These words were penned 14 years ago:
“The only factor that could lead to a mass exodus from the dollar is serious economic and financial mismanagement by the United States.
“And recent developments remind us that such mismanagement is certainly not beyond the realm of possibility.
“A dollar crash might still happen, but it would only be if we orchestrate it ourselves. The Chinese won’t be doing it to us.”
Barry Eichengreen, an economics professor at the University of California, Berkeley, expressed these thoughts in the aftermath of the 2007-09 financial crisis.
His words resurfaced last week when Martin Whetton, the head of Westpac’s financial markets strategy, made a shocking claim regarding the ongoing turmoil in the global economy.
Mr. Whetton remarked that it was “astonishing” to observe on Wednesday how the market dysfunction caused by Donald Trump’s tariffs led traders to cease regarding the United States as a financial haven.
He expressed that he had never encountered anything like it.
He indicated that this change signifies the demise of US exceptionalism and “exorbitant privilege.”
“Since the conclusion of World War II, the US has maintained a primary position in global finance, reinforced by Bretton Woods decades ago,” he stated.
“Surrendering that hegemony, authority, liquidity, and reserve status—perhaps not willingly, but carelessly and without thoughtful consideration—is not something you simply reclaim.”
When he articulated his views on this remarkable situation in a note on Thursday, he titled it: “Exorbitant privilege: 1946-2025.”
This underscored the message he intended to convey.
His note quickly made the rounds among Australia’s market analysts and economists, many of whom concurred with his assessment.
What does “exorbitant privilege” mean?
While analysts deliberate on Mr. Whetton’s assertion, it’s essential to grasp what he meant by “exorbitant privilege.”
In light of the current state of Trump’s America, this concept may help clarify some trading behaviors we anticipate in financial markets in the years ahead.
Professor Eichengreen delved into this idea in his 2011 book, “Exorbitant Privilege: The Rise and Fall of the Dollar and the Future of the International Monetary System.”
This is where the quotes at the beginning of this piece originate.
The term “exorbitant privilege” was first used in the 1960s by Valéry Giscard d’Estaing, then the French finance minister, to describe the financial advantages the US has enjoyed since the post-World War II era, thanks to its currency being the global reserve currency.
How did the US dollar become the world’s reserve currency?
Following World War II, a new international monetary system emerged.
Under this new framework, numerous countries agreed to peg their currencies to the US dollar (either directly or indirectly), while the US dollar was tied to the price of gold.
This arrangement was intended to replace the outdated gold standard, which had collapsed during the Great Depression, with a more adaptable system.
“In practice, however, this system granted the United States the most flexibility, allowing it significant leeway to pursue domestic policy goals and maintain persistent balance-of-payments deficits,” Ben Bernanke, a former chair of the US Federal Reserve, noted.
That’s essentially the essence of it.
What types of privileges exist?
As Eichengreen elucidates, with the US economy positioned at the heart of the global system during the post-war era, the US dollar evolved into the primary currency for invoicing and settling international transactions, including for imports and exports that never touched US soil.
He asserts that using this approach made sense when the US economy comprised over half the combined economic output of the so-called ‘Great Powers’ immediately after the war.
However, this scenario provided the US with numerous financial advantages.
“Being the largest importer and main source of trade credit, it made sense for imports and exports to be denominated in dollars,” he explains in his book.
“Since the United States served as the leading source of foreign capital, it followed that international financial dealings were conducted in dollars.
“Moreover, with such considerations driving central banks to stabilise their currencies against the dollar, it was logical for them to hold dollars in reserve for potential issues in foreign exchange markets.”
Under this system, the high demand for dollar-denominated assets enabled the US to borrow at more favorable interest rates than other countries, granting it greater freedom in pursuing both domestic and international policies.
“This effect is considerable,” Eichengreen remarked in his book.
“The interest rate that the US must pay on its foreign obligations is generally two to three percentage points lower than the return on its foreign investments.
“As a result, the US can maintain an external deficit equal to this difference, importing more than it exports and consuming beyond its production capabilities year after year without significantly increasing its indebtedness to the rest of the world.
“Alternatively, it can acquire foreign companies to the same extent, owing to the dollar’s unique status as the world’s currency.
“This asymmetry in the financial system has long been a point of contention for foreigners, who feel they are underwriting American living standards and supporting US multinationals.”
Are there additional exorbitant privileges? Certainly, there are.
According to Mr. Eichengreen, another advantage for the US is the tangible resources that other nations must provide to acquire US dollars.
“Producing a $100 bill costs only a few cents for the Bureau of Engraving and Printing, while other countries must provide $100 worth of actual goods and services to obtain one,” he stated.
And there are further examples.
Historically, traders have flocked to the US during times of economic and financial crisis, even when these crises originated from within the US itself.
“In 2008, amidst the most severe financial crisis in 80 years, the US government could borrow vast amounts at low interest rates because international investors perceived the dollar to be the safest currency during turbulent times,” he noted.
“Similarly, in spring 2010, when financial volatility surged, investors gravitated towards the most liquid market—the US Treasury bonds—resulting in lower borrowing costs for the US government and, consequently, mortgage interest rates for American households.
“This encapsulates the essence of exorbitant privilege,” he concluded.
A future with multiple reserve currencies
The post-war financial system has undergone significant evolution since the 1940s, and America’s economic supremacy has diminished as nations like China have emerged.
There is an ongoing debate regarding the current relevance of the US’s exorbitant privilege (often suggesting that maintaining this system has also come with costs for the US).
With the introduction of the Euro, the US’s reserve currency position has faced a small, albeit imperfect, competitor in recent decades (which seeks to secure its own exorbitant privileges).
Nevertheless, Mr. Whetton’s assertion raises an important point: what we witnessed last week when traders unexpectedly turned away from the US amidst extreme market dysfunction merits serious consideration.
What implications does this bear for the future?
In 2011, Mr. Eichengreen advocated for preparing for a multipolar future characterized by multiple reserve currencies.
“Except for the rather unique latter half of the twentieth century, there has generally been more than one international currency,” he noted.
“There is no reason why, in the near future, nations bordering China couldn’t utilize the renminbi for their international dealings, while European countries could employ the euro, and nations engaging with the United States could continue to use the dollar.”
In light of last week’s market turmoil, has the world taken a significant leap towards this potential future?
