The Globalization of the U.S. Dollar
The widespread use of U.S. dollars abroad is good for everybody.
By February 1, 1999
For years, consumers have been told to prepare for a cashless society in which smart cards, internet commerce, and other financial innovations have made cash obsolete. But the death of cash is highly exaggerated. The total amount of U.S. currency held by the public equals approximately $400 billion, or more than $1,600 for every man, woman, and child in the country. Adjusting for inflation, real per capita holdings of U.S. currency have risen 70 percent since 1960. The proportion of the basic money supply-cash and checking account deposits-composed of cash rose from 20 percent to 30 percent.
Taken at face value, the numbers don't make sense. If Americans held all that cash, the typical family of four would have more than $6,000 stashed away someplace. In fact, U.S. residents admit to holding just 12 percent of all currency outstanding when surveyed. Businesses also hold cash, but no more than 8 percent of the total. That leaves 80 percent of all U.S. currency, or more than $300 billion, unaccounted for. Even if you add in the enormous sums of cash used by drug dealers and the rest of the underground economy, it is very difficult to account for that gap (see sidebar).
So where is the money hiding?
A growing portion of U.S. dollars is held by foreigners who fear that their own currencies will soon be worthless. Most Russians, for example, prefer dollars over rubles. Some forty billion U.S. dollars are now held there. Countries such as Panama and Liberia have periodically used U.S. dollars as their currency. "Dollar bloc" countries from Hong Kong to the small island states of the Caribbean keep enough dollars on hand to maintain a fixed rate of exchange between their currency and the U.S. dollar. Among the results: Hong Kong has avoided the worst of the Asian contagion, and U.S. citizens can island-hop without fear of a sudden drop in their dollars' value.
The dollar now plays the role once assumed by Dutch guilders and Spanish pieces of eight: a reliable store of value that is prized far outside its home country.
As much as 70 percent of all U.S. currency is held by foreigners, and the share of dollars held outside the United States is rising rapidly (see fig. 1). When dollars held abroad are excluded, the U.S. actually ranks fairly low in currency use. Only residents of the U.K. hold less cash than we do (see fig. 2).
The total amount of currency in circulation is one of the most precisely measured quantities in economics. Governments record every coin minted and every dollar printed. When it comes to the location of currency, however, our knowledge is quite limited. For the same reason that the U.S. dollar is so popular, the flow of dollars abroad is difficult to measure precisely: cash is easily concealed and readily carried across borders. A briefcase, for instance, can hold $1 million in one-hundred-dollar bills. Whereas most ones, fives, tens, and twenties circulate within the U.S., the vast bulk of one-hundred-dollar bills are overseas. A 1995 survey of U.S. households could account for just 3 percent of all such bills in circulation. Foreigners hold at least thirty times more one-hundred-dollar bills than do U.S. residents.
People also wire cash abroad, and individual shipments of up to $10,000 do not have to be reported to the Customs Department. Customs does keep records on shipments above that amount, however, and these provide some information on currency flows abroad.
The data show that between 1988 and 1991, U.S. currency flowed first to Latin America (especially to Argentina, which suffered chronically high inflation during this period), and then to the rest of the world in response to the uncertainties created by the Persian Gulf War. Since the early 1990s, Europe has become the dominant destination for U.S. currency. Russia alone accounts for more than half of all total net foreign shipments of U.S. currency. Although dollar outflows tend to slow when economic and political conditions stabilize, the dollars remain in place well after the crisis has subsided.
Advantages of Global Dollar
How does a globalized dollar matter? There are four advantages to a country's having its currency used as the lingua franca of world commerce. It is certainly more convenient for our exporters, importers, and banks to be able to transact business in dollars rather than foreign currencies. The global use of the dollar, like the global use of the English language, is a natural advantage that American businessmen take for granted.
The widespread use of the dollar also creates more business for U.S. banks and financial institutions. There need be no firm connection between the nationality of a bank and the type of currency its business is conducted in, of course, but it stands to reason that U.S. banks have an advantage in dealing with dollars. Only U.S. banks have access to a virtually limitless supply of dollars through the Federal Reserve System. Unlike banks in economically struggling countries, our banks place no controls on the outflow of dollars.
Another advantage is something called seigniorage. This is perhaps the most important economic advantage of having citizens of other countries hold dollars. Foreign holders of dollars must give up the things dollars can buy-goods, services, travel in the U.S. and so on-to "pay" for the security they receive by holding our currency. Just as American Express profits when people hold its travelers checks, which they willingly do without being paid interest, so the United States profits whenever people in Argentina or Russia hold dollars. We can calculate the benefits directly. The amount of currency held abroad today is approximately $220 billion, and the Treasury bill rate is 4.5 percent; therefore, the amount of seignorage (and national economic benefit) from dollars held overseas is approximately $10 billion per year. Because dollars are, ultimately, an obligation of the U.S. government, many economists consider this amount a form of federal revenue. It is a growing source of such revenue for the U.S.
Finally a strong dollar creates political power and prestige. This advantage is hard to quantify, but the loss of key currency status has historically been linked to the loss of international credit worthiness, along with such noneconomic factors as the loss of colonies and military power.
