The exorbitant burden the impact of the u s dollars reserve and global currency status on the u s twin deficits

The Exorbitant Burden The Impact of the U.S Dollar’s Reserve and Global Currency Status on the U.S Twin-Deficits This page intentionally left blank The Exorbitant Burden The Impact of the U.S Dollar’s Reserve and Global Currency Status on the U.S Twin-Deficits By Dr Taranza T Ganziro Independent Scholar, Centreville, VA, USA Dr Robert G Vambery Pace University, New York, NY, USA United Kingdom À North America À Japan India À Malaysia À China Emerald Group Publishing Limited Howard House, Wagon Lane, Bingley BD16 1WA, UK First edition 2016 Copyright r 2016 Emerald Group Publishing Limited Reprints and permissions service Contact: permissions@emeraldinsight.com No part of this book may be reproduced, stored in a retrieval system, transmitted in any form or by any means electronic, mechanical, photocopying, recording or otherwise without either the prior written permission of the publisher or a licence permitting restricted copying issued in the UK by The Copyright Licensing Agency and in the USA by The Copyright Clearance Center Any opinions expressed in the chapters are those of the authors Whilst Emerald makes every effort to ensure the quality and accuracy of its content, Emerald makes no representation implied or otherwise, as to the chapters’ suitability and application and disclaims any warranties, express or implied, to their use British Library Cataloguing in Publication Data A catalogue record for this book is available from the British Library ISBN: 978-1-78560-641-0 ISOQAR certified Management System, awarded to Emerald for adherence to Environmental standard ISO 14001:2004 Certificate Number 1985 ISO 14001 Contents Summary ix List of Equations xvii List of Boxes xix List of Charts xxi List of Graphs xxiii List of Figures xxv List of Tables xxvii List of Appendices xxix CHAPTER Introduction CHAPTER Literature Review 2.1 Theory of Reserve Currency 2.1.1 Principle 2.1.2 Functions of the Leading Reserve Currency 2.1.2.1 Store of value 2.1.2.2 Medium of exchange 2.1.2.3 Unit of account 2.1.3 Reserves Currency Accumulation Motives 2.1.3.1 Mercantilist rule 2.1.3.2 Self-insurance precautionary rule 2.1.3.3 Collateral rule 2.1.4 Cost of Excessive Reserves Holdings 2.1.5 International Reserve Currency Status Criteria 2.1.5.1 Economic and geopolitical weight 2.1.5.2 Macroeconomic stability 2.1.5.3 Trade openness 2.1.5.4 Financial depth dynamics 2.1.5.5 Winning the inertial duel 2.1.6 The Implications of Achieving Reserve Currency Status 9 11 12 15 15 16 17 18 19 20 23 23 23 23 24 25 27 v vi CONTENTS 2.1.7 2.2 2.3 Empirical Evidence of the U.S Dollar Reserve Currency Status 31 2.1.7.1 The U.S dollar is the global leading anchor currency 31 2.1.7.2 The U.S dollar is the major form of cash currency worldwide 32 2.1.7.3 The U.S dollar is a transaction À Centric to global forex markets 33 2.1.7.4 The U.S dollar is the currency of choice in the international trade invoicing and settlement 36 2.1.7.5 The U.S dollar is a prominent currency in international debt market 36 2.1.7.6 The U.S dollar is a key currency in banking cross-border lending and investment portfolio 37 2.1.7.7 The U.S dollar dominates foreign reserves holdings 37 Reserve Currency Historical Background 39 2.2.1 Overview 39 2.2.2 Gold Standard: 1819À1914 41 2.2.3 The British Pound Standard: 1914À1945 43 2.2.4 Bretton Woods System 1946À1973 44 2.2.4.1 Overview 44 2.2.4.2 The dollar-gold exchange standard 46 2.2.4.3 The Bretton Woods system dilemma 49 2.2.4.4 Nixon shock 51 2.2.5 Fiduciary Dollar Standard (1973ÀPresent) 53 US Dollar Global Liquidity 55 2.3.1 Overview 55 2.3.2 Private Dollar Global Liquidity 56 2.3.2.1 Eurodollar liquidity 57 2.3.2.2 Dollar-derivatives global liquidity 61 2.3.2.3 The Repo markets and the dollar-liquidity 75 2.3.3 Official Dollar-Global Liquidity 79 2.3.3.1 The Fed and the dollar global liquidity 79 2.3.3.2 The anatomy of banking bailout 82 2.3.4 The Interaction between Private and Official Liquidity 91 CHAPTER Theoretical Framework 93 3.1 3.2 93 94 94 Overview Great Powers Have Great Currencies 3.2.1 Leading Country Theoretical Outline Contents 3.2.2 3.3 3.4 3.5 3.6 3.7 3.8 United States’ Geopolitical Leadership 3.2.2.1 Military power 3.2.2.2 Economic power 3.2.2.3 Political power 3.2.2.4 Global cultural influence 3.2.2.5 Summarizing The Paradox of the U.S Dollar 3.3.1 Overview 3.3.2 Dual Global and Domestic Role Paradox 3.3.3 Paradox of Strong Dollar Policy 3.3.4 Triffin Paradox 3.3.5 Trilemma Hypotheses 3.3.5.1 Mundell-Flemming trilemma 3.3.5.2 Rodrik political trilemma US Dollar and Global Imbalances 3.4.1 Supply-Side School 3.4.2 Demand-Side School 3.4.3 Rebalancing Act Exorbitant Privilege 3.5.1 Overview 3.5.2 Exorbitant Privilege Benefits to United States 3.5.2.1 Convenience for U.S citizens 3.5.2.2 Convenience for the U.S government 3.5.2.3 Seigniorage 3.5.3 Exorbitant Benefits to the Rest of the World 3.5.4 Exorbitant Privilege under Scrutiny Exorbitant Burden 3.6.1 Competitiveness Burden 3.6.2 Exorbitant Reserve Currency Curse 3.6.3 Political Burden 3.6.4 Monetary Policy Burden 3.6.5 Capital Flow Burden 3.6.6 Reserve Currency Status Maintenance Burden 3.6.7 The Twin Deficit Burden 3.6.7.1 Overview 3.6.7.2 Twin deficit identity 3.6.8 Debt Burden Currency Wars Is There a Viable Alternative to the US Dollar as the World Leading Reserve Currency? 