Steven Kamin and Mark Sobel on the Current State of Dollar Dominance

Given the liquidity, safety, and investor protections the dollar provides, its pivotal status as the world’s reserve currency provides numerous macroeconomic and geopolitical benefits.

Steven Kamin is a senior fellow at the American Enterprise Institute, was previously the director of the Division of International Finance at the Federal Reserve Board, and is a returning guest to the podcast. Mark Sobel is the US Chairman at the Official Monetary and Financial Institutions Forum, and he previously served at the US Department of the Treasury for nearly four decades, including as Deputy Assistant Secretary for International Monetary and Financial Policy from 2000 to early 2015. Also, from 2015 through 2018, Mark served as a US representative at the IMF. Steven and Mark join Macro Musings to talk about dollar dominance and whether or not it is here to stay. Specifically, Steven and Mark also discuss current debates surrounding dollarization, the threat that China poses to dollar dominance, the weaponization of the dollar in the global economy, and a lot more.

Read the full episode transcript:

Note: While transcripts are lightly edited, they are not rigorously proofed for accuracy. If you notice an error, please reach out to [email protected].

David Beckworth: Steven and Mark, welcome to the show.

Steven Kamin: Thank you. It's good to be here, David.

Mark Sobel: Thanks. Looking forward to it.

David: It's great to have you back, Steve. You were on last year. We had a fun conversation. Some of the topics we'll revisit today, and I encourage listeners to go back and check out that podcast. But, Mark, this is your first time here.

Sobel: First time.

David: Now, we have been together before. We were at a Cato conference. We were on a panel together discussing fiscal dominance. But more importantly, Mark, you were one of the bosses or upper management when I was at US Treasury International Affairs. I was just a young person out of grad school. You were a Deputy Assistant Secretary, I believe, at the time. I believe that also, at some point, you served as the acting Assistant Secretary in International Affairs. So you had quite a great career at Treasury. Tell us a bit about that career.

Sobel: I did a lot of acting, as you said. Yes, I had the great honor of heading up the International Monetary and Financial Policy Section. It's a great place to work with colleagues at the Fed, work with colleagues internationally, and be at the forefront of key issues that are always hitting the international financial system and working with the IMF and the G7, the G20, the Financial Stability Board, to try and make the system work better. Hopefully, I did a few things right in my time. In any case, let's get on with the dollar, which is really key to the international monetary system, which is what I was doing at the time.

David: Well, before we move to the dollar, one last question about your career there. So you oversaw the Exchange Stabilization Fund, is that correct, in your role?

Sobel: Yes.

David: So you were the person who sat in front of the figurative red button you'd press if it was ever needed. What was it like managing that?

Sobel: I didn't do much pressing. Obviously, the US doesn't intervene in foreign exchange markets. One still had to manage the meager foreign exchange holdings of the US, SDR transactions with other countries, when they wanted to. We kind of got out of the credit stabilization business. There was Mexico in the mid-'90s, there was Uruguay, subsequently, in the early 2000s. But it became difficult to do such operations, and they were much less needed, in any case. I've spent a lot of time worrying about foreign exchange policy, worked on the foreign exchange report, but managing the ESF was a nitty-gritty, fun thing to do, but I really didn't knock that red button very often.

David: Okay. Now, you guys must have crossed paths in your two careers, right?

Kamin: Absolutely. Aside from working on many issues together over the years, we would end up seeing each other and hanging out at many G20 meetings, IMF annual meetings, all over the world.

Sobel: I have to jump in there just to say, it was a pleasure always working with the Fed. A lot of central banks and treasuries don't necessarily have close relations. We had a seamless relation on the international side. We shared briefing books and formulated positions for G20, G7 meetings together. So, yes, Steve and I go way back. In fact, I think I met you when you were a volunteer for a year at CEA, and we were working on Russian reform, for all the good our efforts did us.

Kamin: Good memory. That's true, but I didn't remember the details of it.

David: Well, on the previous show with you, Steve, we talked about your visit at the CEA. So, I encourage listeners to go back and check that out, which is [why it is] great to have both of you here. You're both experts in this area of the dollar in the world economy, and so you have a paper on dollar dominance. Before we jump into that paper, though, you two friends got together recently and participated in a good-natured debate over dollarization in Argentina, so this would be a nice segue into our larger conversation about dollars in the world. What was that about, and what was the conclusion of that conversation?

The Debate Over Dollarization in Argentina

Kamin: What happened was that, as it looked like Javier Milei, the Argentine presidential candidate, would win the election, and he had been on his platform promoting the dollarization of the Argentine economy, I decided to write a short op-ed piece supporting the policy of officially dollarizing the Argentine economy. Where I was coming from is, I actually was following the Argentine economy for the Fed as a young economist back in 1989, 1990.

