Gopinath on dollar dominance in international trade

In Chapter 2 of the Hoover Institution's Currencies, Capital, and Central Bank Balances, edited by John Cochrane, Kyle Palermo, and John Taylor, IMF Chief Economist Gita Gopinath "shows how private international financial intermediaries tend to focus on certain currencies, with the US dollar currently the dominant currency of choice. The dollar is often used for invoicing even when trade is between two non-US entities." A couple things that stuck out to me from her chapter, Dollar Dominance in Trade and Finance, are below.

Dollar dominance in trade, finance, and central bank reserves

1. Trade

The Mundell-Fleming economic paradigm states that the importance of a country's currency in international trade is tied closely to its share in world trade. This does not actually happen because the assumption that countries export goods in their own currencies is faulty. The dollar's share as an invoicing currency is 4.7 times its share in world imports and 3.1 times its share in world exports.

Even Japan and the UK invoice only 40 and 51 percent of exports in their own currencies. US invoices 93 percent of imports and 97 percent of exports in dollars.

2. Asset markets

Dollar liabilities of non-US banks are ~$10 trillion, roughly the same magnitude as dollar liabilities of US banks.

The vast majority of syndicated cross-border loans are made in dollars -- from a low of 61% in developed countries to 97% in Emerging Americas. Euro is second with 24% and 20% in Developed Countries and Emerging Europe.

Data source: BIS locational banking statistics

3. Central bank reserves

$10 trillion in official central bank reserves (2017Q4) -- dollar share is 63 percent, followed by euro at 20 percent.

[Update for 2019Q4: $6.7 trillion of dollar reserves out of $11.8 trillion total ($11.1 trillion allocated)]

Central banks keep dollars not just for trade but also so they can be the lender of last resort to their banking system.

Data source: IMF COFER (Currency composition of Official Foreign Exchange Reserves)

What makes a currency dominant?

In short, history and network effects.

1. History: How does a currency become dominant?

First, the historical evidence described by Eichengreen (2010). How to make a dominant currency

1. Encourage its use in invoicing and settling trade;
2. Encourage its use in private financial transactions;
3. Encourage its use by central banks and governments as a form in which to hold private reserves.

This process will lead to a high demand for the currency, which will decrease the interest rates (raise the price) on safe assets in that currency.

Once you get to preferred currency status, a feedback mechanism can keep it in place: "Why do exporters invoice in dollars? Because it is cheaper to finance in dollars. Why is it cheaper to finance in dollars? Because exporters invoice in dollars."

2. Network effects: How does a currency remain dominant?

Comments made in the discussion were insightful on this point:

Adrien Auclert: "In principle, going forward, we might see the equilibrium switch again, with the euro or the renminbi becoming the new dominant currency. But what this static model misses is that existing assets and liabilities have long maturities. So in a sense, the anchor of history is likely extremely strong--it would take a really long time for all assets and liabilities to be redenominated in any new currency, and the staggered nature of contracts makes such a coordination very large to imagine."

Robert Heller: "in Silicon Valley, we talk all day long about network effects. Isn't the dollar's dominance similar to network effects? The dollar almost took over the world, and it's very difficult for a second competitor to come up and to compete with the currency once it's dominant, just simply because of network effects."

There is interaction and reinforcement between low interest rates, dollar trade invoicing, dollar liabilities in global supply chains. So we have coordination difficulties, network effects, and lock-in by historical events. Dollar dominance seems established for the foreseeable future, but beware information cascades.

Kalecki 1943: Political Aspects of Full Employment

In Joan Robinson's 1971 Richard T. Ely lecture to the American Economic Association, she said that "Keynes himself was not very much interested in the theory of value and distribution. Michal Kalecki produced a more coherent version of the General Theory, which brought imperfect competition into the analysis and emphasized the influence of investment on the share of profits. Kalecki's version was in some ways more truly a general theory than Keynes'."

Here are some notes from Kalecki's 1943 paper "Political Aspects of Full Employment" -- a statement of the economic doctrine of full employment. In this paper Kalecki covers employment policy, interest rates, and inflation. He also provides reasons for why "industrial leaders" might be opposed to full employment.

Before my notes (primarily quotes from Kalecki's paper) I should also add that David Andolfatto summarized this paper in a Feb 2020 blog post http://andolfatto.blogspot.com/2020/02/kalecki-on-political-aspects-of-full.html. I like his summary: "The paper starts by taking as given what Kalecki calls the doctrine of full employment. The basic idea is that the private sector, left to its own devices, is prone to Keynesian aggregate demand failures (see here for game-theoretic interpretation). The remedy for these spontaneously-occurring "coordination failures" is a government spending program that acts, or stands ready to act, as private demand begins to falter."

