Tuesday, May 28, 2019

A Primer on Reserve Currencies (Part 4 of 4): Eleven Reasons Why the Reserve Dollar Will Remain Dominant for the Foreseeable Future (8 thru 11)

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7 MIN READ - The Cautious Optimism Correspondent for Economic Affairs and Other Egghead Stuff concludes his deep dive into reserve currencies and the U.S. dollar with the last chapter of in-depth analysis of why predictions of the dollar’s demise may be premature—and an added focus on China's prospects for a global reserve yuan.


In Part 3 of this four-column series we discussed the first seven of eleven traits a country and its currency must exhibit to be chosen by world central banks and governments as a primary global reserve currency. The first seven can be found in that column at:


We continue with:

(8) A commitment to run consistent trade deficits. 

This requirement may surprise trade hawks and disappoint President Trump himself. While the U.S. trade deficit is definitely too high and the result of overseas currency manipulation (by China in particular), export subsidies, import quotas, and protectionist tariffs, the reality is a United States that runs a trade surplus or even a zero trade balance will quickly lose reserve status for the dollar.

Why? The world economy is growing every year and trade between nations grows every year. Thus the world demands more and more dollars, year after year, to accommodate rising levels of international trade, and the issuer of the reserve currency has an implicit responsibility to supply the world with the means of settling global payments.

Therefore the U.S., or more specifically the Federal Reserve, has to provide the world with higher dollar balances every year. The COCEA’s rough calculation is that the world demands approximately 250 billion new dollars each year to fill the growing reserve holdings coffers of its central banks.

As we discussed in Part 2, there are three main ways to inject $250 billion into overseas central banks year after year. The first is the Fed can figuratively print the money and give it away, but U.S. policymakers and the public are hardly going to choose that option.

The second is to invest dollars overseas and the purchasing of foreign assets does happen on regular basis.

But the third and most common method for exporting $250 billion is to exchange it for all kinds of cool goods and services. Why give the money away when Americans can receive nice cars, fine foods and drink, TV’s, computers, and all kinds of other cool stuff in return?

Hence the moment the U.S. stops running a trade deficit or even runs a surplus, the supply of new dollars dries up overseas and the nations of the world will quickly search for an alternative and, if they find one, divest their dollar holdings.

A commitment to consistent trade deficits eliminates some competitors. China famously insists on running huge trade surpluses every year, making the yuan unsuitable as a global reserve currency.

The Eurozone is more complex as its member nations are a mix. Germany famously runs a consistent trade surplus while the troubled periphery nations do not. However if the euro is to provide any meaningful competition to the United States then the Eurozone region as a whole has to run trade deficits every year, also to the tune of US$250 billion equivalent or even higher.

(9) Democracy* and political liberalization. 

There is an ongoing debate as to whether the issuing nation of a reserve currency must be a democracy. Traditionally dominant reserve currencies have always been issued by democratic governments—the U.S. dollar, the British pound in the 19th century, and the Dutch guilder even earlier.

However what is not open for debate is that the issuing nation must practice property rights, rule of law, and economic liberalization. No central banker wants to park large quantities of foreign reserves overseas in a nondemocratic country just to watch the dictator wake up one morning and arbitrarily seize their funds or nationalize all their assets. Once again, the established players like the USA, U.K, Eurozone, and Japan qualify. China’s political system doesn’t engender sufficient trust for central banks to hold the yuan as a major global reserve.

(10) Military superpower status. 

It’s no coincidence that the traditional reserve currencies have been issued by strong military powers. Obviously the United States today, in the 19th century the British Empire, and the 17th and 18th centuries Dutch Empire had a formidable military force as well.

Some people mistakenly believe that military superpower status is required so that the issuing country can physically force (or at least intimidate) other nations into accepting its currency. While having great military might gives a country the political clout to apply some pressure, the truth is that military strength is much more important for a different reason: survival of the monetary regime itself. The 1980’s German mark provides an illustrative example:

In the 1980’s West Germany was the world’s second largest economy, it had had a commitment to low inflation since the days of the Weimar Republic (excluding the chaotic final days of the Third Reich), its government bonds and financial markets were considered transparent and trustworthy, and there was talk that the mark might become a viable competitor to the dollar as a reserve currency. Granted it was a long shot, but after the 1970’s and early 1980’s inflation era the world was looking for an alternative.

