1. Does the dollar confer an exorbitant privilege to the US economy?
Does the dollar confer an exorbitant privilege to the US economy?
Robert McCauley*
Monetary and Economic Department, BIS
Presentation to the Bank of Korea
Seoul, 6 November 2014
* Views expressed are those of the author and not necessarily the views of the BIS

2. Exorbitant privilege: manifold meanings, none convincing
Exorbitant privilege: manifold meanings, none convincing
Original sense: US need not settle, now no one does “If I had an agreement with my tailor that whatever money I pay him he returns to me the very same day as a loan, I would have no objection at all to ordering more suits from him” (Rueff, 1978).
Cash held by ROW: $0.5 t X 2% = $10b/ year<0.1% of GDP => de min
US able to borrow in own currency? Yes but others do too.
US Treasury borrows cheaply because of demand of official reserve managers? Through portfolio balance effect, effect broadly shared.
Better returns on US international assets than on US international liabilities? Yes but reflects dynamics of US mergers and acquisitions market, not the international role of the US dollar.
US firms earn “denomination rents”? Actually US-headquartered banks hold only16% of international dollar claims.

3. Exorbitant privilege looks right from Chinese perspective
Exorbitant privilege looks right from Chinese perspective
China does not lend in its own currency—so US borrowing in own currency may seem a privilege.
China holds lots of US Treasury securities—so plausible that keeping US Treasury rates lower than they would be otherwise.
China pays net international investment income on its net foreign assets!
That is, receives much lower returns on its international assets than it pays on its international liabilities.
Plausible that US is just the flip side, earning net international investment income on net international liabilities.

4. Chinese perspective: China does not lend in renminbi
China NIIP = ¼ GDP.
Debt claims almost all forex.
Net equity liabilities more than all renminbi
So China’s net long forex position ~ 3X NIIP, something like ¾ GDP

5. China holds lots of US Treasury securities
China (all sectors) resident holding of US securities, June 2013
US Treasury 1,272 billion
Agency
Corporate
Equities
Total (incl short-term) 1,735 billion
Source: Department of the Treasury, Federal Reserve Bank of New York, Board of Governors of the Federal Reserve System, Foreign Portfolio Holdings of U.S. Securities as of June 30, 2013, April 2014

6. Chinese perspective: China’s net international investment income usually negative
Decent returns on direct investment in China vs low return on assets.
Positive return only in crisis years when direct investment in China less profitable

7. China: Long official safe assets, short private risky assets

8. Exorbitant privilege: manifold meanings, none convincing
Exorbitant privilege: manifold meanings, none convincing
Original sense: US need not settle, now no one does “If I had an agreement with my tailor that whatever money I pay him he returns to me the very same day as a loan, I would have no objection at all to ordering more suits from him” (Rueff, 1978).
Cash held by ROW: $0.5 t X 2% = $10b/ year<0.1% of GDP => de min
US able to borrow in own currency? Yes but others do too.
US Treasury borrows cheaply because of demand of official reserve managers? Through portfolio balance effect, effect broadly shared.
Better returns on US international assets than on US international liabilities? Yes but reflects dynamics of US mergers and acquisitions market, not the international role of the US dollar.
US firms earn “denomination rents”? Actually US-headquartered banks hold only16% of international dollar claims.

9. Borrow in own currency? US does finance its net international liabilities in dollars… but so does Australia
US borrows enough US dollars to finance negative NIIP and to go long foreign currencies.
Australia, with only a minor role as reserve currency, does the same.
Green + Blue liabilities > Liabilities - Assets
NO PRIVILEGE HERE

10. Exorbitant privilege: manifold meanings, none convincing
Exorbitant privilege: manifold meanings, none convincing
Original sense: US need not settle, now no one does “If I had an agreement with my tailor that whatever money I pay him he returns to me the very same day as a loan, I would have no objection at all to ordering more suits from him” (Rueff, 1978).
Cash held by ROW: $0.5 t X 2% = $10b/ year<0.1% of GDP => de min
US able to borrow in own currency? Yes but others do too.
US Treasury borrows cheaply because of demand of official reserve managers? Through portfolio balance effect, effect broadly shared.
Better returns on US international assets than on US international liabilities? Yes but reflects dynamics of US mergers and acquisitions market, not the international role of the US dollar.
US firms earn “denomination rents”? Actually US-headquaretered banks hold only16% of international dollar claims.

11. Who borrows cheaply? US Treasury, US dollar bond issuers or global bond issuers?
US Treasury only? Then US interest rate swap spread should be wider than those in other major currencies.
All issuers of US dollar bonds? Then privilege shared with issuers of $8.2 trillion of international bonds denominated in dollars.
Global bond issuers? Then really privilege?

