Quantifying Benefit Of USD As Reserve Currency

[jyl]

Some of you guys have been wringing your hands about the decline of the USD. A decline which, I think, is actually desired by the US government and much of US industry.

From the WSJ Economics blog

Should the U.S. worry if central banks around the world decide they don’t want to hold their reserves in dollars anymore? Given the amount of hand-wringing over the dollar’s status as a reserve currency, one would think that losing what is known as the “exorbitant privilege” would be a really big deal. But in a new paper, economists at the McKinsey Global Institute suggest that the U.S. might not have all that much to fret about.

“It is not clear that the United States enjoys much of a privilege at all,” the McKinsey economists write. They estimate that in a typical year, the U.S. gains the equivalent of about 0.3% to 0.5% of annual economic output — or $40 billion to $70 billion — thanks to the dollar’s dominant global role. Here’s how they break down the benefits, and the costs:

1) When people in other countries hold dollars, they are effectively giving the U.S. zero-interest loans — a benefit economists call “seigniorage.” Annual benefit: about $10 billion.
2) When foreign governments and central banks park their dollars in US Treasury bonds, they push down those bonds’ yields. That, in turn, pushes down borrowing rates for U.S. consumer and companies. Annual benefit: about 0.50 to 0.60 percentage point, or about $90 billion.
3) The dollar’s global allure, though, also tends to push up its exchange rate against other currencies. That makes it harder for U.S. exporters to compete abroad, and for domestic companies to compete against imports. Annual cost: $30 billion to $60 billion.

Real Time Economics - WSJ

A net annual benefit of $55BN to the USA is not nothing, but it is hardly the linchpin of the American Way Of Life either.

[pwd72s]

Interesting and valid viewpoint. Still, being the reserve currency has a prestige factor...an indication of financial strength.

[jyl]

Agreed. Being displaced as the world's reserve currency would be a negative. But I think that's a low probability, and the downside in that low probability event appears manageable. Low probability of a negative but manageable event = not something to freak out about.

The reason why I think it is a low probability is because I don't see a good alternative global reserve currency.

JPY - Japan's national debt situation is the worst in the industrialized world and that economy can't seem to grow.

EUR - probably the best alternative but the national debts in the EU are for the most part worse than the US, you're actually seeing credit downgrades of some countries (Greece), and the EU's economic growth rate is inferior to the US

RMB - no-one is ready to trust the Chinese govt yet, they manage the RMB to the USD anyway, and the Chinese economy is not yet big or mature enough - yet.

Gold - it should be obvious to all but the gold nuts that the world cannot go back to a gold standard, either as a backstop to currencies or to conduct business in.

[tabs]

Imagine what the value of a USD would be if all those foreign entities WERE TO DUMP their USD and T BILL positions because they no longer needed to hold them in reserve. ALL THOSE USD that are being held would flood the market...

[tabs]

Further under the current circumstances itis unlikely that the USD will be replaced anytime soon. However what is likely to happen is that the major players are going to start to decouple themselves from the USD over time & with stealth. They are going to do this because they no longer trust the US govt to be a responsible financail steward. They will not want to put themselves at risk of being tied soley to the vagaries of US political whims.

Thus over time it is likely that the USD will gradually decline and interest rates begin to climb.

[tabs]

The Russians and the Chinese have proposed that a basket of world currencies or a super currency be established as the new reserve currency. The rational is that no single actor on the stage should be in a dominant position as the risk is too great.

[Westy]

The USD is about to be replaced as the global fund in oil trades. Saudi Arabia and quite a few other OPEC types are planning to start their own currency for oil. They desperately want to copy the EU Euro system, but for Arab States. When their exchange rate is established by them, and not attached to the dollar (think Yuan), you will see some serious problems with the dollar. And when the dollar starts to lose ground, it will get dumped by investors.

There's a domino principle going on, and it's hanging by a thread. Many naysayers out there, but of course WW1 was the war to end all wars. They didn't really consider economic war, now did they? Decoupling makes sense [on paper] for a lot of these countries. Hundreds of billions spent yearly only in oil trades. Their oil, their monetary system, their rules. I don't like playing the role of hostage. And those of you that think the dollar will rebound, look at the results of the last few auctions. NO buyers. No one wants our dollar. 'Cept me, of course.

[Taz's Master]

Originally Posted by tabs

Imagine what the value of a USD would be if all those foreign entities WERE TO DUMP their USD and T BILL positions because they no longer needed to hold them in reserve. ALL THOSE USD that are being held would flood the market...

What would it cost those investors to completely devalue their investment?

[tabs]

Originally Posted by Taz's Master

What would it cost those investors to completely devalue their investment?

If you had read on you would have read that the likely scenario is that foreign enities are going to DECOUPLE themselves from the USD OVER TIME and WITH STEALTH...that will cause the USD to be devalued slowly...foreign holders of the USD are not going to shoot themselves in the foot and dump USD enmass. By the same token they are not going to solely rely on the USD anymore either as they feel the US govt is following an unsustainable path.

