Within national boundaries, a single, national currency is normally used by all operating businesses. However, for international transactions there is more than one currency from which to choose. Which one is chosen for pricing purchases and sales or for the denomination of loans or other financial deals? Overwhelmingly, it is the US dollar. Even in 2013, more than a decade after the birth of the euro, the dollar was on one side of 87% of all global currency transactions, far beyond the US share of international business and more than twice the share of the euro (BIS 2013c, Table 2, p. 10), whose member countries in aggregate were otherwise not far behind the US in terms of their international economic significance.1
Evidently it is simpler, and potentially less costly or risky, for a company to use its own national currency when engaging in foreign trade. Even for multinational companies with a wide range of foreign operations, there is usually one currency that acts as the basis for its accounts, and that is usually the domestic currency of the corporation's headquarters.2 If a company can use its 'own' currency for pricing its exports and the imports it requires, then that amounts to a significantly lower commercial risk when exchange rates are volatile. Even when it is possible to insure against such risks, for example through currency forward transactions, these usually involve commercial transaction costs. The European Commission cited that avoiding such costs – estimated at 0.3-0.4% of European Union GDP per year – was a key economic factor favouring the euro's introduction (European Commission, 2007, p.
17). The more countries that joined the euro, the lower would be such costs, and further reductions would follow from non-euro member countries using the euro as an invoicing currency for international transactions.
The US dollar is used as an invoicing currency for close to 100% of US exports and over 90% of its imports (Goldberg and Tille, 2006, Table 1, p. 15). By comparison, in 2012 the euro was used as an invoicing currency for less than two-thirds of exports outside the euro area, and for just half of imports (ECB, 2013, Table A12, p. 78). The US dollar made up most of the remaining currency share for euro country external trade. In the case of the UK and
1 Note that the market shares of all currencies would add up to 200%, since there are two currencies involved in any foreign exchange transaction.
2 Exceptions occur, as in the case of BP, the UK oil major. Its annual accounts are reported in US dollars, given the dollar pricing of energy products in global markets. However, Vodafone, BAE Systems and GlaxoSmithKline, other big UK corporations, report in terms of sterling.
Japan, over half of their trade is priced in currencies other than their national currency, so they do not benefit as much as the other two currency blocs.
The US gains most from this factor because international commodities, from oil, to metals, agricultural products, pharmaceuticals, plastics, aerospace and defence equipment are priced in terms of US dollars. This means that in competing with foreign companies in international markets, the exchange rate risk falls principally on non-dollar countries. While this can cut both ways – if the US dollar's exchange rate goes up, then other countries might prove to be more competitive in tendering for a contract – it is still a risk that US dollar-based companies are under far less pressure to manage. This is because many contracts will run for more than one year. Even if the initial dollar exchange rate works for a non-dollar company to secure a deal to buy or supply commodities, this may not be true for later years when currency values change. Overall, this way of reducing commercial costs and risks for US international business dealings is likely to be more important than it is for other countries. However, I am not aware of any quantitative estimates of this advantage.
A separate issue under this currency heading is 'seigniorage'. The term describes the benefits to the state of issuing fiat money notes that cost a few cents each to produce but which have a much higher nominal face value, of $10, $20 or $100, etc. Whenever such currency is held and not spent, the national state authorities producing the currency – via the central bank – have gained value because others have accepted the low-cost paper currency in payment for goods and services provided.
All governments printing money that will be accepted within their national boundaries have this advantage, but this can also extend into the international arena for powerful economies. Especially when the national currency is seen as unstable – for example, when there is a very high inflation rate – companies and individuals may also hold on to the currency of another, more stable economy as their 'store of value'. The US has a particular imperial advantage in this respect because the dollar is the most widely accepted currency in other countries as a store of value or as a means of payment. In 2012, the IMF listed 43 countries that had the US dollar as a currency anchor, from Ecuador, which has used the US dollar since 2001 as the sole legal tender for notes, to others whose currencies are managed in relation to the dollar through a currency board exchange rate peg or some other method (IMF, 2012c, Table 1, p. 5). The euro was used by 27 countries, and in a similar variety of ways. In Kosovo and Montenegro, the euro replaced the national currency, while Bulgaria has a euro-linked currency board. Denmark is a member of Europe's Exchange Rate Mechanism, keeping the Danish krone within narrow limits to the euro, and 14 countries in Central and West Africa, 12 of which are former French colonies, use the CFA franc, which is pegged to the euro.
If US dollars have entered circulation in another country through the cash payment for that country's exports, then the US has exchanged its green bits of paper for that country's resources. For the non-US company doing the transaction, it has been paid for the goods or services it supplied and it may well use the dollars in a further purchase. However, it still brings a benefit to the US economy because a share of US imports is paid for with US currency that, at some stage in the chain of transactions, does not get spent. In aggregate, the US economy does not exchange its own resources for a portion of its imports and it
appropriates value produced elsewhere.