12. Who borrows cheaply? US Treasury?
McKinsey report by Dobbs et al (2009) cites Warnock & Warnock (2009) to justify a 60 basis point estimate of the impact on US Treasury yields of official holdings.
However, this is overstated: Genberg et al (2005) point out that the estimate of Bernanke et al (2004) of 1 basis point lower 10-year US Treasury rate for every $1 billion of Japanese Ministry of Finance purchases in implies a total compression of US yields by an absurd 300 basis points plus.
US $ swap spreads not consistently wider than the gap between German bunds and DM/euro bunds, despite greater liquidity of US Treasury market.

13. Interest rate swap spread over US Treasury and German bund

14. Who borrows cheaply? All global bond issuers?
Moreover, lower US yields spread across global bond market.
Gerlach-Kirsten et al (2012) find Japanese MoF buying push yields lower in UK, DE, CA even JP bonds.
Neely (2010), Bauer and Neely (2013), Rogers et al (2014) all find that Fed’s bond-buying announcements pushed down yields in global bond markets.
Obstfeld (2013) finds strong effect of US bond yields on rest of world bond yields.

15. Exorbitant privilege: manifold meanings, none convincing
Exorbitant privilege: manifold meanings, none convincing
Original sense: US need not settle, now no one does “If I had an agreement with my tailor that whatever money I pay him he returns to me the very same day as a loan, I would have no objection at all to ordering more suits from him” (Rueff, 1978).
Cash held by ROW: $0.5 t X 2% = $10b/ year<0.1% of GDP => de min
US able to borrow in own currency? Yes but others do too.
US Treasury borrows cheaply because of demand of official reserve managers? Through portfolio balance effect, effect broadly shared.
Better returns on US international assets than on US international liabilities? Yes but reflects dynamics of US mergers and acquisitions market, not the international role of the US dollar.
US firms earn “denomination rents”? Actually US-headquartered banks hold only16% of international dollar claims.

16. US earns more on its assets than its liabilities, but this reflects more the US M&A market than the dollar
In 1960s, US had asymmetry opposite to China’s today, long equity and short safe liabilities.
Today the equity assets and liabilities of US are close to balance.
“the existing differential favoring the U.S. has owed primarily to one factor, a differential in direct investment yields” (Curcuru, Thomas and Warnock, 2013).
Why do foreign direct investors in the United States harvest such poor returns? Gros (2006): it is unlikely that investors from all over the world would continue to pour hundreds of billions of dollars into foreign direct investment (FDI) in the US if they were really being constantly taken to the cleaners…The official data imply that foreigners instantly start losing… when they invest more than 10% into a US company.

17. Foreign companies are taken to the cleaners in US M&A
Long-standing finding is that rate of return directly related to age of direct investment stock (Mataloni (2000)).
Most entry by acquisition, which has tended to keep age of direct investment in the United States low.
Why are foreign investors taken to the cleaners?
Weak companies are sold to foreigners—low margins on sales (adverse selection; Laster and McCauley (1992)).
Prices are bid up—high price to earnings ratios (winner’s curse).
High rates of attrition in the form of sale back to US firms or investors (“Ransom of Red Chief”—O’Henry).

18. Exorbitant privilege: manifold meanings, none convincing
Exorbitant privilege: manifold meanings, none convincing
Original sense: US need not settle, now no one does “If I had an agreement with my tailor that whatever money I pay him he returns to me the very same day as a loan, I would have no objection at all to ordering more suits from him” (Rueff, 1978).
Cash held by ROW: $0.5 t X 2% = $10b/ year<0.1% of GDP => de min
US able to borrow in own currency? Yes but others do too.
US Treasury borrows cheaply because of demand of official reserve managers? Through portfolio balance effect, effect broadly shared.
Better returns on US international assets than on US international liabilities? Yes but reflects dynamics of US mergers and acquisitions market, not the international role of the US dollar.
US firms earn “denomination rents”? Actually US-headquartered banks hold only16% of international dollar claims.

19. A pot of gold for Chinese banks at the end of the RMB internationalisation rainbow?
Much discussion in China presumes that the international role of the dollar provides economic rents to the US economy.
Consistent with this presumption, Chinese scholars have produced estimates of the “seigniorage” gains to China from renminbi internationalisation (Hai and Yao (2010)).
One aspect of this presumption is that Chinese banks stand to gain from wider international use of the renminbi (though not in Ba et al (2010)).
This motivates the question: how much do US financial firms benefit from the international use of the dollar as means of exchange, unit of account and store of value?

