Exorbitant privilege

The term exorbitant privilege (privilège exorbitant in French) refers to the benefits that the United States, as the world's supplier of safe assets, derives from its own currency (the US dollar) being the international reserve currency.^[1] These safe assets, primarily government debt, tend to be sold at higher prices than the debt of other governments.^[1] Exorbitant privilege enables the United States (and other states in a similar situation in history) to borrow beyond the fiscal capacity of other states.^{[1][2][page needed][3]}

The Dutch Republic had exorbitant privilege in the 17th and early 18th centuryThe United Kingdom had exorbitant privilege for much of the 19th and early 20th century. Around 1815, British national debt accounted for more than half of the world’s traded securities.^[1] Prior to World War I, the UK was at the center of global trade, the pound was the world's reserve currency, and the UK was the world’s safe asset supplier.^[1] When exorbitant privilege is lost, investors into government bonds suffer substantial losses and the affected government resorts to financial repression.^[1]

Scholars have debated to what extent the position of the United States as the supplier of the world's safe assets is in peril for the future.^{[2][page needed][4][5]}

Academically, the exorbitant privilege literature analyzes two empirical puzzles, the position puzzle and the income puzzle. The position puzzle refers to the difference between the (negative) U.S. net international investment position (NIIP) and the accumulated U.S. current account deficits, the former being much smaller than the latter. The income puzzle is that despite a deeply negative NIIP, the U.S. income balance is positive, i.e. despite having much more liabilities than assets, earned income is higher than interest expenses.^[6]

Origin

The term exorbitant privilege was coined in the 1960s by Valéry Giscard d'Estaing, then Minister of Finance, who would later become president of France.^{[2][page needed][1]} The phrase is often incorrectly credited to Charles de Gaulle, although he also did share similar views.

Opposition in France

In the Bretton Woods system put in place in 1944, U.S. dollars were convertible to gold between countries. In France, it was called "America's exorbitant privilege"^{[2][page needed]} as it resulted in an "asymmetric financial system" where foreigners "see themselves supporting American living standards and subsidizing American multinationals". As American economist Barry Eichengreen summarized: "It costs only a few cents for the Bureau of Engraving and Printing to produce a $100 bill, but other countries had to pony up $100 of actual goods in order to obtain one."^{[2][page needed]}

In February 1965 President Charles de Gaulle announced his intention that France exchange its U.S. dollar reserves for gold at the official exchange rate. He sent the French Navy across the Atlantic to pick up the French reserve of gold and was followed by several countries.^[7][8] As it resulted in considerably reducing U.S. gold stock and U.S. economic influence, it led U.S. President Richard Nixon to end the convertibility of the dollar to gold on August 15, 1971 (the "Nixon Shock"). This was meant to be a temporary measure but the dollar became permanently a floating fiat money and in October 1976, the U.S. government officially changed the definition of the dollar; references to gold were removed from statutes.^[9][10]

Effects of the exorbitant privilege

• Lower Borrowing Costs: The US can borrow at lower interest rates because there is a high demand for dollar-denominated assets.^[1][11]

• Trade Deficits: The US can run larger trade deficits without facing a balance of payments crisis, as its imports are purchased in its own currency.

• Currency Stability: The dollar's status provides domestic stability and liquidity in global markets.

• Economic Influence: The US has greater influence over global economic policies and financial markets.

• Global Financial Stability: Since many countries hold reserves in US dollars, any significant shift in the value of the dollar can affect global financial stability.

• Geopolitical Power: The dominance of the dollar enhances the US's geopolitical influence, as many countries rely on it for international transactions.

• Export Consequences: A stronger dollar can make US exports more expensive and less competitive in global markets.

• Capital Flows: The US experiences significant inflows of foreign investment^[12]

• Monetary Policy Autonomy: The Federal Reserve has greater flexibility in setting monetary policy without worrying as much about the immediate effect on exchange rates or capital flows.
• Seigniorage revenue: to obtain U.S. dollars, other countries have to supply the U.S. with goods and services in return for those dollars.^{[2][page needed]}

See also

• Demurrage currency
• Reserve currency
• Seigniorage
• Euro