Employment policy

"A solid majority of economists is now of the opinion that, even in a capitalist system, full employment may be secured by a Government spending programme, provided there is in existence adequate plant to employ all existing labour power, and provided adequate supplies of necessary foreign raw materials may be obtained in exchange for exports.

"If the Government undertakes public investment (e.g. builds schools, hospitals, and highways) or subsidises mass consumption (by family allowances, reduction of indirect taxation, or subsidies to keep down the prices of necessities), if, moreover, this expenditure is financed by borrowing and not by taxation (which could affect adversely private investment and consumption), the effective demand for goods and services may be increased up to a point where full employment is achieved."

Interest rates

Where will people get the money to lend to the government without decreasing investment and consumption?

"imagine for a moment that the Government pays its suppliers in Government securities. The suppliers will, in general, not retain these securities but put them into circulation while buying other goods and services, and so on until finally these securities will reach persons or firms which retain them as interest-yielding assets ... In reality the Government pays for the services not in securities but in cash, but it simultaneously issues securities and so drains the cash off; and this is equivalent to the imaginary process described above.

What happens if people don't want to buy all the Government securities?

"It will offer them finally to banks to get cash (notes or deposits) in exchange. If the banks accept these offers, the rate of interest will be maintained. If not, the prices of securities will fall, which means a rise in the rate of interest, and this will encourage the public to hold more securities in relation to deposits. It follows that the rate of interest depends on banking policy, in particular on that of the Central Bank. If this policy aims at maintaining the rate of interest at a certain level that may be easily achieved, however large the amount of Government borrowing. Such was and is the position in the present war. In spite of astronomical budget deficits, the rate of interest has shown no rise since the beginning of 1940."

Inflation

In response to questions about whether Government expenditure financed by borrowing will cause inflation, Kalecki explains the role of resource constraints similar to the way that MMT economists explain them:

"the effective demand created by the Government acts like any other increase in demand. If labour, plant and foreign raw materials are in ample supply, the increase in demand is met by an increase in production. But if the point of full employment of resources is reached and effective demand continues to increase, prices will rise so as to equilibrate the demand for and the supply of goods and services ... if the Government intervention aims at achieving full employment but stops short of increasing effective demand over the full employment mark, there is no need to be afraid of inflation."

Opposition

Kalecki provides three categories of reasons for the opposition of the "industrial leaders" to full employment achieved by Government spending:

1. Dislike of Government interference in the problem of employment as such;
2. Dislike of the direction of Government spending (public investment and subsidising consumption); and
3. Dislike of the social and political changes resulting from the maintenance of full employment.

For 1, Kalecki writes "Every widening of State activity is looked upon by "business" with suspicion, but the creation of employment by Government spending has a special aspect which makes the opposition particularly intense. Under a laisser-faire system the level of employment depends to a great extent on the so-called state of confidence. If this deteriorates, private investment declines, which results in a fall of output and employment (both directly and through the secondary effect of the fall in incomes upon consumption and investment). This gives to the capitalists a powerful indirect control over Government policy: everything which may shake the state of confidence must be carefully avoided because it would cause an economic crisis. But once the Government learns the trick of increasing employment by its own purchases, this powerful controlling device loses its effectiveness. Hence budget deficits necessary to carry out Government intervention must be regarded as perilous. The social function of the doctrine of "sound finance" is to make the level of employment dependent on the "state of confidence."

2 - "The fundamentals of capitalist ethics require that "You shall earn your bread in sweat"--unless you happen to have private means."

3 - "Indeed, under a regime of permanent full employment, "the sack" would cease to play its role as a disciplinary measure. The social position of the boss would be undermined and the self assurance and class consciousness of the working class would grow." Ultimately, Kalecki argues that business leaders care more about "discipline in the factories" and "political stability" than profits.

Overall Andolfatto is pretty skeptical of these points. I'm not sure where I land on this, but I'd add that today most students (future industrial leaders) are trained by economists who were trained by economists who took a lot of this as given. We have the issues of network effects, lock-in, and coordination failure locking in a generation of academics who might not be as aware of what they are doing as previous ones. But that's a broad claim and I'm not sure.

Other notes

"The fascist system starts from the overcoming of unemployment, develops into an "armament economy" of scarcity, and ends inevitably in war."

Reducing interest rates or taxes to stimulate private investment in a downturn does not guarantee full employment, even in a resulting boom.

"The rate of interest or income tax is reduced in a slump but not increased in the subsequent boom ... In the new slump it will be necessary to reduce the rate of interest or income tax again and so on. Thus in not too remote a time the rate of interest would have to be negative and income tax would have to be replaced by an income subsidy."