policies, which serve to preclude criminal behavior, with the inherent American right to privacy, is an important task. Modernizing the existing American regulatory and legal regime as part of creating the digital dollar is likely the best means to preserve the values of the status quo. Today, there are few currency alternatives that are likely to achieve the pervasiveness of the dollar combined with a modernized version of Western standards and values. The Euro has an uncertain future, while China’s digital Yuan (DCEP) is part of a system restricted by autocratic intervention in the rule of law, capital controls and surveillance – this stands in direct contrast to the liberal economic order the world has enjoyed thus far.
A digital dollar may be used by governments, banking and selected business institutions in the wholesale market, or by consumers in the retail market to transact cheaper, faster and more conveniently by eliminating frictions in payments, and clearing and settlement, including cross-border payments such as remittances. While most developed countries already have a fairly sophisticated wholesale payments infrastructure, the utilization of CBDCs in the wholesale market can, nevertheless, facilitate inter-bank clearing, cross-border transfers, international trade settlement and capital market transactions. According to Forbes, “the global market for retail cross-border payments alone is estimated at $3.5 trillion a year and CBDCs could be a real game-changer to liquidity and settlement.” In the retail market, local fiat currencies must often be exchanged to more widespread fiat currencies like the U.S. dollar or the Euro and then must be converted back again at significant cost. More centralized and liquid digital exchanges and the elimination of middlemen should assist in reducing transaction costs. For the general population with a smartphone, CBDCs will enable anyone to send and receive U.S. dollars with lower transaction costs than those provided by traditional solutions. Faster transaction times and higher volumes reduce costs generated from bid-ask spreads and excess intermediation (too many transfer touchpoints). Lower costs reduce the burdens of market participation and foster financial inclusion, lifting the wealth of both the domestic and global populations. This is especially important when considering the growth and international inclusion of emerging markets in Africa, which will host greater than a quarter of the world’s population and consumers by 2050.
A digital dollar can aid policy efficacy by more directly reaching the intended beneficiaries of government assistance payments and generating data on how money flows through the global economy, which will inform better policy. CBDC’s can contribute to more focused targeting of stimulus payments and greater financial inclusion by reaching anyone with cell phone capability, including the currently unbanked populations of the world. Recently, Vice President Kamala Harris discussed the option of using digital banking and micro-lending to address the immigration crisis resulting from violence, disease, and disruption in Guatemala, El Salvador, and Honduras. “There’s a whole big segment in most developing countries that don’t have access to traditional lending mechanisms, and digital is much quicker, transparent and equitable,” according to George Ingram, a fellow at the Brookings Institution…And there’s less opportunity for corruption.”Further, CBDCs can be built with smart capabilities such as the requirement to be spent within fixed periods of time for maximum impact. Narrow targeting and smart contract capabilities are just two examples of the potentiality of central bank digital currencies. A digital dollar should assist governments in monitoring spending, tracking currency circulation, and using this generated data to calibrate monetary policy better, improve budget allocations and improve spending accountability – wherever the U.S. dollar circulates. Long-term data analysis on the dollar will increase the potential for predicting anomalous events, adapting to changing economic conditions, and ideally improving financial stability.
A U.S. digital dollar should be constructed with the goals of promoting trust and assuring accountability. In the digital world, this means providing improved transparency, accountability, and auditability of operations. A digital currency built on a robust platform in a democratic country should offer its citizenry the ability to answer questions such as who are the government’s contract counterparties? Who are the recipients of its targeted assistance programs like the Paycheck Protection Program? Where did the foreign assistance dollars end up? U.S. CBDC, in combination with access to a blockchain and smart contracts, can contribute to strengthening social trust and fighting corruption through more transparent contract and foreign assistance systems.