However at that time there were countless divisions of Warsaw Pact/Soviet tanks and infantry right across the border in East Germany threatening to roll into West Germany at any moment. No overseas central bank wanted to hitch its wagon to the mark just to watch the Soviets invade and occupy West Germany. All its securities, its financial markets, the Bundesbank, etc… would disappear or at a minimum be converted into less desirable (an understatement) communist equivalents.

In stark contrast very few people could envision Soviet tanks rolling into and occupying the United States. Thus America’s military superpower status gave central banks confidence that its reserve dollar holdings were safe from a foreign invasion effectively nullifying the soundness, indeed the very existence, of the U.S. dollar. The same couldn’t be said about West Germany so the mark never made reserve inroads.

Today a few countries might qualify having sufficient military power status to “protect” their currencies. The Russian and Chinese armed forces might not be as strong as America’s, but they are powerful enough that no one is going to invade them—especially when they have a nuclear deterrent. The U.K. isn’t considered a military superpower but it’s an island nation and has its own nuclear weapons. The Eurozone doesn’t possess a powerful military, and although France has nuclear weapons there are questions as to whether it could or would be willing to use them to deter invasion of a periphery nation like Greece or some of the Eastern European republics. Finally Japan relies heavily on the United States for protection and has no nuclear weapons at all.

(11) A central bank to act as lender of last resort.

Any country that deals heavily in dollars will host commercial banks that deal in both its own domestic currency as well as dollars. Since that country’s domestic banking system will lend in dollars, and to an extent accept deposits in dollars, its banks will need access to a lender of last resort central bank in times of crisis. Unfortunately for them, neither the European Central Bank nor the Bank of Japan nor the Bank of England nor any central bank other that the Federal Reserve issues dollars. Therefore without the Fed, overseas central banks will refuse to use dollars as a primary international reserve currency.

Although the Fed QE’s, discount window loans, and the TARP occupied most of the USA’s domestic headlines during the 2008 financial crisis, the Fed also made extensive discount loans to foreign banks and issued dollar reserves to buy assets from overseas banks as well. To the extent the public was aware of the Fed’s export of vast quantities of dollars to international banks the practice was controversial. However the Fed’s LOLR role to foreign banks that deal in dollars was well established long before 2008 since it was a prerequisite for the dollar’s global reserve currency status.

(Note: The Economics Correspondent is not a big fan of the Federal Reserve, but “End the Fed” proponents should bear in mind that if the Fed is dismantled the world must first be weaned off the global reserve dollar. Otherwise a “cold turkey” end of the Fed would precipitate a rapid repatriation of the $6.2 trillion in overseas dollar reserve holdings and foster a major inflationary event)


When rating the viable candidates we assign a point for each of the eleven traits we've reviewed that a currency must satisfy to compete for leading global reserve currency status.

THE DOLLAR ITSELF. The dollar scores 11 out of 11 since the United States provides all the necessary characteristics to make its currency attractive to central banks and governments as a reserve currency.

THE BRITISH POUND. The U.K. scores about 6 out of 11, failing on several fronts. The pound doesn’t have the incumbent advantage, the British economic zone is not large enough to support a world reserve currency, its sovereign debt doesn’t provide a large enough securities market for over $6 trillion in reserves to be “parked,” its commitment to run a sufficiently large trade deficit falls into doubt, and it’s no longer a military superpower—although the British military does possess a nuclear deterrent.

THE JAPANESE YEN. Japan scores about 5 out of 11, also failing in many areas. No incumbency, an inadequately large economic zone, an inadequately large securities market, a history of manipulating foreign exchange rates to boost exports, a definite lack of willingness to run trade deficits, and a weak military that depends on the United States for protection all make the yen unattractive as a dollar alternative.