It is difficult to measure with any precision the value to the US economy of international seigniorage. The New York Federal Reserve has estimated that in December 2007 the total stock of notes in circulation was $829bn, and 'the majority is held outside the United States' – a proportion believed to be close to 60%. In addition, it said that the amount of dollar cash in circulation had 'risen rapidly in recent decades and much of the increase has been caused by demand from abroad' (New York Fed, 2008). Hence, a stock of some $500bn of US currency is circulating overseas, close to 3% of US GDP. Part of this stock of foreign dollars will be funds taken out of the country by US citizens; part will be money used in drug deals and other illegal activities.
At bottom, this is a transfer of value produced elsewhere to the US state, the printer of the notes. Some foreign suppliers have delivered the commodities and held onto the paper dollar cash. The main risk to the dollar's role in this respect, also true for other currencies, is that the ability to benefit from seigniorage will also depend on market perceptions of the strength of a currency's exchange rate against other major currency alternatives. This was indicated in 2007: as the US dollar's exchange rate was continuing to fall, Brazilian supermodel Gisele Bündchen declared that she wanted to be paid for her services in any major currency except dollars (Nielsen and Brasileiro, 2007).
The benefit for state issuers of other major currencies is much smaller than it is for the US. While the numbers are not insignificant for the euro, the benefits of seigniorage accrue to all the euro member countries, not just to one country. They derive largely from the previous role of the Deutsche mark as the most important European currency of the most powerful economy, but France's CFA franc zone in Africa was also a factor. Ironically, because the Deutsche mark was prominent especially in countries neighbouring Germany that joined the euro area in 1999, there was actually a dip in the 'seigniorage' total for Germany after that point as DM were translated into euros. Nevertheless, with the growing influence of euro area financial markets, to a level well beyond what was feasible on the basis of Germany alone, and despite the financial turmoil in the late 2000s, the scale of euro seigniorage has risen sharply. The European Central Bank estimated the value of euro banknotes held outside
the euro area countries at €36.4 billion in mid-2003 and the figure jumped to €130 billion by end-2012 (ECB, 2005, p. 58; ECB, 2013, p. 23). The latter is about 30-40% of the respective US figure and roughly 1.5% of euro country GDP. There has been speculation about how much foreign circulation of euro banknotes is also due to criminal activity. In 2010, British banks withdrew the high value 500-euro note from circulation after the Serious Organised Crime Agency estimated that 90% were not being used legitimately (Telegraph, 2010).
I have found no contemporary estimates of foreign seigniorage for the UK, Japan or Switzerland. The UK's benefit will have declined with the dissolution of the Sterling Area in the early 1970s. Sterling's very much smaller role in foreign payments compared to the US dollar, and the trend decline in sterling's value, likely mean that seigniorage amounts are negligible in relation to UK GDP. This is not contradicted by the UK's large financial role in the world, since, as Chapter 5 will explain, this financial role is not really based upon sterling.
It is probable that the foreign circulation of Swiss francs, and even Japanese yen, are more important in relation to their GDPs. The longer-term trend of appreciation in the value of the latter currencies, and their low interest rates, makes holding cash in the form of notes relatively attractive.3
Seigniorage is only a very narrow measure of the potential economic gains from a currency's international role, however. Although the stocks of currency circulating abroad may be large absolute sums, these remain only small shares of GDP. Even in the case of the euro, a newer currency than the other majors, the incremental amounts each year are not significant. The following sections discuss other, economically more important dimensions of financial privilege.
4.2 'Exorbitant privilege'
The global role of the US dollar and the linked economic advantages for the US have been discussed in the literature in a different context from seigniorage, usually under the heading of 'exorbitant privilege'.4 This can mean either the privilege the US gets from being able to fund its external deficits by borrowing at low cost in terms of its own currency, its original meaning, or the ability to earn an 'excess return' on net foreign assets.5 These are indeed important privileges, ones available only to a select few powers. As noted in Chapter 2, such advantages may accrue directly to capitalist companies or to national governments.
3 Holding a bank account (in Swiss francs or Japanese yen, for example) outside the relevant country does not mean that any notes actually leave the national territory and are physically held. Seigniorage refers to holding currency notes.
4 The term originates from French government criticism of the dollar's role in the 1960s, and was coined by De Gaulle's finance minister, Valéry Giscard d'Estaing, who used it to refer to the US ability to fund its current account deficit by issuing dollars at low rates of interest (Eichengreen, 2011, p. 4).
5 Eichengreen 2011 mainly refers to the former while Habib 2010 focuses on the latter.
Most users of another country's currency for international trade, investment or finance do not hold the physical cash, but a bank account or securities denominated in that currency.
With these, the holders may receive interest or dividend payments, so the deposit-liability-holding or security-issuing country does not get the funds for free, as with seigniorage. But a key benefit the US gains from the global role of the US dollar is to get (usually) cheap, low risk finance. This comes about in two ways.