20. Alexandre Swoboda’s “denomination rents”
Early on in 1968, a Jim Tobin student proposed in "The euro-dollar market: an interpretation“, Princeton Essays in Inter-national Finance no 64 (the Geneva Reports then?), that financial firms HQed in the key currency country profit from “denomination rents”.
“the average level of profits of the banking system of an issuing country will tend, other things equal, to be higher [due to the extension of the market] than that of the banking systems of other countries”.
Swoboda, however, sees the eurodollar market as a “means of distributing a part of the denomination rents…to the residents of other countries. That is, European [Japanese, Chinese…] banks, by issuing dollar liabilities, can bid away part of the gains from dollar denomination that previously accrued exclusively to American banks” [emphasis added].

21. Political scientists half-read Swoboda
Helleiner (2014, p 76): …”powerful private financial firms on Wall Street gained ‘denomination rents’ from the dollar’s international role, which put them in the center of the selling of dollar securities to foreign investors as well as other global financial flows”
Cohen (2012): “Since home banks enjoy privileged access to the resources of the issuing country’s central bank, enabling them to more easily create monetary liabilities denominated in the national currency, a distinct competitive advantage is gained relative to banks elsewhere. Business can be expanded abroad at lower cost, generating greater earnings than would otherwise have been possible…Includ[ing] … commissions charged for an increased volume of foreign-exchange transactions as well fees for loans, investment services, or other ancillary activities”.
Frieden (2003, p 326): “widespread use of a currency increase demand for financial services from firms whose home base is the country of issue, given the deeper financial markets and greater security of the home market”.
Broz (1997, p 76): “the country issuing an international currency derives rents vis-à-vis other nations because its banking sector enjoys a monopoly over the issue of monetary liabilities denominated in the vehicle currency”.

22. Economists (used to) read Swoboda
Makin (1976, p 23) took up Swoboda’s competition theme:
“international traders in goods, … found the large and resilient capital markets of the United States an attractive source of short-term assets”.
“These developments [provided]… ‘denomination rents’ in the form of a larger spread between borrowing and lending rates to US financial institutions dealing in dollar instruments”.
“In the absence of barriers to entry, such monopoly profits attracted competitors in the form of financial intermediaries outside the United States which offered deposit and loan facilities denominated in dollars”.
Eichengreen (2011) does not mention denomination rents or Swoboda.

23. Swoboda and Makin are right; political scientists wrong
Do US banks enjoy a monopoly in the production of US dollar deposits (or loans)?
Not in the eurodollar market!
Though the global financial crisis, with its demonstration of the usefulness of access to the Fed, has made US banks (again?) number 1 for official dollar depositors.
Do US firms occupy the “center” in the issuance of dollar debt securities?

24. US banks have a small share in eurodollar market
US headquartered banks have 20% of international dollar liabilities of BIS-reporting banks and 14% of all international liabilities.
Where we can measure best, in the $1.4 trillion market for local dollar deposits by non-banks outside the United States, the US bank share of liabilities is just 10%, below that of UK and Japanese banks.
The dollar share of overall liabilities is 48%.
Thus, the dollar has a higher share in international banking than US banks (including Goldman Sachs and Morgan Stanley).
But global financial crisis has made US banks the most preferred place for official reserve managers to deposit dollars.
Cohen’s “privileged access to the resources of the issuing country’s central bank”?

25. International dollar liabilities by nationality of bank March 2014
Source: BIS Quarterly Review, September 2014, Table A2.

26. US dollar deposits by official reserve managers by bank nationality Amounts outstanding in billions of US dollars
US dollar-denominated liabilities outstanding to official monetary authorities1
Amounts outstanding; in billions of US dollars
Graph 3
By bank nationality
1 International liabilities comprising USD denominated liabilities to foreign OMAs and USD denominated foreign currency liabilities to resident OMAs by banks in the BIS locational reporting countries. There are reporting gaps.
Source: BIS locational banking by nationality statistics
Source: BIS.

27. In international securities market, how much of an edge does the dollar give US banks?
Autostrade, the first dollar bond issued in London
For $15 million, was issued with a guarantee by the state holding company IRI.
Listed on London and Luxembourg stock exchanges
Arranged by S G Warburg, a London merchant bank.
Other underwriters: Banque de Bruxelles, Deutsche Bank, Rotterdamsche Bank
No denomination rents from day 1!

29. Book-runners and currency: international bonds issued by nationals neither of US nor of euro area, (July) In billions of US dollars
$6.6 trillion of gross issuance in $ or euro by those outside US and euro area, 72% dollar
US banks run the books in about 60% of deals.
US book-runners do about $0.5 trillion more book-running in the dollar than would expect—8% of the total.
A fairly subtle advantage.
Book-runner:
Currency US
Euro area
Total
Dollar
3,838
989
4,827
Euro
740
1,069
1,809
4,578
2,058
6,636
Source: BIS.
Chi-squared test statistic of 915 permits rejection of
the null hypothesis of no relationship between currency
of issue and nationality of book-runner at level.

