The Cost of America’s Free Lunch
By Daniel Gros
BRUSSELS – For decades, the world has complained that the dollar’s role as global reserve currency has given the United States, in a term usually attributed to Charles de Gaulle but actually coined by his finance minister, Valery Giscard d’Estaing, an “exorbitant privilege.” As long as exchange rates were fixed under the Bretton Woods system, the nature of that privilege was clear: the US was the only country that could freely determine its own monetary policy. All others had to adapt to the policy dictated by the US.
This changed with the advent of floating exchange rates in the early 1970’s, which allowed more stability-conscious countries, such as Germany, to decouple from a US monetary policy that they considered too inflationary. But, even under floating exchange rates, the US retained an advantage: given that the dollar remained the key global reserve currency, the US could finance large external deficits at very favorable rates.