Firstly, the US can draw upon the financial resources of the world economy and it has much easier access to funds than do other countries. One important aspect of this is the dollar's high share – around two-thirds – of official foreign exchange reserves. After the Asian financial crisis of 1997-98, many countries in the region – and elsewhere – built up their currency reserves as a deliberate policy of economic insurance against renewed trouble. The US dollar was the currency of choice for these extra reserves, not only because it was the principal means of payment for trade and finance, but also because many countries had currencies linked to the dollar. Through the 2000s, a growing US current account deficit was funded in this way by huge inflows of finance, especially from Asian central banks that bought US Treasury securities and other US dollar-denominated assets (Higgins and Klitgaard, 2004). From 2000 to 2007, the cumulative US current account deficit was a massive $4.7 trillion; the annual deficit peaked at 6% of US GDP in 2006. Over the same period, China's foreign exchange reserves, excluding gold, grew by $1.4 trillion. Assuming that three-quarters of China's reserves were held in US dollars, this implies that China's official reserve accumulation of US dollars alone was enough to fund roughly one-fifth of the US current account deficit over that period.6 The further accumulation of China's FX reserves, from $1.5 trillion at end-2007 to $3.8 trillion by end-2013, starkly illustrates the continuing support for US deficits from external finance. Such figures dwarf the seigniorage estimates.
It was not only the easy funding of US deficits that stood out in the 2000s. The demand for dollars was so high that, despite the huge deficits that needed financing, US yields fell. A variety of factors was responsible for the falling yields, but one study suggested that the impact of foreign purchases of dollar securities was to reduce the borrowing costs of the US government by as much as 150 basis points for 10-year debt (for example, a yield being lowered to 3.5% rather than remaining at 5%), compared to what the cost might otherwise have been (Warnock and Warnock, 2005). Since the foreign purchases of US securities were not only by foreign central banks, and not only of US Treasuries, but also of equities,
6 US current account data are from the regular reports of the Bureau of Economic Analysis. China's FX reserve data are taken from Arunachalam 2010 (Table 3, pp. 76-77). The composition of China's FX reserves is not reported, but when discussing with a Japanese finance ministry official in 2005, he told me that 80% or more of China's reserves were held in US dollars in the early part of that decade. The dollar proportion was reduced in later years, but is widely believed in the financial markets to be around 60-65% now.
corporate bonds and 'agency' bonds (asset-backed securities issued by semi-official US institutions, based on mortgages and student loans), lower bond yields and higher security prices spread throughout the US financial markets.7 Although this was an important factor in the ensuing crisis, it reflected a structural feature of US financial privilege in the world economy. This also indicates that analyses of 'financialisation' must be set in the context of global economic and financial developments and not be confined to individual countries (Christophers, 2013).
Secondly, by issuing debt denominated in US dollars, the US state can avoid taking on foreign currency risk. In a US-centred crisis, the value of the dollar might fall against other major currencies, but the US state has little debt denominated in euros, Japanese yen or sterling, so it will not face much increase in its liabilities from this source. Countries that do not have a privileged position in global finance – those that are not imperialist powers – are in a much worse position. One interesting paper examines this problem for Latin American countries, noting how, even if they have good 'credit ratios', financial markets give such countries a high 'risk premium', making their costs of borrowing higher, because they have little ability to borrow long-term in their domestic currencies (Hausmann, 2002). Often they borrow funds denominated in the major foreign currencies, especially the US dollar, but at interest rates that would appear to be in excess of their underlying credit risk. This would seem to result from the risk of domestic currency depreciation versus the borrowed currency in the event of a crisis.
The interest rate cost for the US of borrowing dollar funds might be higher than the interest rates available on other major currencies. Financial privilege does not necessarily mean lower yields, since these yields will also depend upon domestic inflation and central bank monetary policy. For example, yields on German and Japanese government bonds have usually been below yields on US Treasuries. However, the dollar section of the credit market is the biggest in the world and the easier access to this for the US government, and US companies, together with the absence of any exchange rate risk on borrowing, remain key US financial advantages. The funds borrowed can finance extra consumption of imports or they can offset outflows on the financial accounts for US investments in foreign assets (direct and portfolio investments). Notably, the interest costs on US foreign borrowing have been far less than the returns on US foreign investments. This has enabled the US to maintain a positive net investment income, despite the persistent, large net deficit on its foreign investment position.
At end-2012, the US net foreign investment stock position was minus $3,864bn (BEA, 2013a,
7 Even if the foreign purchases were only of US government securities, the lower yields would have spread throughout the credit system. Other bond and longer-term loan interest rates are based upon the benchmark rate for government securities.
p. 14). However, in 2011-2012 the US gained an annual average net $236bn from foreign investment income, more than double the amount in 2007 (BEA 2013a, lines 13 and 30, Table 1, p. 73). The higher net income was helped by its ability to pay close to zero interest rates on US government debt owned by foreigners.
Hausmann and Sturzenegger (2006) perform an impressive feat of obfuscation when analysing this issue. The question they ask is why foreign investors accept lower returns on US assets, thus allowing the US to derive a positive income balance from a deficit investment position. Their solution is to assume away the existence of different rates of return and instead
Hausmann and Sturzenegger (2006) perform an impressive feat of obfuscation when analysing this issue. The question they ask is why foreign investors accept lower returns on US assets, thus allowing the US to derive a positive income balance from a deficit investment position. Their solution is to assume away the existence of different rates of return and instead