30. Conclusion: the promise of RMB internationalisation
Idea that the dollar’s role confers an exorbitant privilege to the US economy may not be well founded.
It is easy to overstate the benefit of cheaper government debt to the reserve currency issuer given portfolio balance effects in global bond market.
US return advantage on international assets has more to do with US M&A market than with the dollar’s role.
US dollar’s market share in international banking much higher than that of US banks, suggesting that US banks and US shareholders do not earn much “denomination rents”.

31. References
Ba, S, B Wu, P Yuan, M Wang and Z Yiu (2010): “Effects of RMB internationalization on China’s finance industry”, in C Shu and W Peng, eds, Currency internationalization: international experiences and implications for the renminbi, Palgrave Macmillan, Basingstoke.
Bauer, M, and C Neely (2013): “International channels of the Fed’s unconventional policy”, mimeo, 6 February.
Broz, J L (1997): The international origins of the Federal Reserve System, Ithaca: Cornell University Press.
Cohen, B (2012): “The benefits and costs of an international currency”, Open Economies Review, vol 23, pp 13–31.
Curcuru, S. E., C P Thomas and F Warnock (2013): “On return differentials”, Journal of International Money and Finance, vol 36, pp 1-25.
Dobbs, R, D Skilling, W Hu, S Lund, J Manyika, C Roxburgh (2009): An exorbitant privilege? Implications of reserve currencies for competitiveness, McKinsey Global Institute.
Eichengreen, B (2011): Exorbitant privilege, Oxford University Press.
Frieden, J (2003): “The political economy of dollarization”, in E Levy Yeyati and F Sturzenegger, eds Dollarization, pp
Genberg, H, R N McCauley, Y-C Park and A Persaud (2005): Official reserves and currency management in Asia: myth, reality and the future, Geneva reports on the world economy, number 7, Geneva & London: International Center for Monetary and Banking Studies and Centre for Economic Policy Research.
Gerlach-Kirsten, P, R McCauley and K Ueda (2012): “Currency intervention and the global portfolio balance effect: Japanese lessons”, BIS Working Paper no 389, October.
Hai, W and H Yao (2010): “Pros and cons of international use of the RMB for China, in Shu and Peng, op cit, pp
Helleiner, E (2014): The status quo crisis: global financial governance after the 2008 meltdown, Oxford U Press.
Laster, D and R McCauley (1994): “Making sense of the profits of foreign firms in the United States”, Federal Reserve Bank of New York Quarterly Review, vol 19, no 2, summer-autumn, pp
Ma, G and R McCauley (2013): “Global and euro imbalances: China and Germany”, BIS Working paper no 424, September, also in China & World Economy, Vol 22, Issue 1, January-February 2014, pp 1–29.

32. References (cont)
Makin, J (1976): “Eurocurrencies and the evolution of the international monetary system”, in C Stern, M Makkin and D Logue, eds, Eurocurrencies and the evolution of the international monetary system, American Enterprise Institute.
Mataloni, R J Jr (2000). “An examination of the low rates of return of foreign-owned U.S. companies”, Survey of Current Business, March 2000, pp
Neely, Christopher J. (2010): “The Large-Scale Asset Purchases had large international effects”, Federal Reserve Bank of St. Louis Reserve Working Paper, 018B.
Rogers, J, C Scotti, and J H Wright (2014): “Evaluating asset-market effects of unconventional monetary policy: A cross-country comparison”, mimeo.
Rueff, J (1972): The monetary sin of the West, translation of Le Péché monétaire de l’Occident by Jean Clement. New York: Macmillan.
Swoboda, A K (1968): The euro-dollar market: an interpretation, Essays in International Finance no 64, Princeton.
Warnock, F, and V Warnock (2009): “International capital flows and US interest rates”, Journal of International Money and Finance, vol 28, pp

33. Annex: US banks and the foreign exchange market
US dollar on one side of 87% of all trades in April 2013
Euromoney poll results: US banks sum to 32%:
Bank
share
Citibank
16.04%
Morgan Stanley
2.28%
Deutsche Bank
15.67%
Credit Suisse
2.07%
Barclays
10.91%
Société Générale
1.83%
UBS
10.88%
Stand. Charter’d
1.38%
HSBC
7.12%
Nomura
1.16%
JPMorgan
5.55%
State Street
1.14%
Bank of America ML
4.38%
Westpac
0.96%
RBS
3.25%
Commerzbank
0.90%
BNP Paribas
3.10%
RBC
0.72%
Goldman Sachs
2.53%
ANZ
0.61%