Economic Report President

connection between the currency in which banking is conducted andthe nationality of the banks conducting it (or between the nationalitiesof savers and borrowers and the nationality of the intermediatingbank). British banks, for example, continued to do well in the Eurodollarmarket long after the pound’s international role had waned. Nevertheless,it stands to reason that U.S. banks have comparative advantagein dealing in dollars.Having an international currency may confer power and prestige,but the benefits therefrom are somewhat nebulous. Nevertheless, historiansand political scientists have sometimes regarded key currencystatus and international creditor status, along with such noneconomicfactors as colonies and military power, as among the trappings of agreat power.Some view seigniorage as perhaps the most important advantage ofhaving other countries hold one’s currency. Seigniorage derives fromthe fact that the United States effectively gets a zero-interest loanwhen dollar bills are held abroad. Just as a travelers’ check issuerreaps profits whenever people hold its travelers’ checks, which they arewilling to do without receiving interest, so the United States profitswhenever people in other countries hold dollars that do not pay theminterest. International seigniorage is possible wherever hyperinflationor social disorder undermine the public’s faith in the local currency,leading them to prefer to hold a sound foreign currency instead. Andtoday the dollar is the preferred alternative. (Illegal activities areanother source of demand for cash, of course.)How much does the United States gain from seigniorage? One wayto compute cumulative seigniorage is to estimate the stock of dollarsheld abroad and calculate the interest that would otherwise have to bepaid on this “loan” to the United States. Foreign holdings of U.S. currencyare conservatively estimated at 60 percent of the total in circulation.With total currency outstanding in mid-1998 at $441 billion,foreign holdings are about $265 billion. Multiplying this figure by theinterest rate on Treasury bills yields an estimate for seigniorage ofabout $13 billion a year.A final advantage is the ability to borrow in international capitalmarkets in one’s own currency. Some have argued that the UnitedStates’ financing of its current account deficit through foreign borrowinghas been facilitated by the ability to issue dollar-denominated liabilities,and the concern has been expressed that this ability may behampered by a loss of reserve currency status. This concern is probablyoverdone, however. First, many industrial countries whose currency isnot a key currency are able to borrow in domestic currency. Second,countries with larger current account deficits than the United States(as a share of their GDP) have regularly and persistently financed suchimbalances with borrowing in foreign currency rather than their own.Countries become unable to borrow to finance current account imbal-302