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U.S. Dollar’s International Currency Status: Gift or Curse? — Ben Bernanke

(Kitco News) – Is the U.S. dollar’s international currency status a gift or a curse? One former Fed chair argues that it may actually be working against the country’s economy.

“I’ll argue that the benefits of the dollar’s status to the United States have been much reduced in recent decades,” Ben Bernanke, Fed chair from 2006 to 2014, said in a Brookings Institute blog post Thursday.

Since the U.S. dollar is considered the most widely used currency, with roughly 60% of international reserves held in dollar-denominated assets, Bernanke continued, it is often argued that the U.S. has gained flexibility and — as some have said – has benefitted from an “exorbitant privilege.”

However, Bernanke said that this comes with a price, and the disadvantages may just be outweighing the benefits. For one, the benefits of having a currency as widespread as the dollar are simply “symbolic, a sort of ‘good housekeeping seal of approval’ for U.S. markets, institutions and policies.” 

“The tangible benefits to the U.S. of issuing the world’s principal reserve currency—the ‘exorbitant privilege’—have, I think, been significantly eroded by the greater actual or potential competition from other currencies, such as the euro and the yen, and by America’s shrinking share of the global economy,” he added.

In fact, this recognition of the dollar can actually be working against U.S. firms, he continued, “since it implies that they become less competitive (the dollar is stronger) at precisely the times that global economic conditions are most difficult.”

Due to the dollar’s dominant role in international trade and finance, it is also thought that U.S. policymakers have a “special responsibility” to take other economies into account when coming up with domestic monetary policies, and that any Fed action has international implications. However, Bernanke noted that this may just be the international community’s own fault.

“A principal channel of the Fed’s international influence works through dollarized credit markets,” he said. In other words, many borrowers in the emerging world – both banks and corporations – borrow heavily in dollar-denominated terms, even when dealing with non-U.S. lenders, which gives them access to larger and more liquid global credit markets, he explained.

Despite this, Bernanke said that the Fed shouldn’t be considered the “world’s central bank” and instead shift focus onto these emerging economies that are burdening themselves with debt in U.S. dollar terms. 

“If the Fed tightens, say, and the dollar appreciates sharply and unexpectedly, then what initially appeared to be cheap dollar loans can become very costly after the fact, because they must be repaid in expensive dollars,” he explained.

“Obviously, this effect would not be as strong if less foreign borrowing was denominated in dollars, or if dollar borrowing were better hedged against exchange-rate risks,” he added.

Bernanke said the risks of financial stability of “unhedged borrowing” provide a basis for emerging-market governments to monitor and constrain access to dollarized credit markets moving forward.

“The most natural place to do this is in the banking system, where regulators should check to make sure that lenders are not overexposed to the risk of dollar appreciation,” he said.

By Sarah Benali of Kitco News;
Follow me on Twitter @SdBenali