3.8.1 Overview 3.8.2 Viable Alternatives 3.8.2.1 Special drawing rights (SDR) 3.8.2.2 EURO 3.8.2.3 Chinese Renminbi (RMB) 96 99 103 110 111 113 121 121 121 125 125 127 127 131 134 135 136 139 142 142 143 143 144 145 147 147 149 149 151 152 152 152 153 154 154 154 160 162 165 165 165 166 169 176 vii viii CONTENTS 3.8.3 3.8.4 3.8.5 3.8.6 Is There Any Other Currency Alternative? Multipolar Reserve Currency System Is the U.S Dollar Trapped into the Global System? Way Forward 188 188 191 192 CHAPTER Methodology 195 4.1 195 195 196 196 198 203 204 204 204 204 204 206 207 4.2 Model Specification 4.1.1 Overview 4.1.2 Variables Specification 4.1.2.1 Dependent variable specification 4.1.2.2 Independent variables specification 4.1.3 Model-Equation Specification 4.1.4 Data 4.1.4.1 Data source 4.1.4.2 Data description Quantitative Analysis 4.2.1 OLS Regression 4.2.2 Stationarity Tests 4.2.3 Cointegration Tests 4.2.3.1 Johansen maximum likelihood tests 4.2.3.2 Johansen ML results and analysis 4.2.4 Vector Error Correction Model 4.2.4.1 VECM regression 4.2.4.2 VECM diagnostic tests 4.2.5 Results Analysis 208 208 209 210 212 219 CHAPTER Conclusion 223 Appendices 229 References 233 Index 247 Summary I t is neither simple, nor inexpensive to be the home of a leading reserve and global currency at the epicenter of the world economic system The US dollar is the living history of this paradox and its dual role À as both a national and a global reserve currency À has set off a plethora of competitive analyses and debates in demonstrating that a global monetary system that is dollar-centric is inherently unstable because the dollar is first and foremost a domestic currency subjected to the monetary and fiscal policies and national interests of the United States It has been often opined that the US policies À even if they are domestically sound À are not necessary concomitant with the global interests of the rest of the world which however remains inextricably under their influence This is because À given the dominant status of the US dollar as an international reserve asset and global currency À the US policies naturally reverberate globally through the dominance of the US dollar over the global economy and inevitably generates significant externalities for the rest of the world; thus making the dollar-dominated global financial system vulnerable to US domestic monetary and fiscal policies Dismayed by the vulnerability of global financial system to US policy through the US dollar dominance, the World Bank (2011) went on to argue that the Multipolarity in the world in terms of security and economic relations should be matched by a Multipolar Reserve Currency System simply because the transformation of global patterns of economic growth necessarily drive change in the international monetary system To comply with such Multipolarity, the SDR (Special Drawing Rights) became in the view of many analysts, the natural alternative reserve currency because À being a basket of currencies À it is assumed that it can stabilize the global financial system preached by the World Bank and be able to impartially enforce discipline on both the deficit countries and surplus countries that respectively issue and relentlessly accumulate reserve currency-denominated assets that entertain the global financial imbalances Reference is often made to the historical rise and fall of British Pound À the last monarch on the international reserve currency throne À as a useful lesson of experimental decadence that the ix .. .The Exorbitant Burden The Impact of the U. S Dollar s Reserve and Global Currency Status on the U. S Twin- Deficits This page intentionally left blank The Exorbitant Burden The Impact of the U. S. .. to be the first attempt at an assessment of the costs and benefits of reserve currency status This study is part of the pioneering endeavor to decipher the burden on the back of the US economy... become the Global System Maker and Privilege Taker (Mastanduno, 2009); thus sucking savings from the Rest of the World and squandering them into reckless consumptions just because of the dollar global