THE CHINESE YUAN. China scores about 5 out of 11. This may come as a surprise to many who see China as a rising power, but its governmental structure still makes the yuan untrustworthy in the eyes of central banks. While China has a large economy and a large and growing financial market, questions still exist about the reliability of Chinese government debt (as opposed to U.S. Treasuries). China’s financial markets are definitely not trustworthy and transparent enough, and central banks view its financial regulatory controls as inadequate. China still imposes capital controls, its authoritarian government is more able to arbitrarily expropriate foreign assets (they already do with intellectual property and technology), and it fails miserably on the currency manipulation and trade deficit fronts. The Chinese government famously engineers a system of massive trade surpluses year after year. Hence the number two world economy’s currency only represents about 1.5% of world reserve holdings.

THE EURO. The Euro scores 8 out of 11, making it the closest thing to a legitimate rival to the U.S. dollar out there. The Eurozone has a large economic zone with large, liquid, transparent, and regulated financial markets. The euro has a record of low inflation, European governments don’t impose capital controls (exception: Greece during its crisis), the euro exchange rate floats freely, and its governments generally don’t arbitrarily nationalize foreign assets. The euro’s weaknesses include non-military superpower status, its willingness as a bloc to run consistent trade deficits is in doubt (especially when its largest member, Germany, relies on annual trade surpluses), and there is some uncertainty just which country’s securities to park holdings in as evidenced by the last decade’s performance in Spanish, Portuguese, Italian, and Greek bonds.

All this is reflected in the euro’s 20% global share of reserve holdings and number two position after the dollar.

Thus the euro posed the greatest threat to the dollar’s dominance pre-2008. When the financial crisis struck in 2008 and the Fed launched quantitative easing the euro gained at the dollar’s expense as central banks began to doubt the Fed’s commitment to low inflation, but when the euro crisis struck in 2011 there was a flight back into the dollar which has enjoyed a consolidated leadership role ever since.


One more note about China. In a recent conference of international economists the China question was discussed and former Egyptian finance minister Youssef Boutros-Ghali asked a rhetorical question that explains why the yuan commands less than 2% share of global reserve holdings plus why the Chinese government isn’t interested in growing that share to any meaningful level anytime soon:

“Why would anybody [implying China] want their own currency as a reserve currency?” 


“If I were China I would resist violently having my currency as a reserve currency in the world because it implicates my banking system, it forces me to eliminate all capital controls, if forces me not to intervene to fiddle with the exchange range. It puts so much stricture on the system that given their authoritarian infrastructure of government it would unravel their control system of the economy… it flies right in the face of their political system.”

-Youssef Boutros-Ghali

Boutros-Ghali makes an excellent point. Reserve currency status doesn’t suit authoritarian regimes that manipulate their currencies very well. The Chinese Communist Party insists on strict control of its banking system, capital controls, currency manipulation, a strong export-driven model, and dictatorship in general.

The CCP would have to forgo all that command and control to convince the world’s central banks to accept the yuan as a leading global reserve currency and park large sums of RMB’s in Chinese securities markets. In today’s China, this is too unpalatable a political pill for the autocratic CCP to swallow.

So for now, China is willing to forgo the benefits and prestige of a global reserve yuan and, in the Economics Correspondent’s view, is content continuing to run large trade surpluses and accumulating large dollar holdings which it then uses to purchase overseas assets that further its own geopolitical interests.

Monday, May 27, 2019

Salesforce Chairman: San Francisco's Homeless Crisis the Result of "Unregulated Capitalism, Unbridled Capitalism, Capitalism Run Amok"

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1 MIN READ - From the CO Correspondent for Economic Affairs, the anti-quote of the week:

“This is unregulated capitalism, unbridled capitalism, capitalism run amok. There are no guardrails."

-Salesforce founder and chairman Marc Benioff, a fourth-generation San Franciscan commenting on his city's housing and homelessness crises.

Therefore in Benioff's eyes, San Francisco's Board of Supervisors, Mayor, and their government policies are all "far right?"

Read full article from The Blaze here

Wednesday, May 15, 2019

A Primer on Reserve Currencies (Part 3 of 4): Eleven Reasons Why the Reserve Dollar Will Remain Dominant for the Foreseeable Future (1 thru 7)

Click here to read the original Cautious Optimism Facebook post with comments

7 MIN READ - The Cautious Optimism Correspondent for Economic Affairs and Other Egghead Stuff truly deep-dives into reserve currencies and the U.S. dollar with an in-depth analysis of why predictions of the reserve dollar’s demise may be premature.


