Economics · Neoliberalism

“Exorbitant Privilege”, by Barry Eisengreen

Below are some brief notes on Eisengreen’s book Exorbitant Privilege: The Rise and Fall of the Dollar and the Future of the International Monetary System.  These notes basically explain how exorbitant privilege Works:

The idea of Exorbitant privilege begins with the fact that the world Reserve currency is the dollar. And also almost all international trading is done in dollars, not all but almost all. Not only oil is traded in dollars but almost everything. The fact that the world’s trading is done in dollars and that the world’s Reserve currency is in dollars gives big advantages to the United States.  Here is how it works. Say you are China and you have just sold a bunch of goods to America, and Americans of course paid for this in dollars. So you have a pile of dollars on your hands that you have to do something. You would like to get some kind of interest on your dollars. You really can’t turn these dollars into reminbis. Because as soon as you buy remimbis the price of the remimbis goes up and you totally screw the advantage that having a low currency gives your exports. So what do you do with all these dollars. The easiest thing to do is to invest them in American bonds or other American assets. Say you want to buy American Treasury Bonds which many Chinese did want to do.   You’re very anxious to buy American Savings Bonds because there’s nowhere else that you can put all these dollars you have that’s nearly as safe or stable as American dollars and so you buy American bonds and assets which are basically the equivalent of American dollars.  Since you’re buying a lot of bonds this pushes the price of bonds when up and the interest that you get goes way down. Basically the US Treasury doesn’t have to pay very much interest to get you to buy. You’re already going to buy. The opposite thing happens when America invest in foreign countries, the foreign banks and business men really want American dollars.  They want you to invest in their bonds. So to get you to invest in their bonds,  banks are willing to pay high interest rates. The result is that there’s a big difference between what America gets on its foreign investments and  the interest it has to pay to attract  foreign nations to invest in American bonds.   This is about a 3% difference, this is huge if you’re an investor. Actually the money we make from this difference in interest rates is enough to offset what America is losing in its trade deficit, and more.  

And this is just one way that America profits from its exorbitant privilege. Basically what happens is that America can print all the dollars its wants, and it pays off  foreign importers using these dollars.  And then the exporting countries turn right around and send all of those dollars right back to us.   (Basically they are returning our IOUs).  And we can always repay all of these loans to foreigners with more dollars that we just print.  We print up play money to pay for what we want and other nations have to get money the old fashioned way by actually making things, and then they have to turn this money into dollars to buy from us.  This argument is not held by everyone, since printing money can only go so far; too much money printing turns into serious inflation.  

And then if there is a recession and dollars lose value, America wins again.   All US foreign assets denoted in foreign currency turn into many more dollars when converted back to dollars.  And all debts in dollars can be paid off with devalued dollars.  

Basically what is going on is that poor foreign families are transferring money to rich American families in the form of savings.   Our trade balance is negative.  We buy more imports than we make on exports. And to pay for this difference we borrow money from foreign nations, all of those bonds and assets we sold to China, et al.  Or you can look at it in terms of savings.  Americans save very little and consume a lot.  Especially in the nineties there was an orgy of American consumerism.  There was not enough American savings to pay for the investments  needed to manufacture all this stuff so we imported the savings of foreign countries and used that, these were the dollars invested by China and the rest of the  East Asian export based economies.  And, of course, American consumers didn’t have the money to pay for what they bought, so, again, they were loaned  money from the huge pile of money  China etc loaned to us.  Basically the US injected all of that foreign money loaned to us into our economy and used it to create the sub-   housing bubble and other bubbles.  

This is kind of the idea of Exorbitant Privilege.  I’m not getting it quite right yet.  Ben Bernanke made a speech in 2005 on the Savings Glut that explains some of this a lot better.

The savings glut is basically the foreign currency reserve that many exporting countries around the world built up to be prepared for the next Asian Contagion that was the 1999 global recession.  This recession happened because a lot of third world exporting countries experienced a panic when foreign investors were convinced that their investments in third world exporters was devaluing so these foreign investors  pulled all their money out and then of course local currencies really did devalue.  If these countries had all had a large stock of US dollars as a foreign currency reserves, they could have used these dollars to buy their own currency and thus re-inflate their own currency.  Any currency which is heavily purchased in the FOREX market will increase the value of that currency. 


This article is still in progress.  It will be finished soon.

Winter Beach, Maine Seacoast.  Picture by Hanselmann Photography. 

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