Kamin: I saw hyperinflation with 180% inflation just in March of 1990 alone. They got the inflation down, they introduced the convertibility program, and at the time I thought, alright, these people have gotten religion. They understand that fiscal deficits are the devil behind inflation, and they're never going to have it again, but I was wrong. Their plan exploded a decade later, and the Peronists introduced many anti-liberal economic policies.

Kamin: Then, when Mauricio Macri became president in 2015, I thought, okay, they've gotten religion again, and a lot of investors thought so and bought 100-year bonds, and then that program went up in smoke. So, now, this is their third shot at neo-orthodox economic policies. My view at this point was, I'm not trusting this economy anymore, alright? They need to dollarize and get rid of their currency altogether, and I wrote a short op-ed to that effect. Meanwhile, Mark wrote a paper as well. Do you want to talk about that for a second, Mark?

Sobel: Well, I didn't agree with your basic viewpoint.

Kamin: That's acceptable.

Sobel: One cannot, if they work on the international monetary system, escape Argentina, for better or for worse, and for worse might be my leaning on that question. Basically, in my view, Argentina is a country that overborrowed domestically, and the central bank ended up monetizing the debt, causing hyperinflation. They borrowed excessively abroad to finance themselves. The markets gave it to them. Don't ask me why, but the markets did, and then it serially defaults.

Sobel: So, at the core of Argentina's problem is excessive borrowing, and that's the issue that needs to be tackled. And they need sweeping liberalization, they need a realistic exchange rate policy. So, the question is, is dollarization the answer? To me, dollarization is a bit of a Hail Mary pass. It's not going to magically stop borrowing. It's not going to magically introduce fiscal discipline. We've already seen that Argentine provinces are talking about introducing pseudo-currencies and IOUs and scripts and stuff.

Sobel: They don't have the reserves to back a dollarization program. Then, as Steve mentioned, they seem to have religion in the second half of the '90s, but then the dollar was up, all of their competitors' currencies were down. They lost competitiveness, and then it all blew up very disastrously, which set the stage for 15 years of horrific Peronist policies. Then, the other thing is, if you have a dollarized system, you have to rely on internal devaluation, which is very painful if you lack some lever in the exchange rate.

Sobel: So, basically, Steve is right to question whether Argentina has the political will. I just think that the central issue is getting the fiscal house in order and stopping monetary financing. And I think that's where the focus should be. We'll see where the dollarization debate ends up. Milei has basically punted it into the medium-term grass for the time being. We'll see if he eventually does it. But, if they don't get their house in order, it's going to be chaos no matter what.

Kamin: So, just to follow up, I wrote my paper. Mark wrote his paper. Then, I think—I was thinking this, and then your pal, Christopher Smart, suggested, "Well, we’ve got the ex-Treasury official arguing against dollarization, the ex-Fed guy arguing for it. Let's have a steel cage match and duke it out." And that's what we did. Now, just to follow up, if any country needs a Hail Mary pass, it is Argentina. So, I agree with Mark that the plans for dollarizing have been put aside, mainly because they don't have the dollars to do it. They're focusing on stabilizing the economy, which is the right way to go. My view is, if they succeed in stabilizing the economy, then that's when they should dollarize in order to preclude another fallback into chaos.

David: Are you guys hopeful that Milei can actually do this? Can he pull off some fiscal consolidation, get things in order so that he can make that next step?

Sobel: I'm not an Argentine expert, but what I have been reading is that he's put forward some very radical, comprehensive bills, and he's had to pull them back. So, where they stand right now, and how he's going to advance his plan, I don't know. I know that they slashed spending in December and had a balanced budget for the first time. But how sustainable that is, absent of a comprehensive plan, I don't know. So, I think it is always safe in saying, when it comes to Argentina, the jury is out.

Kamin: I would note that their economic situation is very dire at the moment. Inflation on a year-over-year basis was around 250% in January, reflecting a devaluation of their currency of around 50%, as well as reducing subsidies and freeing prices. And, as Mark alluded to earlier, one of the governors, I think of La Rioja, one of the provinces, is now contemplating creating their own currency, which people were predicting, because they cut off the flow of funding from the federal government to the provinces, and that has been a major factor, basically, in the country's consolidated fiscal deficits. Huge numbers of people are on the public payroll, so what are you going to do when that financing stops?

