Sunday, November 23, 2014

Reserve Currency Status

What are the benefits of providing a reserve currency?

I was recently reading a post by David Glasner, where he explained that the benefit is seignorage.   Glasner was mostly responding to a proposal for replacing "the dollar" with gold.  

If we think of replacing gold with the dollar, and see the dollar as being paper hand-to-hand currency, then we can imagine foreign central banks holding stacks for $100 bills in their vaults, just as they once kept bars of gold.  

The U.S. government, then, can print up these dollar bills, and so creates a flow of revenue much as the gold mining industry received a flow of revenue from its output of money.  

But how realistic is this?

Doesn't the use of the dollar as a reserve currency really mean that various foreigners, including foreign central banks, purchase dollar-denominated bonds?   At first pass, then, I would see this as creating a ready market for low interest rate U.S. government debt.   Assuming the U.S. has a national debt, then it can be financed at lower interest rates than otherwise.

Presumably, this benefit spills over to private borrowers as well.   U.S. borrowers of all sorts can borrow in terms of our own unit of account at lower interest rates.  

To the degree that this results in a larger banking system, the demand for reserves is somewhat higher.   And further, there may even be some increase in the demand for U.S. hand-to-hand currency.   Certainly, the conventional wisdom is that there are substantial holdings of U.S. dollar notes in foreign countries.

But most of the "high finance" related to the role of reserve currency is not based upon sacks full of currency.  

Of course, I have become a "seignorage" skeptic anyway.   If there is a strong commitment to some nominal anchor other than the quantity of base money, then seeing base money as a type "paper gold" is a fallacy.   Monetary liabilities are rather a type of short term debt.    Those parts of it that are issued at a zero nominal interest rate, like tangible hand-to-hand currency represent at zero interest loan.   From this perspective, to the degree serving as reserve currency increases the demand for base money rather than other sorts of dollar-denominated debt, simply means more borrowing at lower interest rates.

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