Why So Much Interest? International Role of the Dollar Rise of Euro US Current Account Deficit Role of Oil Pricing and Iraq War 797 Lecture Raises General Issues The Nature and Role of Reserve Currencies or, more generally, Key Currencies Key Currencies and Asymmetries Charles De Gaulle, the post war president of France, called it: the exorbitant privilege referring to the ability of U.S. to run balance of payments deficits by printing their own currency (or, in other words, borrowing in its own currency). 1
Questions What determines which countries have key currencies? How stable are they? What are the determinants of evolution of key currency status? What are the costs and benefits for the key currency country? How are those costs and benefits distributed? What are the costs and benefits to the rest of the world? Outline of Rest of Lecture Key Currencies What are key currencies? How have they evolved historically? What is some of the theory about their evolution and the nature of their costs and benefits? Outline Continues Some Stylized Facts about the recent evolution of key currency status. B. Roohi Prem s Analysis of the Determinants of Key Currencies. C. The nature and evolution of the U.S. Current Account Deficit in the Recent Period D. Is it sustainable? Costs and Benefits. Role of Dollar? E. Role of the Dollar in the build-up to the Iraq war. Official Private Medium of Exchange Intervene in currency markets Buy and sell international products and assets Unit of Account Price Official Assets and Liabilities (eg. In IMF) Price securities and commodities Means of Payment Repay Official Debts Used to settle debts Store of Value Central Bank Reserves Store Wealth in this currency 2
Another View of Functions Sector Function Private Official Private and Public Roles Are they Siamese Twins? Unit of Account Store of Value Medium of Exchange Means of payment Invoice Financial Assets Vehicle/substitution Repay debts Peg Reserves Intervention Repay debts DENOMINATION RENTS Recent evolution of key currency role Do financial institutions get extra profits, or RENTS, from their country s reserve currency roles? IF they once did, do they still? 3
4
Currency Pegs 5
6
Seignorage from dollar holdings Brief History of Roles of Key Currency Sterling A key to British Hegemony and gold standard Dollar: Key in Bretton Woods concern about exorbitant privelege and Triffin Dillemma Various proposals for increasing global currencies: sdr s, substitution account, debt overhang But concern in financial circles about siamese twins connection between private and offical roles In the end, before 1973 benign neglect---kindleberger and Salant us is global financial intermediary and there is no overhang What determines size of key currency role? Standard Determinants Enforcement determinants 7
Standard Determinants New York Fed Paper on Invoicing Depends on The Particular Role Reserves Vehicle Intervention Invoice Means of Payment Store of Value New York Fed Continued Standard Determinants Size of the economy Importance in international trade Size depth, liquidity and openness of domestic financial markets Convertibility of currency Macroeconomic policies inflation, interest rates, accumulation of debt 8
Enforcement determinants What are the enforcement determinants according to Roohi Prem? Enforcement Determinants Central Bank Independence (credibility) Foreign Investment hostages Military Expenditure Ability to protect stability (What about role of military expenditure as a way of providing protection: is this related to enforcement by her definition)? Roohi Prem s Econometric Results 9
10
Is the U.S. Current Account Sustainable? What is the role of the U.S. Key Currency Status in helping to sustain U.S. Current Account Position? Bretton Woods TWO? Are Countries, particularly in Asia maintaining fixed exchange rates with the US and accumulating reserves to maintain fixed exchange rates while the US promotes benign neglect? Is this promoting a balance of financial terror? 11
Reserve Accumulation sterilization 12
Roubini and Stestser The US As A Net Debtor Some Facts on The US Accounts 13
14
15
Advantages of US Relative to most other countries when dollar depreciates, the value of us net debt goes down Us can borrow in negative real interest rates Resource Gap measure of debt sustainability: the difference between Simple Algebra of sustainability (r-g)d/y=ca/y Where r=real interest rate g=growth rate of gdp Ca=current account surplus Y=real gdp 16
17