I have said beofre give the USD 3 to 5 years...that will be about the right amount of time for foreign holders of USD to devest themselves from the USD...ONce they do that what do they care if the USD goes to zero..they don't want it to go there of course but you get the idea.

However it is intriguing about the Saudi's there has been a poopooded news report recently that the Saudis had a secret meeting about replacing the USD in three years... I beleive that meeting did take place..AND THAT THE SAUDIS ARE PLANNING ON NOT USING THE USD FOR OIL TRADES...Once that happens everyone who now holds USD for those trades WILL TRANSFER OUT OF USD...

A CRISIS OVER THE USD IS GOING TO BE THE NEXT CRISIS TO HIT THE US...3 to 5 years is my time horizon...it maybe sooner than I think though...then say BYE BYE to the USD...and guess what else...

[island911]

"and dump USD enmass."

What? ...planes will fly over the US dumping all the Chinese & Saudi USD's and T-bills?

Note how much new money flooded the US economy, as the housing bubble put hundreds of thousands of dollars into every home-owner's equity accounts. ...which they "leveraged' to make additions, install $100k+ kitchen remodels, buy the new Benz...

Even if all the US debt were 'dumped' (no goods in return - not goiing to happen) it still would not hold a candle to the new money generated from that housing bubble. --where we did see some general inflation.

That's how I see it. Please correct me, if I'm wrong.

[island911]

The Saudis can, at any moment, stop selling oil to the US. Or, stop taking USD for oil sold.

Perhaps they want to drink the oil, rather than have the goods and services of the USA.

There is oil all over this globe. The Saudis are just one source.

[tabs]

Originally Posted by island911

The Saudis can, at any moment, stop selling oil to the US. Or, stop taking USD for oil sold.

Perhaps they want to drink the oil, rather than have the goods and services of the USA.

There is oil all over this globe. The Saudis are just one source.

...foreign holders of the USD are not going to shoot themselves in the foot and dump USD enmass.

Oil consumption vs oil production is tight even though the world has suffered through a global depression and not recession. The world let alone the industrial nations DEPEND ON OIL TO FUNCTION...the USA would collapse in a week without oil being imported (the USA would run out of oil being held in reserve a week later). Without oil production you would be living like your forefathers did in 1700. The world would be in a veritable new Dark Ages...

The Gulf states are heavily invested in the USA and Europe, they are not going t shoot themselves in the foot. HOWEVER it is becoming apparent to them and the rest of thee world that their perception of American financial omnipotence was a myth which has been dispelled. No longer does the world look up to the USA for it's financial expertise...they have seen behind the curtain with this crisis. The world is going to start moving away from the USD as the reserve currency..if for no other reason to protect themselves from another debacle such as the one the world has just gone through.

[jyl]

The idea of OPEC states creating a single currency is far fetched. OPEC can't even stick to a oil quota, why do you think they can create and manage a currency?

For the euro to be created, the euro zone countries had to give up control of their monetary policy to a single European Central Bank and commit to uniform government debt limits. You think Mexico wants it's monetary policy decided by Libya, Iran will let Iraq tell it what budget deficit it may run, Venezula will let it's interest rates be determined in Saudi Arabia?

And where will they get the money? The Eurosystem has total reserves of 437BN EUR or 625BN USD. Sure, the richest OPEC countries could contribute this much, but if Saudi Arabia ponies up $500BN it will want to control the currency, and then you're back to who in OPEC wants to be ruled by Saudi Arabia?

Don't forget that the OPEC countries, as a whole, don't have much of an economy beyond oil. So your hypothetical OPEC currency will be backed by oil and nothing else. Which means it's value will tend to rise and fall with the price of oil and the volume of oil transactions. When demand for oil declines, the price of oil already tends to decline, and now it will be exacerbated by the decline in the OPEC currency. So, instead of suffering through a 70% fall in oil price (140 USD to 40 USD) now OPEC gets to suffer, let's say, an additional 30% decline in their misbegotten currency too? For a 79% decline in effective purchasing power? Yeah, that sounds like a good idea. When their USD declines, at least they can buy things from the US and China with no decline in purchasing power.

A last point. Consider the volume of FX trading in the world. Appx 4TR USD per day. Then consider the volume of oil transactions - it is a small fraction of that. This suggests to me that an OPEC currency would be very vulnerable to manipulation, and there'd be plenty of incentives to do so. Not so great to have your national currency being slammed around by FX and energy traders.

This is one of these ideas that sounds intriguing but falls apart when you actually think about it.

[tabs]

JYL one has to agree that the Opeckers are not going to creat a curency. However that is not to say that they won't be behind and support the creation of a SUPER currency that is composed of a basket of currencies including the USD.

[tabs]

The days of USD hegemony are coming to a close.

[jyl]

Originally Posted by tabs

JYL one has to agree that the Opeckers are not going to creat a curency. However that is not to say that they won't be behind and support the creation of a SUPER currency that is composed of a basket of currencies including the USD.

So, how would that work and what would be the consequences?

I'm asking you (and others) to think it through carefully.