David: Let me ask one more question about Argentina, and then we'll move on to dollar dominance more broadly. But when I was at Treasury many years ago, Mark, you were there. I was part of some meetings with a certain Undersecretary of International Affairs at Treasury. And they suggested using the Exchange Stabilization Fund as seed money for dollarization in Argentina. Do you think that's even something being considered today, or would it be on the table?

Sobel: No.

David: No? Okay. Alright, well, let's move on, then, to dollar dominance more broadly, since you answered that question for me. You guys have a nice paper, co-authored, and it's the reason we're here, really, together, to talk today. It's called, *Dollar Dominance Is Here to Stay for the Foreseeable Future—the Real Issue for the Global Economy Is How and Why.* We'll provide a link to that in the show notes, and encourage our listeners to check it out. Let's begin our conversations about this paper by looking at its motivations, and then we'll get into some of the arguments and claims you make in it. But, why this paper now? Why so much interest now in dollarization? What's been happening that makes this a hot topic?

Why Is Dollarization a Hot Topic?

Sobel: Well, at one level, having seen this issue for decades and decades, I'm always fascinated at the fascination of this issue. But, I kind of like it because, as is evident here today, it gives Steve and me something to talk about, which keeps us out of our wives’ hair. The other answer is that there are big shifts going on in the global order. You've got Russia's war on Ukraine. You have diversion of Russian energy exports to India and China. You have people asking questions, well, given financial sanctions, how are countries going to pay for this? Are there alternatives to avoiding the use of the dollar given the potential presence of financial sanctions?

Sobel: China's talking about bolstering RMB internationalization. China's playing a rising role in the global economy. And let's not forget that US inflation has been high, and it's not as if our fiscal house is in order, so people have doubts about the US at times, to say nothing of our politics. So, it seems to me that there was a perfect storm last year for chattering about this issue. I think it's dying down, partly because the data doesn't change and the dollar is remaining super strong. And when you look at China, the RMB is still under 3% of reserves, and we'll come back to that. So, basically, I think the subject is dying down for now, but we're still delighted to be here today to talk about it.

Kamin: Absolutely. We love to talk. It keeps us young. I want to just add to that. I mean, Mark hit the nail on the head with those points. I just want to add the word “weaponization” to the issue, because I think that was a very prominent part of the discussion last year, was the idea that the United States, in particular, is abusing its sanction power by weaponizing these economic and financial sanctions against bad actors like Russia, Iran, North Korea, et cetera. And so there was this widespread view that the US was going too far in this weaponization, and that that was going to push countries away from using the dollar and motivate them to move to the RMB or maybe cryptocurrencies.

Kamin: And then that came on top of the other trends that Mark noted, which is China's interest in internationalizing its currency, Russia's movement away from the dollar. And also, on top of that, there had been a lot of buzz, that also is quieting down, about the idea that the dollar might be superseded by cryptocurrencies or central bank digital currencies. It seems like all of these kinds of trends basically have come off the boil in terms of public interest.

David: I consider you two senior statesmen of dollar diplomacy, global dollar issues. And so, as you alluded, Mark, you've seen this before, right? You've put many decades into this issue, you've looked at it. So, what is it like for you to sit back and see this come up again and again? I think previously, Steve, we talked about 2003 to maybe 2008. There was talk of the dollar being dethroned because of the huge current account deficits. That was the crisis, in fact, that they were predicting before the great financial crisis emerged. There was the QE infinity, the debasement of the dollar back right around the years after 2008, and nothing happened then as well. So, what is it like to see this argument come up every few years, and yet here we are, still, with the dollar?

Kamin: It just suggests that people around the world are a little bit uncomfortable with the hegemonic position of the United States and the hegemonic position of the dollar and, as a related matter, of the Federal Reserve. So, it's naturally going to attract attention, and that attention is going to come in waves prompted by particular developments. In the early 2000s, it was the fall in the dollar in the context of our large current account deficits. In the 2013, '14, '15s, it was the Fed's QE and how that was spilling over to emerging markets. And then, in the last couple of years, it was the weaponization of US sanctions in the context of those types of developments. So, it happens, and I expect that it will continue to happen.

David: Okay, and we'll come back to the podcast and do another show when it happens again. Okay, let's go to your paper. In the first section, you provide evidence that the dollar is still dominant. Walk us through that evidence.

Evidence of Current Dollar Dominance

Sobel: First of all, I want to really thank Steve. He was the main mover and shaker behind this paper. He did much more work. I was a free or easy writer. So, thank you, Steve.

Kamin: He is too humble.

