The US has long been thought to enjoy an ‘exorbitant privilege’ based on the dollar’s role as the major global currency.[1] This article looks at the different elements of the dollar privilege and how these work, not only in ‘normal’ times but, especially, in the current crisis.
1. Global role of the dollar
All paper currencies are so-called ‘fiat’ currencies, with a value set by the governments that issue them, not by their intrinsic value. Currency notes cost a few cents each to produce, so their much higher nominal value and buying power of $1, $5, $20, $100, etc, is based upon an established system of commercial law that means they can be exchanged for goods up to the same price. As long as the power of the state is unquestioned, at least in this regard, then there is no need to waste resources producing currency that has an intrinsic value in line with its nominal value. In other words, there is no need to have a $20 bill that actually costs $20 to make. This works well within the national boundaries of the state, which are usually the limits for the national fiat currency being legal tender.
But why then should a European, Asian, Latin American or African country accept dollar payments for their products when they are outside the national territory of the US? The dollar payments will not even necessarily be in the form of paper bills, and may only be a credit registered in a bank account. The reason for the dollar’s acceptability is US economic and political power. The US established a system of global finance after 1945 that was dollar-based, and the US was, and still is, the largest economy in the world. [2]
US pre-eminence is diminishing, but the institutions of US power remain in place and have so far faced little challenge. In foreign exchange trading, for example, the US dollar was on one side of 85% of all global currency deals in 2010, despite the alternative of the euro.[3] Important commodity prices are quoted, and contracts are set, in terms of US dollars, from oil to agricultural products and metals, and this phenomenon also applies to major industrial goods such as aircraft, components for electronics products, military equipment and the products of other many other industries traded internationally.[4] In financial securities markets, the US also stands out as the biggest in the world. The New York Stock Exchange is the largest equity market, by market capitalisation, and the US is also home to the world’s largest bond market.[5]
So the US currency has a global role based on US power. The sections below spell out what advantages the US gains from this.
2. Dollar seigniorage
The simplest form of advantage for the US, and also the least important, is that of ‘seigniorage’. The term describes the profit that a government can make by printing money with an exchange value higher than its cost of production, as in the printing of denominations of dollar bills mentioned above. All governments printing money that will be accepted within their national boundaries have this advantage, but the US has a particular advantage because the dollar is also accepted in many foreign countries. Especially when the local currency is seen as being unstable, for example when there is a risk of very high inflation rates, then companies and ordinary people may hold US dollars as their ‘store of value’. They are holding bits of paper that cost a few cents each to produce but which may have a legal tender value of many thousands of dollars. If the dollars have entered circulation in the 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.
It is obviously difficult to measure with any precision the value to the US of international seigniorage, and estimates vary widely, but it is thought that a stock of perhaps $300-600bn of US currency is circulating overseas, an amount that rises every year.[6] A proportion of this will be money used in drug deals and other illegal activities, but the effect is to deliver the US economy a sizeable benefit. In some manner, foreigners have delivered the US the goods that it wants, whatever these may be, and many of the providers have held onto the cash.
3. Cheaper dollar finance
Seigniorage is nevertheless only a very narrow conception of the advantages that the US gains from the role of the dollar. Most users of the dollar in international trade and finance do not hold the cash in their hands, but in a bank account or in the form of US dollar financial securities (titles of ownership to US assets, such as equities or bonds). With these, the holders receive interest or dividend payments, so the US does not receive the funds for free. But a key benefit of the global role of the US dollar is to get cheap, low risk finance. This comes about in two ways.