The digital dollar can facilitate economic growth. It should be constructed to, among other things, spur free market competition and consumer adoption. A digital dollar should encourage competition among payments service providers, financial institutions, virtual asset service providers, and selected other institutions in order to gain broader adoption, provide greater user utility and spur a related entrepreneurial technology products ecosystem (e.g., digital wallets). If given a choice, consumers will gravitate towards transacting with the greatest simplicity, expediency, utility, and reliability. A digital dollar should be able to make retail payments, provide for instantaneous transfers, request payments, and transact peer-to-peer at lower costs. It should be seamlessly interchangeable with commercial bank account money and central bank reserves and should provide easy convertibility into selected other currencies and selected cryptocurrencies. Transactions should settle quickly and offer the most liberal privacy standards. A digital dollar, if accepted in different parts of the world, could expand access to trade and labor for business, for example, by making it easier for an employer in a developed country to hire and pay an employee in a developing country in U.S. CBDC. A digital dollar also facilitates microtransactions for individuals remitting monies to family members in developing countries and for whom the current money transmission fees are too high. Any contribution to the seamlessness of trade and the perceived elimination of geographic boundaries will serve to expand economic trading zones, which is generally beneficial.
The digital dollar can offer consumers and institutions the greatest safety of funds as a digital form of genuine Federal Reserve currency. In recent remarks, Lael Brainard, a member of the Board of Governors of the Federal Reserve, noted that one of the primary policy considerations leading the Federal Reserve to focus on a central bank digital currency is to “ensure that consumers retain access to a form of safe central bank money.”[i] New forms of currency may develop, some linked to useful service offerings; however, none offer the Federal Reserve Bank as a direct counterparty. Further, the circulation of a digital dollar will likely be accompanied by greater transaction security and subject to higher Federal penalties for bad behavior, than other circulating currencies.
Josh Lipsky, The Director for the Atlantic Council Geoeconomics Center noted, “The US cannot win the race for the future of money by being content with current dollar dominance. Other countries are out-innovating the US and partnering with their own private sectors to deliver life-changing financial technology to citizens. Developing a digital dollar would be a signal to the world that the most sought-after currency will continue to be the most sophisticated currency.”
Conclusion
Controlling the dominant currency is central to exercising influence and the United States’ stewardship of the U.S. dollar has provided many benefits to the world. The world is in the midst of competition between governments (liberal, illiberal, and authoritarian); Big Tech -- social, payment, and other platforms; and a populist libertarian movement to control the world’s values, freedoms, and standards. Currently, the lines separating competitors in terms of spheres of sovereignty, areas of cooperation versus competition, and geographic relevance are blurred. Further, even the fundamental composition of a currency as a unit of measure, medium of exchange, and store of value may become unbundled and repackaged with other platform features, payment, or data services. According to BIS, “New currencies will emerge as the central lynchpins of large, systemically important social and economic platforms that transcend national borders, redefining how payments and users’ data interact. The advent of these new monies could reshape the nature of currency competition, the architecture of the international monetary system, and the role of government-issued public money.” Deferring currency leadership to authoritarian regimes and alternative value systems in the digital currency race may provide ample opportunity for a long-term shift in currency preference. Recognizing the changing political, technological, and competitive landscape and the many global benefits provided by a dollar and potentially provided by a U.S. digital dollar, the development of a digital dollar with Western interests, contemporary capabilities, and global appeal in mind should be a U.S. priority. The dollar’s benefits to the global financial system are worth preserving.
Statements and views expressed in this commentary are solely those of the authors and do not imply endorsem*nt by Harvard University, Harvard Kennedy School, or the Belfer Center for Science and International Affairs.
Michael B. Greenwald is Director at Tiedemann Advisors and Director for Digital Asset Education for Tiedemann Advisors. He is a fellow at Harvard Kennedy School’s Belfer Center for Science and International Affairs and a Senior Fellow at the Atlantic Council Geoeconomics Center. From 2015-2017, Greenwald served as the first US Treasury attaché to Qatar and Kuwait.
Michael A. Margolis is the Managing Member of Maric Fund Management, LLC and affiliated entities. He is a member of the board of directors of the Atlantic Council where he is co-chair of the future of money task force at the Atlantic Council GeoEconomics Center; a member of the board of directors of Chief Executives Organization (CEO); and a member of the Economic Club of New York.
This article is supported by research advisors Logan Weber and Michael Poor. Weber is a graduate of Harvard University and graduate student at Texas A&M University studying International Affairs. Poor is a graduate student at UC San Diego’s School of Global Policy & Strategy.
[i] https://www.federalreserve.gov/newsevents/speech/files/brainard20210524a.pdf. p. 2.