Sobel: So, the answer to the question is super easy, and I think it's super easy because of the great work of Steve's former colleagues at the Fed, Carol Bertaut, Bastian von Beschwitz, and Stephanie Curcuru, and their paper on the international role of the dollar, and a gentleman also named Colin Weiss at the Fed and his work on geopolitics and the dollar's reserve currency role. So, if you look at a range of measures that they cite in global private finance and official reserves, it's pretty clear.

Sobel: So, you look at the currency denomination of international trade. Well, basically, the dollar is 75% or higher usage in regions around the world except for Europe. It's noteworthy that the Chinese RMB is now roughly a quarter or more of trade denomination in Asia. You look at international bank loans, and the dollar is about 60%, the euro is 20%, euro sterling is another 10%. [For] international debt securities, the dollar is around 70%, the euro is 20%. You look at foreign exchange transactions.

Sobel: So, the BIS does a triennial survey… and now it's very weird. They, basically— because foreign exchange transactions involves two currencies, like I sell you a dollar or you give me a euro, right? And so, the BIS sums it up to 200%. And what you find is that the dollar is in the upper 80%. I, having been a mere Treasury person and not a member of the secret temple society of the BIS and central banks, am not smart enough to realize why these high-priced economists in the BIS haven't learned how to divide by two and just tell us it's in the upper 40s, but it's okay. Steve maybe knows the answer to that.

Sobel: And then, the thing that's often widely cited— and this is official, it's not the private side— is basically the dollar's role in reserves. And the IMF keeps good data on that. It's been remarkably enhanced since 2015. If you look at that measure, the dollar is now at 60%, just a little tad below. Some people go, “In 2000 the dollar was 70, and now it's 60, so the dollar's role is coming off.” But if you go back a few years before that to 1995, the dollar's role was 60.

Sobel: So, to me, the dollar's role is still very dominant. And let me just say a few other quick points. One is, I do think market participants are looking at the margins for diversification alternatives. But they have an interest— and we may come back to this— in open liquid capital markets. And so they look frequently at Canadian dollars and Australian dollars and Swiss francs, but those are small places. There's only so much you can get. But, there is some movement there. And then the other one that everybody is talking to— and we'll definitely talk about this later— is the Chinese RMB. The Chinese RMB share is now under 3%.

Sobel: Another observation I'd make is that the IMF data do not include gold holdings. There's definitely evidence that some central banks are shifting a little bit of their work in gold. Then, just since I mentioned Colin Weiss, I'd just say that his paper basically says that three-quarters of foreign government holdings of U.S. safe assets are held by countries with some form of military tie or alliance to the US, and that US allies are more inclined to rely on the dollar and less prone to diversify given [their] close ties with the US. 

Kamin: I would just add to what Mark noted, that he cited all of these areas in which the dollar has great dominance in terms of international financial holdings and transactions. That's all against the background of a US economy that only accounts for about 10% of GDP and 20% of global trade. So, the point is that the dollar punches way above its weight relative to the weight of the US economy, in both global trade and global GDP.

Sobel: I think we're about 25% of global GDP using market exchange rates, and I think it's 15-ish or… no, it's about 20 on PPP. 

David: Alright, let me go back to one of the set of statistics that you brought up, and that's the BIS's measure of bank loans and, I believe, also, corporate debt. I sometimes check in on that data. I think they call it the “global liquidity indicator,” and they sum all of this up, and they do it by currency. What's been fascinating to me is that if you look at the amount of this debt, the bonds and bank debt, that's issued in a currency and outside of the country itself, so dollar-denominated liabilities being issued outside the US, it's like 13 trillion or so. And you look at other countries, and it's much smaller, 4 trillion, maybe, of euros. It drops dramatically, but it's not just the absolute size. There's a growing gap between the two, which suggests that this dollar dominance is deeply embedded and might be growing. The network effects are growing. Do you think that's a fair assessment, that it's not just that we're here, but it's getting stronger over time?

Kamin: I think that's what the data says. I will note that it's surprising that that should be the case, because you would think that, first of all, with the rise of China and its attempts to internationalize the RMB, with growing more sophisticated reserve management on the part of central banks that Mark alluded to, where they're trying to diversify into other currencies. And now, there's a lot of movement toward trying to rationalize cross-border payment flows and use technology, instead of the dollar, as a vehicle currency. All of these things should be cutting in to dollar dominance, and, I think, ultimately will, but it's not happening anytime soon. And it does look like the dominance of the dollar is actually being cemented in rather than eroded away. So, it is surprising.

David: And that's the next part of your paper. Dollar dominance is here to stay for the time being at least, right?

Kamin: Yes.