Firstly, through the fact that the US can draw upon the financial resources of the world economy, so it has much easier access to funds than do other countries. One important aspect of this has been 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 means of economic insurance against renewed trouble.[7] The US dollar was the currency of choice for these reserves, as the major means of payment for international goods and global finance. So it was that through the 2000s, a growing US current account deficit was funded by huge inflows of finance, especially from Asian central banks that bought US Treasury securities and other US dollar-denominated assets. One study suggested that the impact of these purchases of dollar securities was to reduce the borrowing costs of the US government by as much as 150 basis points (or 1.5%) for 10-year debt, compared to what the cost might otherwise have been.[8]
Secondly, by issuing debt in terms of dollars, the US can avoid taking on foreign currency risk. In a US-centred crisis, the value of the dollar might fall against other major currencies, but that does not matter if the US has little or no debt denominated in euros, yen or sterling. Countries that do not have such a privileged position in global finance – those that are not imperialist powers - are usually forced to borrow in the major foreign currencies and suffer the full consequences when a crisis hits.
This cheap, low risk finance cuts the cost of funding the large US trade deficit. It also enables the US to generate more earnings on its foreign investments than foreigners do on their investments in the US. This is despite the fact that the value of US overseas assets is far less than the value of assets that foreign investors own in the US. In 2010, US net foreign investment income amounted to a massive $171bn.[9]
4. US benefits in a crisis
The US government controls the world’s major currency with by far the biggest impact on international trading and financial transactions, even if these deals do not involve the US economy or US companies. Deals that are made in US dollars need to be settled in US dollars. This is not necessarily done by getting hold of the cash bills. Much more frequently it is done by getting access to dollar finance through a banking relationship. It is here that US financial power is supreme.
A crisis disrupts business, making companies and people more vulnerable to changes in financial relationships. Perhaps a buyer cannot get access to the loan required, or a producer may not be able to finance the output that was planned. Market prices may also be pushed too low or too high by dramatic currency or commodity price moves. As doubts grow regarding who can survive the crisis, having access to credit is indispensable. The Federal Reserve, the US central bank, is in charge of this for much of the world economy given the role of the dollar, and access to financial support from the Fed counts.
In recent years, many central bank authorities have had to bail out their domestic banking systems, but the Fed has played a much bigger role. It has provided extra funds, for a fee, to foreign banks in the US – especially the European ones. It has also provided extra dollar liquidity, also for a premium fee, to the European Central Bank to distribute to euro-based banks, the latest in mid-September. The New York Times reported on why this move was in US interests:
“In recent days some European banks have faced difficulties in borrowing dollars, whether from other banks or from money market funds in the United States. There was fear that if they could not borrow dollars, they would be forced to cut off loans to American companies or sell dollar-denominated assets, perhaps forcing prices down in already unsteady markets.”[10]
This vulnerability of European banks – despite the protection they get from the ECB – is based on the fact that much of their business is conducted in dollars, a currency that only the US can print, and of which the US controls the supply. So far, the fear of economic collapse and the contagion from it has led to cooperation between the major powers. But the role of the dollar in pricing aerospace products and other international commodities means that it is critical for non-US banks to be able to access dollar funds, and the cooperation seen so far from the US need not be as easily available in future. Le Monde has already complained that the US Fed was making non-US banks in America file non-US assets as security, even if they were not actually borrowing any dollar funds from the Fed. [11] The complaint was rather confused, but reflects the fact that, even in a crisis, the US is in a privileged position to set the rules when it comes to finance.
5. Imperial power and the dollar
Declining US economic power is offset to an important extent by the continued prominence of the US in global finance. As has been shown, the US is able to borrow in its own currency at low interest rates, and it can readily attract funds based on the huge size and liquidity of dollar financial markets, given the global role of the US dollar. Even the US credit rating downgrade in August did not dent this. It is the dollar’s global role based on the continuing power of US imperialism that makes the US a ‘safe haven’ for financial markets, even when the American economy is in crisis.
