27 August 2023
Edward Lotterman
A French president once asserted, to much acclaim, that the U.S. dollar’s status as a “reserve currency” conferred an exorbitant privilege on our nation.
As I write this, members of the six-nation BRICS bloc are meeting in South Africa. The ways in which the dollar’s status harms these nations is a central topic and measures to reduce its influence will be announced.
Six other nations are joining the bloc. Many others, including other aspirants to membership, have sent observers. China has held bilateral talks with Brazil, Mexico and Nigeria, among others, on how a greater fraction of their bilateral trade should be settled in their own currencies, not dollars.
At the same time, respected and obscure pundits both regularly proclaim how this imminent “downfall” of the dollar will cripple the U.S. economy. There is a particularly silly one by Bethann Moorcraft, on the Moneywise site, asserting that India paying rupees for 100 million barrels of oil from the United Arab Emirates “could spell doom for the greenback.”
Yet also this week, China is selling off some of its substantial official holdings of U.S. Treasury bonds — but not because they are a bad investment. The exchange value of the Chinese renminbi is falling undesirably. The way to slow that is to buy up the Chinese currency. The flip side of “buying” renminbi is that one is “selling” dollars. If the dollars are parked in U.S. bonds, then one sells the bonds.
So what to make of all of this? There is far too much for one column, so let’s start with important background facts necessary to understand key issues, with a follow-up promised for next week.
True, there are advantages to a nation issuing any currency that is used by other nations to hold their foreign exchange reserves. But these advantages are highly overblown.
There can be distinct disadvantages to nations holding reserves in the form of dollars, especially when U.S. economic policies gyrate wildly. When Germany complained about the effects of Reagan-era policies in the 1980s, they had a legitimate beef. But when the yelping comes from Nigeria or a serial defaulter like Argentina, ignore it.
Now, move to some basics of “foreign exchange.” There are two very different primary reasons why governments of other nations or their businesses or citizens may want to own the currency of another nation.
First, foreign currencies are used for “settlement” payments needed in the buying and selling of imports and exports. Use of a few common, easily tradable currencies like the U.S. dollar, euro or yen, means that Lesotho, in southern Africa, can buy something from Switzerland or Kazakhstan can sell something to Canada without any of the domestic currencies of any of these nations changing hands.
But second, direct or immediate use for trade settlement is only part of internationally held stocks of currency. Nations may choose to hold money of other nations as a prudent reserve to be able to meet future payments, perhaps of interest or principal on international debt or to pay for vital imports even if the world economy is roiled by global political or economic disturbances. This is little different from a household savings account to meet emergencies
Also understand that while the official foreign exchange reserves of a nation consist of currencies controlled by its central bank or national treasury or finance ministry, it is difficult to separate these from foreign currency assets owned by the nation’s businesses and individuals.
These may want to own foreign currency for the same reasons as governments do. A multinational corporation may want to avoid bringing profits of a foreign subsidiary home if that would trigger higher taxes. It may hold them abroad pending some anticipated investment in a new plant or equipment. It may see other currencies as a more stable store of value in the intermediate term.
Individuals similarly want to keep money out of sight and reach of tax authorities or because their home currency is not stable or safe. They may want funds if they need to flee the country suddenly because they are criminals or simply because they are at odds politically or financially with powerful people there.
Financial firms may use foreign currencies to be able to broaden their portfolio of investments. This is not limited to large Wall Street entities trading for their own account. My 401(k) account from my Federal Reserve employment offers international investment funds as do my 403(b) accounts from teaching and our own IRAs with Vanguard. State and local retirement fund managers invest internationally as do labor union funds and insurance companies. Note that this is to make long-term investments in stocks, bonds or real estate in other countries, not for short-term currency speculation.
Such speculation is, however, significant. Quantifying use for short-term trading accurately is difficult, as is determining exactly what fraction of reserves are held for purposes that are illicit in at least one of the countries involved. And it is difficult to fully separate foreign currencies held in government bonds or in bank accounts from those held in other financial instruments such as private sector stocks or bonds.
A recently released “Report on Foreign Portfolio Holdings of U.S. Securities at End-June 2022,” shows that about $25 trillion in U.S.-issued securities of all types are owned outside our country. A much narrower tabulation, “Major Foreign Holders of U.S. Treasury Securities” per se shows $7.4 trillion at the beginning of 2023, down slightly from a year earlier.
However, consider that after big industrial nations like Japan, China and the United Kingdom, the next largest holders of U.S. Treasurys are Belgium, Luxembourg, Switzerland and the Cayman Islands, and that Bermuda, with a population well under Duluth’s, is right behind Germany. This screams that these markets lack transparency.
Note that while the U.S. dollar plays the largest role in international settlements, it is not alone. The euro, yen, British pound, Swiss franc plus Canadian and Australian dollars all are safe ways to hold value internationally. Note that these are all stable democracies with well-established rules of law and relatively transparent financial systems — even when the national governments pursue bad economic policies. All have financial markets in which bonds are traded and values determined openly. This is largely true for Brazil, to a degree for India and South Africa, and not at all true for China or Russia.
Issues of the pricing of oil, the degree, if any, of “exorbitant advantage,” and the future role of the dollar as the BRICS bloc expands must wait for next week.
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St. Paul economist and writer Edward Lotterman can be reached at [email protected].