Since the 2008 financial crisis there’s been no shortage of speculation in the press and public discussion that the dollar is teetering on collapse from its perch as the world's leading global reserve currency.

In the early days of the crisis and Great Recession the euro was predicted to make major gains against the dollar or even replace its leading role in international payments transactions. However the 2011 Eurozone crisis dampened those expectations.

There was also speculation that a gold-backed Russian ruble, or a joint gold-backed Russo-Chinese reserve currency would displace the dollar. Neither government has since made good on its overtones to back any currency with gold, and the ruble remains an insignificant reserve holding.

Many have predicted that China’s ascent to world’s number two economy will catapult the Chinese renminbi (RMB, aka the yuan) as the world’s new reserve currency and dethrone the dollar. While China has made moves to sign some bilateral agreements to trade in RMB with Pakistan and a number of regional partners, and some Belt and Road Initiative countries have also increased their RMB holdings, the RMB mysteriously remains a global nonplayer. As of early 2018 the yuan represented less than 1.2% of all global reserve holdings.

Why has the dollar been so resilient and is it in as much danger as pundits predict of losing its leadership position?

The truth is that global reserve currency leader status is the U.S. dollar’s to lose. The dollar and the country that backs it—the United States— exhibit a unique set of traits that keep the greenback the preferred holding among world central banks, and that none its rivals can yet claim to fully duplicate.


In this section we’ll review the first seven of eleven attributes the dollar exhibits and which a foreign currency rival must also possess to be considered a legitimate competitor.

No one authority “decides” what these properties must be. Rather they are simply favored in the “marketplace” of global reserve currencies, a marketplace where the consumers or users of global reserve currencies are predominantly central banks.  No one can pass a law that forces other countries’ central banks to accept dollars. Political pressure can slightly sway their decisions, but even the United States doesn’t have the political clout to pressure every central bank in the world to choose dollars if the dollar itself is unattractive.

So what are these characteristics that are so allegedly important and make a reserve currency attractive to central bankers?

In a nutshell they are:

1. Incumbency
2. A large economic zone
3. Large, liquid financial markets
4. Trustworthy, transparent, regulated financial markets
5. A commitment to low inflation
6. No capital controls
7. Free/floating exchange rates
8. A commitment to run consistent trade deficits
9. Democracy* or at minimum some political liberalization
10. Military superpower status
11. A lender of last resort central bank

For the sake of space we’ll discuss numbers 1-7 in this article and complete the remainder in the last installment.

(1) Incumbency

The sad reality for the dollar’s potential rivals is that the incumbent enjoys an enormous advantage simply by already being the reserve currency of choice. It’s jokingly referred to as “the Facebook effect” by economists since one user leaving Facebook loses far more in access to the network than he gains in autonomy. 

The balance sheets of central banks are loaded up with trillions of U.S. dollars and replacing them is a complicated, expensive, and laborious matter. Every country already settles payments in dollars and for one or even a few countries to break away means incurring considerable costs to operate under an incompatible currency regime.

In short, those costs are related to what would become constant dollar-currency exchanges and foreign exchange movements and would be borne by the breakaway country’s commercial banking sector and exporters (making them less competitive globally) as well as consumers and even governments.

See Part 1 of this series for a primer on the costs of “going it alone” and leaving the dollar network at:


So there remains a built-in incentive to “stay with the pack” and there are enormous financial incentives and pressures to remain on the international dollar standard.

(2) A large economic zone

Any competing reserve currency has to be issued by a country or bloc of countries that operates a large economy or economic zone.

Why? Because foreign central banks hold large quantities of reserves, well… (as the name itself implies) in reserve. They don’t drive their reserve balances to zero as doing so would suddenly make it impossible to import goods and services on a moment’s notice. So while they hold a buffer of tens or even hundreds of billions of dollars in reserve they prefer to put those dollars to work.

Likewise foreign commercial banks also prefer that their reserve currency holdings are accepted in a large economy where they can be put to work. As University of California Berkeley economist Barry Eichengreen puts it, “a reserve currency isn’t much good if you can’t do anything with it.” 

