Dollar Hegemony - Definition

Definition

The term describes a geopolitical phenomenon of the 20th century in which the U.S. dollar, a fiat currency, became the primary reserve currency internationally. Three developments allowed dollar hegemony to emerge over a span of two decades.

• The Bretton Woods system established in 1945 a fixed exchange rate regime based on a gold-backed dollar. The US did not view cross-border flow of funds necessary or desirable for promoting trade or economic development. In response to the accrual of negative consequences from the Triffin dilemma, President Richard Nixon abandoned the Bretton Woods regime in 1971 and suspended the dollar's peg to gold as U.S. fiscal deficits from overseas spending caused a massive drain in U.S. gold holdings.
• The second development was the denomination of oil in dollars after the 1973 Middle East oil crisis; see petrodollars.
• The third development was the emergence of deregulated global financial markets after the Cold War that made cross-border flow of funds routine.

A general relaxation of capital and foreign exchange control in the context of free-floating exchange rates made speculative attacks on the exchange rates of currencies a regular occurrence. These three developments permitted the emergence of dollar hegemony in the 1990s. At the end of the 20th century it was for the most part undisputed that the US dollar is the most important reserve currency in the world. As of 2007, it still has the largest share (65.7%) of foreign reserve holdings, with the euro some distance behind at 25.2%. However since 2000, the dollar share is falling and the euro share is rising, though the trend is very gentle and does not signify dollar hegemonic decline (cf. Fields & Vernengo, 2012).

The monetary hegemon must be able to borrow in its own currency and provide a secure asset free of default risk to the world economy. The ability to provide a risk free asset is not an 'exhorbitany privilege', since privileges must be granted. The dollar is the key currency because the United States can impose that key commodities are traded in its own currency. The role of the dollar in international markets, and the advantages that come with it, are the spoils of hegemonic power (Fields & Vernengo, 2012).