The Exorbitant Privilege: The Dollar's Value as World Reserve Currency

McKinsey Global Institute (MGI) has attempted to estimate the dollar's value as the world's reserve currency. The results are not as advantageous as many might think.

According to MGI, the United States may not enjoy much of a privilege in this regard. In 2007-2008, the privilege translated into an estimated value of between 40 billion and 70 billion dollars, or 0.3 to 0.5 percent of US GDP. This can be further corroborated by former Federal Reserve Chair Ben Bernanke's estimation, who suggested that the dollar's international role is an "exorbitant privilege."

How Americans Gain from the Reserve Currency Status

There are several ways to assess the dollar's value as a reserve currency. One is to consider the gains Americans receive year after year. While this is difficult to calculate precisely, one approximate figure is the trade deficit, which currently stands at around 500 billion dollars a year and cumulatively abut 8 trillion dollars over the last 40 years. Essentially, America's trading partners are giving the US 500 billion dollars in real goods and services for green pieces of paper. This would likely not happen were the dollar not the reserve currency.

Overvalued Dollar and Potential Collapses

The second method to answer this question involves determining whether the dollar is overvalued considering a substantial portion of the 8 trillion dollars were to be redeemed for real goods and services. A precise answer is hard to give, but estimates range from 10 to a complete collapse of the dollar.

Advantages of Reserve Currency Status

There are some clear advantages to the US being a reserve currency. For instance, it provides some protection against the complete and sudden collapse of the dollar. However, the currency is still vulnerable to large fluctuations based on global events. During a global recession, for instance, other countries pour money into the dollar. While this helps the dollar retain its value, it can also be a deterrent to fixing the trade imbalance, which is crucial at this time.

Additionally, the Swiss franc's appreciation since the beginning of the Eurozone Debt Crisis serves as a cautionary tale. Although Switzerland is currently doing well, its exports might suffer in the future. It's important to note that while exports are still important to the US, a trade imbalance remains a concern as long as imports and exports are not at their natural levels due to productivity differences. The reserve currency status can skew this somewhat.

Global Currency Benefits

However, the US dollar's reserve currency status does offer certain benefits. For example, it provides a significant advantage in the international trade of commodities, such as oil. Moreover, it often saves the US a step when exchanging from one currency to another compared to exchanging through unrelated exotic currencies.

Conclusion

In conclusion, while the dollar's reserve currency status offers several advantages, it also comes with certain disadvantages and vulnerabilities. Understanding these nuances is crucial for policymakers and businesses navigating the global economic landscape.

Keywords: Dollar Reserve Currency, Exorbitant Privilege, US Trade Deficit, Global Currency Benefits