(this is one of the reasons, incidentally, why SDR’s or Special Drawing Rights haven’t made a credible dent in global dollar holdings; you can’t buy or invest in anything with SDR’s)

Thus not only must there be a competing economy to “park” or invest your reserve holdings in, it must be a large enough economy to absorb the trillions of dollars equivalent that the entire world’s central banks hold.

Right away this rules out the Swiss franc, British pound, and Japanese yen for example. Even if those currencies are a stable and reliable measure of value, they can only be used in Switzerland, the U.K., and Japan which have GDP’s of US$731 billion, $2.18 trillion, and $5.22 trillion respectively.

As of 2018 world global reserve holdings of U.S. dollars were approximately $6.2 trillion, so none of those economies is large enough to back a franc, pound, or yen substitute to the dollar.  And Russia, even if it backs the ruble with gold, is so small it’s not worth mentioning.

This leaves really only three players on the world stage that are large enough. The United States, the Eurozone which uses a single currency in a bloc GDP of about US$14 trillion (not to be confused with the larger European Union), and China whose economy is approximately US$14.2 trillion and growing at the fastest rate of the three.

(3) A large and liquid financial market

When foreign central banks “park” their reserve holdings in a large economic zone, they want to earn interest on securities. They don’t want to park their holdings in corporate or real assets like an airline or housing which are burdensome, require expertise to manage, and are hardly liquid when central banks need to cash out.

In other words, foreign central banks want a large securities market to park their reserve holdings and deep liquidity that allows them to “cash out” at an instant when they need immediate access to settle balance of payments.

The United States provides the largest, most liquid financial securities market in the world: U.S. Treasuries. As of 2018 overseas central banks and financial institutions hold $6.21 trillion in U.S. Treasury securities. Easy access and the perceived safety of Treasuries boost the dollar’s appeal to overseas institutions.

Once again, the number of potential competitors who can offer their own correspondingly-sized financial market is very low. The Eurozone has a large and liquid market, but the Eurozone is comprised of over a dozen countries each issuing their own sovereign debt. So does a central bank choose to park its euro holdings in German government debt? French debt? Or does it run the risk of losing its shirt because it picks the wrong sovereign debt such as bonds from Greece, Spain, Italy, or Portugal?

China has its own growing financial markets but they aren’t as mature and established as those in the West. Also the Chinese government hasn’t issued the same levels of sovereign debt as the U.S. or Eurozone countries. Low government debt loads might be a good thing for China’s fiscal position, but it comes at the cost of being unable to offer a large securities market for yuan holders to park funds in.

(4) Transparent, trustworthy, regulated markets

Of the large financial market players, only the U.S. and Eurozone are considered transparent and regulated enough for central banks to trust parking their funds. Chinese securities still don’t engender enough confidence to risk investing tens or hundreds of billions of dollars (or reserve yuan) just to watch a giant scandal slash the value of those holdings overnight.

British, Japanese, Canadian and Australian markets are considered sufficiently transparent, regulated, and safe, but neither their economies nor their financial markets are large enough to support a global reserve currency.

Note: Those who have read the COCEA’s past columns may recall that history shows the most deregulated financial markets (save regulations for countering fraud) have actually been the most stable—notably the nearly laissez-faire Canadian system of 1817-1935 and the even freer Scottish system of 1721-1845, neither of which ever experienced a financial crisis—while the more tightly regulated U.S. and English systems of the same period were basketcases, plagued by repeated crises and bank runs that wiped out fortunes. However, whatever the merits of the “free banking” arguments, the present-day reality is foreign holders of global reserves are not economic libertarians. They’re central banks. And central bankers demand transparency and regulation to consider a financial market a sound investment.

(5) A commitment to low inflation

No one wants to hold or park large holdings of global reserves just to watch the issuing nation’s central bank inflate away its value by 10%, 20% or more per year. Therefore foreign central banks want a currency with a track record of low inflation. Of all the major players—the U.S. dollar, the euro, the British pound, the Japanese yen, and the Chinese yuan—all but the Chinese yuan have experienced relatively low inflation rates going back to the end of the global inflation era of the 1970’s.