Of course, US financial institutions have also been hit by the economic crisis. The US government has organised shotgun marriages of several major banks and many smaller banks have gone bust in recent years. But the US financial system remains in a privileged position in the world economy, as a purveyor of the major currency, backed by the world’s principal central banking authority - the one that controls the tap of global credit and liquidity.[12]
Despite the attacks currently taking place on the living standards of the broad population in the US, it is suffering far less than the countries that were overwhelmed by major financial and economic crises in the past couple of decades, from Mexico, Brazil and Argentina to South Korea, Indonesia and Thailand. The record levels of US debt and borrowing have seen no imposition of austerity policies by the IMF, and the US has faced no sudden halt in its access to foreign capital as many other countries have, not least Ireland and Greece.[13] Such are the benefits of being the major imperialist power in the global economy. This is why the US will struggle to ensure that its dominant position, and that of the dollar, remains unchallenged.
Tony Norfield, 5 October 2011
[1] The term dates back to the 1960s and was coined by Valéry Giscard d'Estaing, when he was a France’s minister of finance. A useful recent book on this question is Barry Eichengreen’s Exorbitant Privilege: The Rise and Fall of the Dollar, Oxford University Press, 2011.
[2] China is likely within the next few years to become the world’s largest economy, overtaking the US. Note that this article only looks at some of the economic and financial aspects of US power, not the military dimension.
[3] Figures taken from BIS, Triennial Central Bank Survey, Report on global foreign exchange market activity in 2010, December 2010. The dollar share was 84.9% and the euro’s 39.1%. Note that here the total is 200%, since there are two sides to all currency trades, but the US dollar’s share was still more than twice that of the euro.
[4] The dollar is the most used currency for all kinds of international transaction, and the currency with the broadest global spread of use. Although the euro has gained acceptability since its inception in 1999, a large part of its use is in Europe and surrounding countries. The euro has been a serious challenger to the US dollar as an alternative currency in which to denominate bond issues, etc, but its market share has always remained a significant margin below that of the dollar. See The International Role of the Euro, European Central Bank, July 2011, for details.
[5] The US is second to the UK as a national base for the global foreign exchange market, but the currency trading in the UK is mainly of non-sterling currencies, and especially dollars.
[6] At the time of the opening up of Central and Eastern Europe and the former Soviet Union to capitalism after 1989, their trade with the US was minuscule, but the dollar played a major role in their economies on the black market. The Deutsche mark had, by contrast, very little penetration, despite Germany’s stronger position in trade with these countries.
[7] The 1997-98 crisis was traumatic for many countries in the Asian region. They suffered collapsing currencies, a slump in living standards and found their national economic policies dominated by the IMF, whose program for ‘reform’ included the sale of domestic assets at low prices to foreign capital. Thailand, South Korea and Indonesia were among the worst affected in this regard, and China, the major accumulator of foreign exchange reserves in the 2000s, took note.
[8] For example, the 10-year US Treasury yield was as low as 4.5%, rather than 6.0%. See Francis E Warnock and Veronica C Warnock, ‘International Capital Flows and US Interest Rates’, Board of Governors of the Federal Reserve System, International Finance Discussion Papers, Number 840, September 2005. Notably, the US restricts the foreign purchase of US corporations if this might seem to be against the national interest, but it has no qualms about taking money from whichever country wants to buy US debt (at low yields). Thus China was prevented from buying US oil major Unocal, but it has been allowed to own a mountain of US Treasuries.
[9] The US shares this advantage with the UK. See ‘The Real US Debt Problem’, 26 July 2011, and ‘The Economics of British Imperialism’, 22 May 2011, on this blog for more details.
[10] New York Times, 15 September 2011.
[11] ‘Comment la Fed assèche les banques européennes’ (‘How the Fed squeezes European banks’), Le Monde, 23 September 2011.
[12] US banks are still among the biggest in the world in terms of global coverage and influence, and US power also extends beyond purely US banks. For example, American nationals working for non-US banks outside the US are still subject to US law, so they cannot deal with any country that the US declares out of bounds. This is a factor that has strengthened the impact of US sanctions on Iran, for example.
[13] The IMF is technically an international body, but runs largely according to US dictates. The US does not need to own it all. It accounts for a significant minority of the votes (17%), well ahead of the second largest country, Japan, with just 6%, and has enough influence over other members to ensure that IMF policies suit its interests.
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