David: What other evidence would you point to? For example, why should we not be concerned about China?

Should We Be Concerned About China?

Sobel: To me, some people give the impression that dollar dominance was foreordained or a dictate from the heavens or Congress or whatnot. That's not the case. The dollar's dominance reflects organic properties, I would call them, of the United States. We have a huge economy, the biggest in the world, market exchange rates. We've generally delivered decent macroeconomic performance, very key. US capital markets are the most open, deep, and liquid in the world.

Sobel: They offer a wide array of instruments to foreigners. Treasuries [are] the world's risk-free asset, for example. Capital can come in and out. It's not going to impact prices all that much. Transaction costs are low. The economy is open. The dollar is convertible. We have rule of law and decent investor protections. And then, you alluded to it earlier, there's what I call the network and inertia effects. People around the world accept dollars. That's already built in.

Sobel: Then, the megabanks of the United States basically power global payments, so they connect the world's financial systems via what I would call a hub-and-spoke network. This reduces costs for everybody, so why change? If it ain't broke, don't fix it. So, those are the inertia effects. I think that is why the dollar is so strong, and these are properties we need to keep because of our self-interest. Others can't match those. So, you take the euro. It's a large economy. Why not the euro? They don't have a deep, liquid, open European capital market.

Sobel: They have a German market, a French market. Their efforts on capital markets haven't really taken off. Then, I think the other question is China. Could it become the major global financial and reserve currency? Just tons of attention paid to this issue. In my view, it could rise, to some degree, especially from its 3% or under reserve threshold in the foreseeable future. But the RMB isn't convertible. Capital controls [are] abound. The economy faces massive headwinds. There's capital outflow these days.

Sobel: And those are huge issues confronting it. Now, on the other hand, it's increasingly used for trade settlements, as I mentioned. China is reinforcing the RMB's role around the world through swap lines. They're trying to build out this cross-border interbank payment system. The People's Bank will seek opportunities here and there to liberalize, if it can. There are questions about Russia leaning heavily on RMB usage to circumvent Western sanctions.

Sobel: Again, those could support a larger, global role. But I think that the upside potential for the RMB is limited, given that it just can't match the properties of our system and markets. Stablecoins and cryptocurrency— as Steve mentioned— I don't think they're going to erode dollar dominance either. Now, it's possible that improving payment systems and all of that could reduce the dollar's role as a vehicle currency, but it's unlikely that the dollar would be threatened. Crypto assets are highly volatile, unsuitable as a medium of exchange or store of value. They lack a legal underpinning, and authorities are not going to tolerate their illicit use.

Sobel: Tether and Circle— these are stablecoins— are tied to the dollar, so that might even enhance the dollar's role. And then— thinking back to what I was saying about China earlier and the properties— again, improving the usage of vehicles as a medium of exchange is not going to change questions about the underlying properties, such as trust in a regime [and] rule of law, which are relevant for store of value considerations. So, this gets to the question of a Chinese central bank digital currency. I don't see digital currencies, either, as having— or the advent of digital currencies in other places as having a major impact on the dollar's dominance.

Kamin: So, obviously, I agree with everything Mark said, since we collaborated on the paper. I just wanted to step back for a second. I think we make a good case that, for the foreseeable future, the dollar is not going to be replaced as the world's single dominant currency by some other country's currency. You could think of a couple of scenarios where the dollar does lose dominance. One of them that gets talked about with some frequency is the idea that, with the world fragmenting into different regional blocks for geopolitical reasons and trade reasons, you could imagine that being accompanied by a fragmentation of dominant currencies. So, basically, you have maybe the West with a dollar block and the East with an RMB block. That's a possibility. I don't think it's as strong a possibility as the dollar remaining dominant throughout, but it's a possibility, and it's the one that would not bring a lot of benefits to global prosperity.

Kamin: Another possibility that I think is even less likely, but is greatly concerning to us, and I'm just leaping ahead to our punchline at the end, is the possibility that the United States' failure to resolve its political dysfunction, and failure to get our fiscal house in order, could actually lead to such economic destabilization that it would trigger a loss of the dollar. What would replace it is unclear, but that would be a deeply concerning issue. And in that issue, as we note, the loss of dollar dominance would be the least of our problems.

David: Right. If we get to that point, there's bigger fish to fry in the republic, for sure.

Sobel: Right, so, the United States of America itself is the biggest threat to dollar dominance.

Kamin: Exactly.

