Very nice analysis.
There are two main benefits to the United States as issuer of the main reserve currency. First is interest from seigniorage—the profit made on issuing additional currency to nonresidents who hold U.S. notes and coins—estimated at $10 billion a year. Second is the fact that the United States is able to raise capital more cheaply because of very large purchases of U.S. Treasury securities by foreign governments and government agencies. We estimate that these purchases have reduced the U.S. borrowing rate by 50 to 60 basispoints over the past few years and are worth about $90 billion to the United States.
I suggested the number might be 50 basis points which is on the low side of the McKinsey estimate. (Clearly I missed my calling as consultant :)). The 90 billion is the cost to government. The one thing their analysis misses is the benefit to American consumers to lower interest rates, since higher government interest rates also impact consumer interest cost. We have 40-50 trillion dollar is total debt, public, private, and corporate. So 50-60 basis translate into a 200-300 billion in additional interest cost. To be fair Americans own a lot of each other debts, but probably 1/3 goes oversea and but the rest is wealth transfer from generally poorer borrowers to wealthier lenders. So losing reserve currency status is another way to help the rich in this country. Gosh on second thought maybe Krugman is on my side after all.
90 billion is…roughly 0.1% of GDP. So ok! Yeah, even low integer multiples of that are in the “annoying” level. Note it’s a one-time cut, not a growth rate change.
I’m far more worried about the debt ceiling or long-term budget disasters leading to some sort of capital flight scenario, which could really fuck up things.
The people who are predicting a negative shift in the standard of living are doing so for very specific reasons.
If some other currency – let’s posit the euro, although that’s massively unlikely – ends up the reserve currency, other countries will start shifting into it. That means a collapse in the value of the dollar as not so many folks want to buy it and lots of people want to sell it. We know that a minor imbalance between buyers and sellers can cause huge shifts in the price (its an on margin thing, basically the very small number of people who want to sell/buy but can’t bid down/up the price until people who were planning to hold their position take action).
So that’d cause a swing in the exchange rate, making the US dollar cheaper than, on the fundamentals, it should be. That means fewer foreign imports and, as exports make up a rather minor portion of GDP, not much in the way of compensating exports. People end up worse off in the short term until the currency adjusts back to the long run average relative to trade partners.
Meanwhile the euro, our hypothetical replacement, is racing upwards. That harms Germany most of all, as the German export machine underlines European economic growth. Supply lines get cut due to funky price shifts, people do poorly and Europe, like the States, enters into a period of funk. Not good funk either, think funk if it was done by Japanese people.
If it happened gradually, it’d be irrelevant as you suggest. Higher menu costs for US exporters and higher interest rates on the debt, but nothing really serious. The fear is of a sudden, earthquake style slip where the dollar drops fast and another currency rises fast.
I can see a currency flight scenario you’re describing based on the market’s finally doing a Wile-E-Coyote looking down when you’re off the cliff, but I don’t think that has a to do anything with reserve currency.
From what I can tell losing reserve currency status comes after the financial panic - when we aren’t the default investment option anymore - not before, and the volumes aren’t high enough to trigger it by itself.