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This chapter investigates whether the dollar might eventually follow the precedent of the pound and cede its status as leading international reserve currency. The link between currency shares and their determinants is nonlinear, but changes are felt only with a long lag. The sustainability of the U.S. current account deficit may depend on the continued willingness of foreign central banks to collect ever-greater quantities of U.S. assets. The euro soon after its debut came into wide use to denominate bonds. The euro is the number two international currency, and has rapidly gained acceptance. Euro enthusiasts endured some serious setbacks in 2005. Data indicate that dollar depreciation would be no free lunch: it could have consequences for the functioning of the international monetary system as profound as the loss of the dollar's preeminent international currency position, and along with it the exorbitant privilege of easily financing U.S. deficits.

The chapter by Carvalho explores the accumulation of international reserves as a defensive strategy, as well as the reasons and limitations of their “self‐insurance” function. Conceptually, countries demand reserves of foreign currencies for a similar set of reasons to those which explain why individuals demand liquidity. However, while individuals hold liquid assets primarily to effect transactions, countries do it mostly for precautionary reasons. Again, as in the case of individuals, the stronger the demand for money, the harder it is to obtain liquidity in public sources and money markets. The chapter notes that international liquidity provision remains as important now as it was in the recent past. Carvalho argues that the best alternative would clearly be an international monetary system where a new international currency could be created according to global liquidity needs, as well as for emergency liquidity facilities to protect countries from adverse temporary external shocks.

At the stage of maturity in the life cycle of an international currency, the challenge is: What should the issuing government do with its currency power? The options are exploitation, evasion, or enjoyment. Should the issuer seek to capitalize on the advantages offered by the newfound power resource? Should it look for some way to escape potential risks of currency internationalization? Or should it, in a passive mode, simply accept the benefits of internationalization as they come? Once again, a brief review of recent history illustrates the importance of geopolitical ambition – its presence or absence – in determining which option will be chosen. Most countries that have seen their money rise to the upper ranks of the global monetary hierarchy, just below America’s top-ranked dollar, have settled for the enjoyment option, eschewing the attractions of currency power. These include today’s euro and yen, Britain’s pound, the Swiss franc, and the Canadian and Australian dollars. For the United States by contrast, deeply enmeshed in geopolitics, passive currency statecraft is not a natural option. The chapter explains and evaluates the many ways that the United States has exploited its currency power, both directly and indirectly.

This chapter reviews the ability of floating local currencies to provide plentiful financial resources at low financial costs, and discusses how international currencies can play the role of standards of value for several reasons. The main one is that they cover large and diversified areas, which can meet all the economic needs of their inhabitants with world-class quality and efficiency. The chapter discusses how, if a local currency is devalued in a poorly diversified economy, as all the developing ones are, the cost of the many goods and services that it does not produce will increase by the magnitude of the devaluation. It analyzes the behavior of interest rates and the volumes of resources intermediated. It also analyzes how these two variables interact with each other to give shape to the financial systems of the developing countries.

After maturity comes decline – the end that history suggests must come to every international currency. At this stage, the challenge is how best to live with fading eminence. Again the choices are three: resistance, reinforcement, or relaxation. Policy makers may actively strive to resist abandonment of their currency, hoping to preserve at least some of the benefits of international use. They can seek to reinforce the process of decline in hopes of managing a “soft landing” for the currency. Or they may just leave it to market actors and foreign central banks to decide matters. The prime example of currency decline in recent history is Britain’s pound sterling, which over the last century has fallen a long way from its once exalted status at the peak of the global monetary hierarchy. Once more, the importance of geopolitical ambition is highlighted. To cope with the challenge of decline, London’s currency statecraft gradually evolved from resistance to reinforcement. After struggling mightily to sustain a role for the pound to commensurate with Britain’s historical role as a great imperial power, strategy eventually moved decisively from opposition to accommodation, once British policy elites began to accept their nation’s diminished place in the world.

This chapter summarizes the conclusions of the analysis presented in the book. It argues that a developing country should surrender its power to create money by adopting an international currency as its own because it is the only way in which it may access a truly optimal currency area. The chapter discusses how the idea that detaching submarkets from bigger ones may be optimal also goes against the grain of globalization—a process which is increasing the productivity of all its participants by rearranging production in accordance with competitive advantages. In particular, it goes against the grain of financial globalization. This is truly odd because monetary and financial economics are so intertwined that it is sometimes very difficult to ascertain when one ends and the other starts.

The global dynamics of complexity and tight coupling unfold at the level of bilateral relationships, creating different levels of risk. The U.S./China relationship is crucial because it involves the world’s two largest economies, and has become increasingly complex in terms of trade, direct investment, and information flows, although it is not as tightly coupled because the U.S. and China are also closely connected to other economies in the world in terms of trade imbalances, portfolio investment, currency trading, and cross-border banking. The greatest concern has to do with the continuing role played by the U.S. and China as the consumer of last resort and the lender of last resort, respectively. The future of the dollar as the most important international and reserve currency hangs in the balance, while the Chinese currency is years away from playing an international role, and digital currencies are still at the experimental stage.

This chapter briefly explains how the global financial crisis of 2007–2008 and its aftermath revealed underappreciated vulnerabilities in the US economy. These led to disenchantment with the American financial model and its global economic leadership. One consequence of this will be to put pressure on the dollar's global role. The chapter discusses two distinct effects felt by states managing international currencies in relative decline: (1) the loss of the benefits associated with issuing international money, and (2) the challenges of issuing a currency experiencing a contraction in global use. The principal consequences of international currency diminution (in general and for US power) include pressure on defense spending, reduced macroeconomic autonomy (and thus the ability to finance ambitious foreign policies), vulnerability to currency manipulation, and greater exposure to debilitating financial distress, especially during international political crises.

Chapter 5 reviews attempts by Japanese authorities to promote international use of the yen, mainly in trade invoicing and cross-border capital transactions. Because efforts involved developing yen-denominated markets and instruments, and dismantling restrictions inhibiting the freedom of domestic and foreign agents to use them, yen internationalization was closely related to domestic financial liberalization. The chapter explains the origins of yen internationalization, Japan’s early attempts to liberalize the financial system, and post-1984 measures to create conditions amenable to greater international use of the yen, including the financial “big bang” of 1998. After assessing the outcomes of yen internationalization efforts, the chapter concludes by arguing that yen internationalization served as a banner under which parties of various vested interests were brought together to forge difficult reforms

This chapter provides an analytical foundation for a discussion of currency concepts. It describes terms such as capital account convertibility, exchange rate flexibility, and purchasing power parity. It also explains the differences between an international currency, one that is used widely in international trade and finance transactions, and a reserve currency, one that is used by foreign central banks to store their foreign exchange reserves.

The rise of the RMB has been impressive by any standard although the currency still has a long way to go before it becomes a major reserve currency that accounts for a substantial portion of global foreign exchange reserves. This chapter concludes the book with the prognosis that, so long as the Chinese government plays its cards right with further reforms and so long as the economic risks are managed, the RMB could become a significant reserve currency over the next one to two decades. At the same time, the Chinese government’s repudiation of broader political, legal, and institutional reforms implies that the RMB will not ascend to the status of a safe haven currency.