David: That's a great perspective. We are our worst enemy when it comes to dollar dominance. But let me go back to this point you made. Even if we get to this place, given the lead, the first-mover advantage, just the magnitude difference between dollar denominated assets and everybody else, it's unclear to me where you would run to if you wanted to get out of dollar denominated assets. Crypto, I mean, you'd have to have a massive issuance of crypto, which would raise questions about the whole point of crypto, right? This reminds me of Mark Carney's speech that he gave at Jackson Hole.

David: I think we talked about this last time. He wanted a synthetic hegemonic currency, some kind of substitute to the dollar. He was criticizing the destabilizing role that he thought dollars had in these problems. Even to create that, someone at the conference told me later that that is the most absurd idea, because you'd have to add all of this debt to central bank balance sheets, in which they'd have to create a digital currency upon, in which you make a synthetic one. There's just no way to get to that point. So, there would have to be a massive issuance of some other asset or a massive price change, [where] quantity and price get to a place where there would be some other substitute for the dollar. Is that fair?

Kamin: Yes. Now, it is possible. If the situation in the United States grew, let's say, much more dire than we can now imagine, and so that central banks in other countries wanted to move their assets elsewhere, they could. They could sell off Treasuries, buy German Bunds, buy liabilities of many other advanced economy governments. The combination of actual trades, along with price movements, could reallocate their portfolios. I think it would be extremely messy. It would leave countries like China with enormous claims on the US, with a now highly devalued stock of assets. But I'm just saying that, in principle, it would be possible.

David: So, a couple more points on that. You also mentioned that, in this world where we have a dollar block, a yuan block, two different major currencies, there is this critique that Ricardo Reis introduced me to— I think it's called the [inaudible] critique— that it would actually be more destabilizing, because it's actually better to have one global medium of exchange than to have multiple, because you could have panics where you run from one to the other. And so, it's not clear that that would be a better world at all, as well as— I think you mentioned in your paper— the role the dollar has done in facilitating global growth, lifting billions of people out of poverty.

David: Let me circle back to another point, and that is this increased use of financial sanctions, the weaponization. I want to draw on a paper that— you probably know these authors, Michael Dooley. And he had a paper recently with some of his co-authors that he's published with before. The title is, *US Sanctions Reinforce the Dollar's Dominance.* So, he took the other argument, and let me just read the abstract. I want to get your response to it, because it is truly a hot take on the weaponization of the dollar's role in the global economy. 

David: This is what it says: "Recent sanctions on the use of Russia's international reserve assets seem likely to reduce the appeal of US dollar reserves as a shock absorber for international payments. But international reserves are also a means to reassure foreign investors that problematic countries will not confiscate their investment. The collateral motive for holding dollar reserves has been enhanced by the demonstration that the US is willing and able to sanction misbehavior. Geopolitical risky countries, now more than ever, need to reassure foreign investors that their investments are safe from expropriation. We conclude that recent events will strengthen the role of the dollar as the key international reserve currency." That was truly a unique perspective. I wonder what you think.

The Weaponization of the Dollar in the Global Economy

Sobel: So, dollar dominance does give the US leverage over other countries through financial sanctions. I think that the topic of whether financial sanctions are going to impact the dollar is a bit overdone. Let me draw a distinction. There's a distinction between whether the United States uses financial sanctions multilaterally in concert with its allies towards a strategic objective. As far as I'm concerned, it has clearly been done with the blocking of Russian Central Bank and oligarch assets.

Sobel: In the other case, the United States is going hog wild, using financial sanctions unilaterally, abusing them at every turn. I don't think that the former scenario, the multilateral scenario, is going to hurt the dollar. I think that the Biden administration has done a good job in working with allies and using sanctions. Now you can say that, well, beyond the G7 and Japan, Australia, New Zealand, et cetera, others, such as China, are going to fret. But as I noted earlier in citing the work of Colin Weiss, some three-quarters of dollar safe assets are held by countries with some alliance ties to the US. More generally, I think that in my interactions over the years with Chinese portfolio managers, the people at safe, they were professional, technical, and as we've said throughout this discussion, there really aren't that many great alternatives to the US markets. So, I think if we act responsibly, this is not a big issue.

Sobel: But— and let me be provocative— if the US does have leverage through the dollar, and if we're not going to use it on Russia, when would we? But, again, we need to act responsibly and recognize that thoughtless abuse overuse could be harmful to the dollar's global role. And I think that former Secretary of the Treasury Jack Lew gave a good speech on this issue in 2016.