In recent years Chinese inflation has fallen to the 2%-3% range which works in the yuan’s favor. However less than a decade ago China was experiencing 8% and 9% inflation rates. Thus China’s track record of low inflation is too short for central banks to entrust their reserve holdings to the yuan.

(6) No capital controls

As mentioned earlier, foreign central banks value liquidity in their reserve holdings’ financial markets. Therefore no one wants to acquire large foreign holdings balances, invest them in the issuing country’s markets, and then watch that country’s government slap capital controls down that prevent or limit the quantity of funds that can enter or more typically leave the country.

The U.S., U.K., and Eurozone members have not imposed capital controls for a very long time (exception: Greece which halted the panic withdrawal of euros from the country when investors anticipated Greek voters would choose to leave the Eurozone and convert euro balances to devalued drachmas). In fact, capital controls are a tool typically used by smaller, developing economies that rely heavily on foreign investment inflows. However, even today China still utilizes capital controls to dictate the flow of investment funds in/out of its economy which makes the yuan unattractive as a global reserve currency.

(7) Free/floating exchange rates (no manipulation)

Foreign central banks don’t want to hold large quantities of global reserves and watch the issuing country intervene in foreign exchange markets to (typically) depreciate its currency. If the Canadian central bank obtains and holds large quantities of Japanese yen, and the next day the Bank of Japan dumps yen to buy Canadian dollars on foreign exchange markets, the Bank of Canada will eat a loss on its yen holdings when they (or their banks or citizens) try to convert them back to Canadian dollars.

Yet again, the established western players such as the U.S., U.K., and Eurozone countries don’t intervene directly in foreign exchange to manipulate their currencies. And while Japan and China both officially claim to no longer intervene, they are not sufficiently trusted (particularly China) for central banks to hold yuan or yen in large enough quantities to be considered a global reserve currency.

In Part 4 we'll review reasons 8 thru 11 why the dollar should remain the world's top reserve currency for a while longer and discuss what's holding back the euro and particularly the Chinese RMB from taking its place.

Friday, May 10, 2019

Paul Krugman: All for 25% Tariffs on China Imports Back in 2010

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1 MIN READ - The Cautious Optimism Economics Correspondent is more than amused by Nobel laureate Paul Krugman's take on tariff wars with China... back in 2010 when a different person and party occupied the White House. Whatever your opinion on the tariff, Krugman is a reminder that your views too can always "evolve" whenever the presidency does.

Krugman: "Tensions are rising over Chinese economic policy, and rightly so: China’s policy of keeping its currency, the renminbi, undervalued has become a significant drag on global economic recovery. Something must be done...."

"..But if sweet reason won’t work, what’s the alternative? In 1971 the United States dealt with a similar but much less severe problem of foreign undervaluation by imposing a temporary 10 percent surcharge on imports, which was removed a few months later after Germany, Japan and other nations raised the dollar value of their currencies. At this point, it’s hard to see China changing its policies unless faced with the threat of similar action — except that this time the surcharge would have to be much larger, say 25 percent."

"I don’t propose this turn to policy hardball lightly. But Chinese currency policy is adding materially to the world’s economic problems at a time when those problems are already very severe. It’s time to take a stand."

Krugman's "retaliatory tariffs are a great idea when Trump isn't President" column can be read at:

Friday, May 3, 2019

A Primer on Reserve Currencies (Part 2 of 4): How Does the Global Reserve Dollar Benefit the United States?

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5 MIN READ - Enjoying global reserve currency status endows many benefits upon the issuing country. Although some advantages are political—for example overseas dollar reserves held in largely U.S. assets are easier for the federal government to freeze as a form of punitive sanctions—this column focuses solely on economic advantages.


1) First among many, the U.S. banking system enjoys conveniences that give it a cost advantage against its international competitors.

U.S. banks take deposits in dollars and make loans in dollars. Therefore there is no uncertainty about returns on lending other than interest rates and creditworthiness of borrowers. However overseas banks that wish to make loans to firms conducting international business have to lend in dollars even though they take most of their deposits in their own domestic currencies.

