The Dominance of the Dollar: A Privilege or A Catastrophe?

ABSTRACT

We present a model to analyze the impact of the use of the US Dollar (dominant currency) in EMEs, which increases the possibility of currency crises in these economies. The USD's worldwide dominance is a privilege that extends far beyond the borders of the US, facilitating international trade and finance. As the globally held reserve currency, the USD allows nations across the globe to make secure and efficient investments. Paradoxically, widespread reliance on the USD can nonetheless increase the likelihood of currency crises in Emerging Market Economies (EMEs), as these countries may fail to accumulate sufficient USD reserves to meet the rising global demand for USD from households and investors. Further, the paper also attempts to outline how the prominent use of dominant currency escalates the spread of currency crises to other EMEs through contagion effect resulting from changes in investors' expectations.