Kamin: Yes, so, that makes perfect sense to me. To Mike Dooley and colleagues' article, I think he's actually been pushing this line even before Ukraine. I'd have to check, but it's part of a broader intellectual effort under the title “Bretton Woods 2,” that they've been pushing for decades. And so, the idea here is that countries will act prudently and responsibly, because they will fear US sanctions, and so, therefore, that incentivizes investors to invest in that country. I'm not convinced that that's a particularly important benefit for anybody— of our sanctions— but I do agree with Mark that the use of our financial sanctions, in coordination with allies, against bad actors, is an appropriate part of US policy. It's a desirable part of US policy, and one that will not lose us many allies, and will not lose us much support for a dominant dollar.

David: It's interesting that the European allies that we are now engaged with in these multilateral efforts against Russia, they were really irritated with us when we abandoned the Iran deal under President Trump, because many of these secondary sanctions and stuff had affected them if they dealt with a bank that dealt with Iran, and we did it unilaterally. We just did it, because we can. And I think that's the concerning place, but these same folks are now thrilled, delighted that we've all come together to go after Russia. So, I think, if anything, if we did damage some of that capital with Iran, [then] we maybe built some of it back up going after Russia together as a group. One other comment on this, and then we'll move on to the next part of your paper, but this is a point that I like to make, and I want to get your response to it.

David: I think that the Federal Reserve itself has enhanced dollar dominance by the way it has responded to the crisis in 2008, as well as 2020, when it steps up and opens up and actively promotes the use of currency swap lines or any of these facilities that keep the global dollar market functioning. It's a signal to investors around the world, "Hey, on the margin, this dollar investment is safe. You can hold--" It's like the FDIC for the world, and maybe you get worried about moral hazard problems and stuff, but it's a signal that your dollar investments will be protected, if push comes to shove, by the Federal Reserve stepping in and opening up these facilities. Is that a fair assessment?

The Dollar’s Dominance as a Safe Asset

Kamin: Absolutely. Now, the motivation for the central bank actions, including the Fed's actions in 2008, and then again in 2020, was not to save foreign investors per se, or to safeguard their assets. The motivation was to basically keep the global financial system working, not be frozen, because that would be critical to keeping the flow of financing going in the United States. And what they recognized with the dominant dollar, and with so many financial transactions around the world being conducted in dollars, is that you had a problem, which is that banks and other financial institutions in the United States had access to the Fed's lender of last resort facility. So, they could access it, but financial institutions all over the world couldn't. And so, in some sense, that represents a flaw in the dominant dollar global financial system.

Kamin: The way to address that flaw was to make sure that other central banks in other countries could also provide those lender of last resort dollars. That's what the swap line did, by providing them with the dollars that they needed in order to keep the dollar part of their financial systems going, so then that could basically promote the overall stability of the global economy. Then, in 2020, the Fed added another facility to that, which was the so-called FIMA Repo Facility, that allowed countries around the world, even those that did not have access to the swap lines directly, to basically post their US Treasuries as collateral with the New York Fed, and get lending from the New York Fed. That had the benefit, to these countries, of being able to easily, but temporarily, liquidate their Treasuries in order to get the dollars they needed, and it had the benefit for the United States and everybody else of avoiding a sale of Treasuries that would actually raise interest rates. So, these were all steps taken to protect the US economy and financial system, but because they all basically improved the functioning of the global dollar financial system, they also had the effect of supporting dollar dominance.

David: Okay, so, let's ask this question. Why does this matter? Why are we having a conversation about dollar dominance, because in the paper, you make an argument that I will push back a little bit against, and that is, it really doesn't affect seigniorage flows that much. It's not like a big boon to the US economy, in terms of the standard exorbitant privilege story, so why care?

Why Do We Care About Dollar Dominance?

Kamin: The narrative arc of our paper is a little funky. We first argue that dollar dominance is here to stay. It's not going to be unduly threatened by other factors. Then, we move to the benefits and costs of dollar dominance. We argue that, for the US, it does gain benefits from dollar dominance, but they're not as huge as some people would argue. But then, in the end, we transition to, if we did lose dollar dominance, the main concern would not be the loss of the dollar dominance per se, but the things that had caused it, i.e. a deterioration of the US economy.

Kamin: That said, let me talk a little bit about the benefits that the US economy does derive. And I think they are there, I think they're tangible, but Mark and I agree that they're not overwhelming. We start with the idea that the French criticism, in the 1960s, of the monetary system at the time, arguing that because the United States could pay with dollars— that might then be held by other countries rather than used to buy things from us— that the US was living beyond its means and was enjoying an exorbitant privilege.