Using, say Sumitomo Bank of Japan as an example, Sumitomo takes its deposits overwhelmingly in yen. But it must lend extensively in dollars for its corporate borrowers who do business overseas, or domestic firms who must use dollars to buy imported commodities or inputs for manufacturing goods. Thus Sumitomo has to convert large yen balances to dollars, a service which doesn’t come free, and when dollar loans are repaid the same costs are outlayed to convert back to yen. So Sumitomo and international banks in general incur currency conversion costs that U.S. banks don’t.

2) Also, once Sumitomo issues dollar-denominated loans it has to worry about yen/dollar exchange movements. If the dollar weakens dramatically against the yen after the loan is issued, Sumitomo might be fully repaid with interest in dollars, but upon converting back to yen the bank still loses money on the transaction.

Obviously international banks are sophisticated enough to insure against such movements by buying foreign exchange hedging contracts, but this is another cost overseas banks incur. By contrast U.S. banks largely take deposits in dollars, lend in dollars, are repaid in dollars, and report profits… all in dollars. So dollar foreign exchange movements are not a worry and hedging contracts are not an expense.

3) Then there’s the benefit for exporters. U.S. exporters pay their expenses in dollars and sell their goods in dollars. While they are cognizant of exchange rate movements in the overseas markets they sell to, they don’t have to constantly reprice their exports and need only worry about changes in demand for their exports when exchange rates move. But foreign exporters incur costs in their domestic currency and then price their goods on the world market in dollars. Thus dollar movements against their currency more directly affect their revenues when converted back to that domestic currency (unlike U.S. firms which service costs and collect revenues both in dollars).

4) The reserve dollar gives America cheaper access to credit. Since central banks and governments around the world hold large balances of U.S. dollars and want to “park” them somewhere to earn interest they overwhelmingly find their way into U.S. credit markets. With the higher supply of loanable funds available U.S. borrowers enjoy lower interest rates than borrowers of other countries.

The largest beneficiary is of course Uncle Sam who’s the world’s largest debtor. Treasury securities are extremely popular with foreign holders of dollars, and the federal government pays lower interest rates than it otherwise would due to simple supply and demand. The demand for U.S. debt is proportionally higher than the sovereign debt of other countries due to such large overseas dollar holdings.

In fact the global reserve dollar explains a great deal of why the United States runs an investment income surplus of about $212 billion annually (Griswold: 2015). Despite the fact that foreigners hold about $28 trillion in U.S. assets while Americans hold less, only $23 trillion in overseas assets, America still earns $212 billion more a year on its assets because the dollar’s global reserve status indirectly allows America to pay foreigners a lower interest rate.

5) Finally the largest benefit of all is simply “free stuff.” As of 2018 approximately $6.2 trillion in U.S. dollars are held in reserve by overseas institutions—mostly central banks—and the only supplier of dollars is the U.S. Federal Reserve.

However the world economy is growing every year. International trade is growing every year. Every government in the world is engaged in some sort of monetary inflation. Result? The world’s appetite for reserve dollars grows with each passing year too. That is, the United States has to export approximately $250 billion a year overseas just to keep the gears of world trade well-oiled and thus maintain the dollar’s reserve status.

Generally speaking, there are three ways for $250 billion in new dollars to find their way overseas. First, the U.S. could print the money and just give it away as a gift. Obviously that’s not going to happen.

Second, the U.S. can buy overseas assets with dollars and a trade takes place: U.S. investors gain tangible overseas assets and those countries receive the dollars they need. And this process does play out to some extent every day.

But third (and most common), why give away $250 billion a year or put it all into overseas assets when you can trade it for all kinds of cool stuff, i.e. imports? This is the primary means by which the U.S. exports dollars to the world: by running a trade deficit. The U.S. prints money virtually cost free and in exchange U.S. consumers get almost $250 billion in real goods and services that our trading partners have to work hard and incur major costs to provide us. It’s a windfall for America's standard of living since the figurative paper dollars the U.S. hands foreigners in return cost almost nothing to produce (ie. seigniorage benefits).

Only a country with a global reserve currency can enjoy such a privilege.

