I recently attended a very interesting roundtable in Kuala Lumpur on the lessons from the Global Financial Crisis. Lots
of interesting topics were touched upon, but it was one issue that really caught my attention: have the US been generous to the rest of the world by committing itself as leader of the Free World, with corresponding high military expenses, and is this generosity
now going away under Donald Trump? This is not only the narrative of Donald Trump, but many other observers who point to the costs of the leadership role the U.S. have been taking over the past 75 years. What is sometimes forgotten, however, is that
this leadership role also comes with privileges, most prominently, the ability to issue the reserve currency of the world. A recent paper by Barry Eichengreen, Arnaud Mehl
and Livia Chitu, which will be presented at the next Economic Policy panel meeting in Vienna in October, shows that to a certain extent it is military alliances and support that explain why a country’s currency is used by other countries as reserve
currency (thus providing it with the equivalent of seigniorage gains). The fact that the U.S. has a leadership role in the West can thus explain why the US dollar is so popular as reserve currency and guarantees lower interest costs for the US government.
A back-of-the-envelope calculation by the authors shows that the benefit of issuing the reserve currency of the world is larger than the costs of military alliances and support the US provides to its allies.
By the way, these
findings might also explain why the Euro has not become a major reserve currency around the world – contrary to the hopes and expectations of Europeans. As the Eurozone and the European Union are primarily economic unions and have no military ambitions,
the findings of Eichengreen et al. suggest that the Euro will not be able to convert itself into a major reserve currency.
One might be able to make a similar argument about privileges vs. generosity about Germany within the Eurozone,
though less in military and more in political terms. The Euro is effectively a foreign currency for most Eurozone countries, with the notable exception of Germany. Political or economic uncertainty in periphery countries resulting in an increase in sovereign
bond yields pushes down the German Bund yield as the result of a run into safety. And it is Germany, which benefits more than from that than any other core country (e.g., Netherlands), given the size and liquidity of the German sovereign bond market. This
also relates to the scarcity of safe assets in the Eurozone, which again puts Germany in a privileged position. These benefits if not privileges from being the core country of the Eurozone make a strong economic but also political argument for taking
more financial responsibilities within the Eurozone (aka as “generosity”), ultimately sharing the benefits of this privileged position with the rest of the Eurozone. While some in Germany might have recognised this point, there is no broad consensus
on this yet and it might take another generation or so to get there, hopefully before the Eurozone breaks apart. But even if there were such a consensus, we have learned from the Trump presidency that a generation-long consensus can be questioned in
a rather powerful way.