Dominant Currencies.

• Author: Itskhoki, Oleg

There are about 180 currencies in the world, but a very small number of dominant currencies play an outsize role in international trade, finance, and central bank foreign exchange reserves. In the modern era, the US dollar has a dominant international presence, followed to a lesser extent by the euro and a handful of others. Gita Gopinath and I recently surveyed the literature on dominant currencies. (1)

The importance of currencies is never more evident than in global trade, where exchange rates are often at the center of fierce economic and political debates. Indeed, the use of currencies in international trade is key for the international transmission of shocks and the design of optimal monetary and exchange rate policy in an open economy. (2)

The use of currency in international trade is not exogenous, but is instead the consequence of active firm-level decisions at the micro level with allocative consequences at the macro level. I study this in recent work with Mary Amiti and Jozef Konings. (3) There is considerable heterogeneity across firms in the use of a handful of global currencies, especially in trade among pairs of developed countries. At the same time, currency choice is remarkably stable over time, with the status of dominant currencies remaining unchanged over decades, supported by the presence of strategic complementary forces that lock in the currency equilibrium. Nonetheless, there can be decisive shifts in the international monetary system over long time horizons, with the status of dominant currencies changing over centuries or half centuries. The previous dominant currency, the British pound, lost its dominant status in the 1930s. However, long after the UK had ceased being the leading world economy, the pound kept its role as an important currency for pricing, anchoring, and financing.

While the US dollar accounts for a disproportionate share of international trade, there is a small subset of currencies that are actively used in this trade alongside the dollar, most notably the euro, but to a lesser extent the pound, the Japanese yen, the Swiss franc, and the Chinese yuan. In some bilateral trade flows these currencies play as important a role as the dollar [see Figure 1], with considerable variation in currency use across individual firms even within narrowly defined industries. The dollar and the euro have emerged as the two leading currencies in accounting for international trade flows, with the role of the euro elevated by the fact that a large portion of international trade happens among European countries or involves one of the European countries. A distinctive feature of dominant currencies is that the same currency is equally prevalent in both imports and exports, a feature common to both the dollar and the euro, which is also at odds with standard international macro models that assume a greater role for many currencies to be present in global trade. Nonetheless, a clear distinction between the dollar and the euro is that the dollar in many cases is also a vehicle currency, not used domestically by either the importing or the exporting country. One can thus think of the dollar as the dominant global currency and of the euro as the dominant regional currency, all in the presence of a handful of other currencies used in specific bilateral trade flows.

The presence of this heterogeneity permits a study of the determinants of currency choice at the micro level, as well as the implications of this choice for exchange rate transmission into export prices and quantities at different time horizons. The findings of these analyses can then be used for counterfactual analysis of changes in the currency equilibrium in response to large...