Foreign dollar holdings help explain one of the big economic mysteries of the 1990s: Why is U.S. inflation declining at a time when the money supply is growing so rapidly? The money supply has grown faster than the economy for nearly two decades. That is a recipe for inflation, according to monetarist models of the economy. But cash held by foreigners does not chase U.S. goods or fund the bubble in the U.S. stock market. Therefore, cash held abroad does not affect our prices. The Fed can safely ignore those dollars when making monetary policy, according to some economists.
Those dollars could come back to the U.S. just as easily as they left, however, which would cause a severe bout of inflation. Some analysts think that the euro-the forthcoming unified currency of the European community-will cause just such a reversal. The European Union has recently decided to fight the dollar's encroachment into its national economies by printing five-hundred-euro notes. Worth approximately $500-five times larger than the largest U.S. note in circulation-these bills will naturally reduce the volume of paper needed for cash transactions. Professor Kenneth Rogoff of Princeton University believes that the decision to print five-hundred-euro notes is an explicit effort of the EU to compete for business in the underground cash economy.
Problems in the U.S. economy could likewise cause foreigners to repatriate their greenbacks. That happened in the 1970s, for instance, when inflation robbed the dollar of its value and caused foreigners to dump dollars. The Fed, however, has the tools to prevent that type of inflation. It can raise interest rates, for example, which would make dollar-denominated assets more attractive to foreigners. Higher interest rates, however, might cause a recession in the U.S. It would be foolish to raise rates now to forestall a price inflation that might never come.
So how do we keep those dollars abroad? We might try going back to the future, by printing $500 bills. The U.S. government discontinued those notes in 1946 and still withdraws from circulation any that come into its possession. Printing those bills again would blunt the impact of the forthcoming five-hundred-euro notes. Some analysts might criticize such a move as capitalizing on the drug trade, but as the sidebar shows, the underground economy holds only a very small percentage of U.S. currency outstanding.
Meanwhile, Back in the USA
U.S. consumers demand high-tech capability in their financial transactions. We expect easy access to ATMs, bank cards, home banking systems, internet banking, and automated touchtone phone systems. But we don't always use what's available. An executive at a regional ATM company was quoted as follows in Credit World: "In twenty-five years we have placed cards in the hands of only 60 percent of our customers, and 60 percent of them use the cards." That is, after a quarter-century of marketing ATMs, less than half of all consumers actually use them.
Consumer resistance is not the only barrier to innovation. Businessmen can be equally stubborn and tradition-bound. Just look at the early years of credit cards. The BankAmericard and MasterCharge card were introduced in the mid-1960s, but a Life magazine article in 1970 said, "Bank cards still encounter areas of resistance. Most big department stores refuse to honor them. . . . Restaurants in many places will have no part of them."
Credit card providers overcame business resistance by marketing directly to consumers. Consumers now charge everything from groceries to gasoline on credit cards, often obtaining free airline miles in the process. But credit cards are still shunned by people who desire anonymity or fear their overuse.
Smart cards have been hyped as a near-perfect substitute for cash. The premise of the cards, which have been pre-loaded with as much as $500, is that people find paying with coins and bills cumbersome, risky, and even unhygienic. If consumers could use plastic to make purchases just as quickly as with cash-without signing a slip or waiting for telephone approval-they would do so.
Or so the thinking goes. But the first major smart-card experiment in the United States failed miserably. This past summer, Chase Manhattan Bank, Citibank, Visa USA, and MasterCard International issued tens of thousands of free, zero-transaction-fee cards to residents in Manhattan's affluent, sophisticated Upper West Side, where they thought the cards would be most likely to succeed. Card readers were installed in every retail store in the neighborhood. Customers never took to the cards.
Why? Evidence strongly suggests that consumers seek out the personal touch when making purchases. In addition, some Upper West Side residents said that the cards were a better deal for the banks than for consumers. "It means they are floating my money without my earning interest," was a typical comment.
Of course, cash yields no interest, either.
Nonetheless, people still prefer cash. The data corroborate the anecdotal evidence. Although most U.S. currency is held abroad, U.S. residents are also holding increasing amounts of it. Per capita holdings were at a record $739 in 1998, or approximately $200 more than in 1988. In inflation-adjusted terms, cash holdings are on a plateau (see fig. 3).
For many Americans, cash is still king.
The media tend to highlight drug trafficking, organized crime, and other "off-the-books" activity as the major factor behind our "missing" cash. But the underground cash economy is not nearly large enough to account for the shortfall. Suppose, for example, that 10 percent of the $8,500 billion U.S. economy (or $850 billion) was generated in the cash economy-an unreasonably large fraction, by most estimates-and that all worldwide illegal drug transactions were done exclusively with U.S. dollars (an assumption that double-counts drug transactions included in the U.S. cash economy). We know that the average piece of paper currency turns over approximately fifty times per year. Thus the amount of currency required to support both U.S. domestic underground economy activity plus all drug trafficking worldwide (reported to be on the order of $300 billion) would be approximately $23 billion (1/50th of $1,150 billion worldwide), or just 6 percent of all U.S. currency outstanding.