Why the US dollar’s reserve status is an exorbitant burden

Economic disadvantages outweigh benefits reaped from the reserve status. Although the dollar gives the US political power and prestige, higher costs of exports mean that it is doomed to run a current-account deficit and is forced to borrow in order to maintain full employment.

Sukhayl Niyazov
Jul 9, 2019 · 6 min read
Source: Quartz

It is a widely accepted conventional wisdom that the reserve currency status of the US dollar gives America certain vague but nevertheless important benefits — after all, we call the position of the greenback an “exorbitant privilege”. It seems like a no-brainer, as a former French finance minister charged in the 1960s, that the United States enjoys an “exorbitant privilege” from the dollar’s reserve currency status.

Media all around the world presents possible dumping of the US dollar in international transactions as a disaster for the American economy. Yet, as surprising as it may seem when delving deeper into the consequences of reserve currencies on the economics of their owners, we can infer from the evidence provided by leading economists and analytical centers that the US dollar’s position yields more drawbacks than merits to the economy.

Many people think that the US does its best to prevent China, EU, Japan from increasing the roles of their respective currencies in the world. In spite of the fact that the US tries to shift some of its “privilege” to other states or other countries engage in policies aimed at diminishing their currencies’ role, people remain ignorant about true consequences of the US dollars status.

So, in order to elucidate our understanding of this issue, let us make a brief overview of the benefits and drawbacks of the dollar’s position.

Source: Time magazine

BENEFITS

1. Seignorage. The issuer of the reserve currency accrues economic benefits from seigniorage — in other words, from issuing the currency, even though the money the US Federal Reserve reaps from seigniorage is trivial (between $40 and $70 billion per year, which is less than 1 percent of the US GDP).

2. Low-Interest rates (this is controversial, later will explain why). Thanks to high demand from foreign investors on US assets, the US has been able to run up huge debts denominated in its own currency at low-interest rates, because high demand on securities reduces interest rates. McKinsey estimates that interest rates have decreased by 0.5–0.6% because of these purchases, and are worth about $90 billion a year in benefits.

3. Political power and prestige. Aside from pride seeing the dollar being used everywhere, there are serious benefits pertaining to Washington’s ability to use the dollar as to prop up the liberal, rule-based international world order, establish justice, punish guilty in fraud and manipulation and ensure the security of the world — because almost everyone, when performing transactions, has to go through the US financial system, this gives Washington a leverage over political adversaries.

nrc.nl

DRAWBACKS

1. Overvalued currency. High demand for US assets means that the dollar exchange rate is higher than it would be without reserve currency status by around 5–10%. This makes US exports more expensive and other countries imports cheaper, thereby reducing the competitiveness of American producers.

McKinsey estimates that “exporters and manufacturers that compete with imports lose out by up to $100 billion because of the strength of the dollar, reducing employment in these sectors by between 400,000 and 900,000.”

Source: Atlas

2. Trade deficits. When foreign central banks intervene in the markets and accumulate US assets, they push down the value of their currencies and will run current-account surpluses exactly equal to their net purchases.

Reverse thing happens with the US — it is forced to accumulate huge current-account deficit. Because foreign demand on dollars pushes up its value, this inflicts damage on US manufacturers, resulting in a higher unemployment rate, and the only way for the US to reduce it is to expand borrowing.

SUMMARY

Returning to conclusions, we can see that except political power and prestige, the US dollar gives little economic value, less than 1% of the US GDP, whilst at the same time forces the US to accumulate huge trade deficits and devastates domestic producers.

And the argument that US dollars status lets America borrow at low interest rates is weak. After all, as we know increased demand leads to lower interest rates, but on the condition that there is no concomitant expansion of supply. But because the US needs to maintain full employment, it needs to issue additional debt, thereby increasing suply in tandem with demand.

Economists highlight that the singular role of the U.S. economy in providing liquidity to the global economy and driving demand around the world makes a U.S. trade deficit central to global economic stability. The dollar’s role as the global reserve currency and primary tool for global transactions means that many other countries rely on holding dollar reserves, creating massive demand for U.S. financial assets. — Council on Foreign Relations

The US loses hundreds of billions of dollars due to the dollar’s position as the world’s primary reserve currency. US policymakers should implement some reforms that would mitigate negative repercussions. And it is clear that the current financial system needs a serious update — otherwise, we will witness the exacerbation of the problems in the US and the rest of the world as well.


Dialogue & Discourse

News and ideas worthy of discourse. Fundamentally informative and intelligently analytical.

Sukhayl Niyazov

Written by

Independent author. Bylines at Global Policy, Towards Data Science, Human Events, Areo Magazine. https://www.linkedin.com/in/sukhayl-niyazov/

Dialogue & Discourse

News and ideas worthy of discourse. Fundamentally informative and intelligently analytical.

Welcome to a place where words matter. On Medium, smart voices and original ideas take center stage - with no ads in sight. Watch
Follow all the topics you care about, and we’ll deliver the best stories for you to your homepage and inbox. Explore
Get unlimited access to the best stories on Medium — and support writers while you’re at it. Just $5/month. Upgrade