If Malaysia buys cool imports from Australia with U.S. dollars, Malaysians still had to pony up real goods and services to acquire those dollars to begin with. But if Malaysia somehow pays for Australian imports with ringgits, Australian firms and central banks aren’t going to simply hold those ringgits because ringgits aren’t a widely accepted reserve currency. They will turn around and quickly use them to buy real imports or assets from Malaysia. That is, both countries’ currency imports are ultimately financed with real goods and services that they have to produce—a symmetric trade relationship. 

This is not the case with the United States which, like Malaysia and Australia, produces its currency at virtually no cost, but unlike other countries enjoys reserve currency status. Thus once American dollars are exchanged for imports approximately $6.2 trillion of those dollars sit in reserve at foreign central banks and don’t demand exported U.S. goods and services in return. It’s about as close to a free lunch as a country can get.


All the benefits that the United States enjoys for issuing the global reserve currency don’t go unnoticed by our trading partners. The nations of the world are fully aware that U.S. banks have lower costs, less uncertainty, that U.S. credit markets enjoy lower borrowing costs, and U.S. consumers enjoy a higher standard of living—all at their expense, simply by being the issuer of the dollar.

If we tally up a rough estimate, the U.S. global reserve dollar bestows over half a trillion dollars in benefits annually upon the American economy:

-$250 billion in “free” imports

-An approximate $212 billion investment income advantage

-At least tens of billions of dollars in savings for U.S. banks and exporters who don’t incur hedging, currency conversion, and exchange rate administration costs

In fact, for decades European leaders were particularly annoyed at America’s dollar indulgences, the French being especially irritated by what Charles de Gaulle’s Finance Minister ValĂ©ry Giscard d'Estaing dubbed America’s “exorbitant privilege.”

Even after de Gaulle’s death, the French plotted constantly to find some way to dethrone the dollar. In the 1980’s Francois Mitterrand and his finance planners approached German Chancellor Helmut Kohl with a proposal to unify the continent’s separate currencies into a single “euro” to counter the U.S. dollar. Germany agreed, mostly out of guilt for damages it had inflicted during World War II, and the rest is history—although the U.K. (Great Britain minus Ireland) wisely opted to retain its own currency, the pound sterling.

Europe hoped to enjoy the same benefits (banking, currency exchange/hedging) with the single euro currency across its multiple nation-states that the U.S. enjoys across its 50 states. And the strategy was the more countries on the euro, the better. The larger the economic zone and the more euros produced and circulating, the more attractive the euro would look to foreign central banks as an alternative to the dollar. Europe hoped it could at last enjoy its share of “free stuff” (ie. imports) and lower borrowing costs, largely at the dollar’s expense.

Although the euro has since succeeded in saving European banks, exporters, and consumers billions in transaction costs with other euro member countries, the “more the merrier” philosophy unfortunately backfired when periphery nations such as Greece, Portugal, and even Spain and Italy were added to the currency zone. When those countries’ fiscal crises struck in 2011, global confidence in the euro sagged and the strain also sparked nationalist and political infighting between the responsible northern countries and their profligate Mediterranean neighbors. 

Nevertheless European policymakers still hope that one day the euro will become a real rival to the dollar and muscle in on the reserve currency “exorbitant privilege” that has been largely enjoyed by the dollar and the United States for the last 75 years.

In Part 3 and 4 we’ll discuss predictions of the demise of the global reserve dollar and why the U.S. dollar is unlikely to lose that status anytime soon.

Thursday, May 2, 2019

Lawrence Reed's Wisdom and Wit on May Day Protestors

Click here to read the original Cautious Optimism Facebook post with comments

The Cautious Optimism Correspondent for Economic Affairs and Other Egghead Stuff bows to the wisdom and wit of economist Lawrence Reed. Today Reed analyzes the logic of this year's May Day celebration crowd with a piercing observation:

"Check out this story. One of the celebrating socialists even says that socialism failed in Venezuela because oil prices fell. Think about that: For socialism to succeed, oil prices must be high. Capitalism works to lower them by producing more, and succeeds whether oil prices are high or not. Why would a thinking person want to hitch his intellectual wagon to a poisonous idea whose "success" depends on price gouging?"

-Lawrence Reed

Click here to read the Federalist article Reed refers to