October 26, 2011
The Dollar and the Renminbi as International Currencies
There's been a lot of discussion of the potential rise of the Renminbi as an international currency. In particular, Jeffrey Frankel has recently written a paper on the subject (blogpost), backed in part on research we did in our papers   on the dollar. Now, the New York Fed's Linda Goldberg, Mark Choi and Hunter Clark have re-examined some of benefits of being an international currency in a post entitled What If the U.S. Dollar’s Global Role Changed?.
Some have suggested that the large benefits extracted by the United States from the dollar’s privileged international status could be undermined should the currency’s role decline. We examine this claim by grouping the potential consequences of a change in the dollar’s relative international status into five “buckets.” These consequences are summarized in the table below and discussed in more detail.
Possible Effects of a Reduced Role of the Dollar
Bucket Impact Comments Seigniorage revenues to the United States Small reduction Seigniorage revenues are relatively low; dollar cash holdings outside the United States are not likely to change much. U.S. funding costs Increase from low levels While the United States does not have an “exorbitant privilege” in funding, reduced demand for dollar reserves can raise U.S. funding costs. Higher funding costs on debt raise interest payments to external creditors. This tightens domestic spending constraints, and some domestic expenditure could be crowded out.
Dollar depreciates; imports become more expensive Dollar depreciation arises from lower net demand for dollars. U.S. insulation from foreign shocks Reduced U.S. autonomy in policy International trade invoicing patterns change and U.S. import prices and consumption become more exposed to foreign shocks and exchange rate movements. U.S. global influence Reduced influence Some rebalancing of country powers in international negotiations and institutions may occur.
The authors discuss all these dimensions, but against the backdrop of how the debt ceiling imbroglio damaged the United States' credit rating, I found this section of particular interest.
U.S. funding costs: The United States is sometimes argued to have an “exorbitant privilege” of facing lower funding costs due to the dollar’s central role in the international monetary system. While there remains a small advantage for the United States in official and bond financings, and the debate over the reason for this is ongoing, recent studies (such as the 2011 paper by Curcuru et al.) attribute the lower rates charged to the United States to risk premia and to differences in tax rates and the relative stability of investment returns across nationalities, rather than to the dollar’s international role per se.
It is possible, however, that funding costs could rise on U.S. government borrowing if other country assets emerge as stronger alternative investment vehicles to U.S. Treasuries. If reduced demand for U.S. official debt leads to increased funding costs in the United States, the fiscal burden of U.S. debt would rise and could increasingly crowd out domestic spending.
Another type of cost arises on transactions in financial markets. High volumes of activity in U.S. dollars keep the dollar market highly liquid and lower the effects on exchange rates of large sales or purchases of U.S. dollars. While transaction costs could potentially rise with dollar exchange rate volatility, other cost drivers are the number of dealers, quote frequency, and transaction size. Unless large volumes of international financial and international trade transactions shift away from dollar use, there is little reason to expect that U.S. dollar transaction costs will rise.
It will be of interest to see if the inability of the debt ceiling supercommittee to come to an easy agreement further damages the US credit rating. While funding costs remain low due to slack in the world economy and relative safe-haven effects, continued demonstrations of our political leaders' intransigence regarding tax revenue increases may move us into new realms.
Posted by Menzie Chinn at October 26, 2011 08:41 AMdigg this | reddit
The primary risk of the US as the reserve currency is that it encourages us to borrow too much.
In the end, the role of the Remnibi will be decided by China. Will China succeed the US as the operator of Pax Britannica? Will it be able to operate as open system, and operate that system neutrally on behalf of all participants? The Chinese will certainly have the commercial sensibilities and technical skill. Whether their ultimate allegiances will be to a liberal order or a nationalist identity is yet to be seen.
Posted by: Steven Kopits at October 26, 2011 09:20 AM
>Seigniorage revenues are relatively low; dollar cash holdings outside the United States are not likely to change much.
Although the level may be low, I suspect the change is significant comparing the last decade to the next one. What would have happened had china not accumulated $2 trillion in U.S. dollar assets over the past decade.
Posted by: Michael Rawson at October 26, 2011 02:08 PM
Nouriel Roubini, speaking on the Charlie Rose Show... (http://www.charlierose.com/view/interview/11941 starting at minute 20)
... Indicated that he believed that the Renminbi could emerge as an international reserve currency in the next 10 to 30 years if China adopts more capital market liberalization...
In his opinion, the speed of China's integration into the international banking system and the Renmimbi's displacement of the dollar will be a function of how well China and how badly America manage their respective economies.
Posted by: MarkS at October 26, 2011 02:41 PM
Michael Pettis offers a contrary perspective.
Ken Austin's recent article on the US as the (voluntary) crown jewel of the contemporary Chinese empire is also worth the read, if only for the refresher in basic international economics.
Count me as someone who will pop the bubbly if the RMB completely replaces the dollar.
An overvalued currency is a developmental curse. Ask the Dutch Republic or the UK -- much better to be a South Korea or an Israel... I'd trade being born in Bangladesh over being born in the UK or the US today -- financialized economies have no future except as technological backwaters dominated by greedy oligarchs.
Posted by: Fred List at October 27, 2011 03:16 AM