Kamin: Mark and I will agree that the dominant dollar affords a privilege. We just think it may be exaggerating to call it exorbitant. In the paper, we go through the different benefits that the dollar offers. One of them is seigniorage. Other countries are holding our cash money. If they were actually holding our Treasuries instead, we'd have to pay them interest on it. That's tangible. Is it a lot? No, the foreign countries have about a trillion dollars of our cash money. If they were being paid 4% interest, if they were hoarding Treasuries instead, that would amount to $40 billion a year. That's not chump change, but it's still less than 0.2% of US GDP.

Sobel: Treasury likes it.

Kamin: Yes, I'm sure they do. Every little bit counts. The second and— I think most people agree— more important benefit that the dominant dollar might offer, is that because US assets and dollar assets are just so desirable, the US Treasury can pay lower interest on its obligations. Mark, I assume that the Treasury likes that?

Sobel: Absolutely.

Kamin: And so that makes perfect sense. Given the safety and liquidity of the bonds, along with the dollar denomination, the Treasury can pay lower interest. The problem is, how much lower interest? And that, nobody knows. Now, a small cottage industry has developed to basically estimate the so-called convenience yield offered by Treasuries, and it gets into areas of finance that are well beyond my limited mental capacity. But I assure you that there's no agreement on how big that convenience yield is.

Kamin: Now, what I like to do, in my more simple-minded way, is just compare real Treasury yields in the US, nominal yields minus inflation, to those in other likely countries, like Japan and Germany. And if you look at charts of those yields— actually, for most of the years in the previous decades— US real yields have been comparable to, or actually even higher than those in Japan and Germany. Now, there could be lots of other factors going on here, but my point is that whatever convenience yields dollar dominance offers are not so great as to overwhelm these other factors. That's why, again, I think it must be the case that dollar dominance lowers our interest rates, but probably not by a huge amount. So, that's a second benefit.

Sobel: It could vary based upon what's going on. So, for example, when China was accumulating reserves out the wazoo, the impact might be greater in a period when China isn't accumulating reserves.

Kamin: Exactly.

David: So, I had a guest on the show previously, Will Diamond, and he's one of the scholars in this cottage industry that you just described. He's at Pennsylvania, I believe, at Wharton. And he estimates convenience yields, he looks at safe assets. I love his work, he's a really interesting person. And one of his papers shows that the convenience yield, the advantage we have, is really just middle of the road if you list all the countries— and again, other papers may show things differently.

David: But, in general, I agree that there isn't a slam dunk case when you look at convenience yields. However, here's my pushback. My pushback is that that's looking just at the price of the security. You have got to look at quantities too. So, if we can go out and just issue a lot of debt— and I'm going to argue proportionally more debt than the next country— and not see a big increase in the financing cost, maybe that's where we're getting our exorbitant privilege. Or are you still convinced it's a meager privilege instead?

Kamin: A couple of things. Number one, I think that our paper actually cited the paper by Diamond that you mentioned as indicating a not unusual convenience yield. To your point, I completely agree with the logic of it. If the United States was issuing so much debt that it was overwhelming portfolio holders, and would have raised interest rates a great deal were it not for the fact that the dollar was dominant, then you could imagine that, indeed, the loss of dollar dominance would lead to a very large increase in our interest rates. Well, a couple of things. Number one, we don't really have a good idea of what that elasticity is, of the interest rate, with respect to an expansion of the share of US liabilities in the global total, coming from our issuance rather than coming from their demand. So that’s number one, we don't know.

Kamin: Number two, because I'm interested in that issue, I have looked at different measures of the US impact on the liability shares. So, one thing you can look at is what they call the NIIP, which stands for Net International Investment Position. And the US has a very large and negative NIIP, equal to 65% of GDP. The only countries that have bigger ones are like Spain, Portugal, and Ireland, which is company you don't want to be in. And, because the US economy is so large, you could imagine that its liability has overwhelmed, again, global demand.

Kamin: But that NIIP is so negative— and has become so negative lately— mainly because our stock prices have gone up so much. And see, the net international investment position isn't just our debt, there's also foreign holdings of equity. So, when our stock price goes up, and foreign investors benefit, that actually makes our NIIP look more negative, which isn't really a good measure of our issuance. So, what I ended up retreating to was just thinking about it in terms of government debt-to-GDP ratios.

Kamin: By that measure, the US, depending on what measure you use, is around 100% of GDP. That's more than Canada and Germany, but it's actually less than Italy and Japan. By that measure, our debt issuance has not been exorbitant from a global perspective, and probably isn't pushing the boundaries of investors' willingness to accept it. So, I'm guessing that, absent dollar dominance, but still retaining the safety and liquidity of US Treasuries, our interest rates wouldn't go up that much.

David: So, as you can tell, Mark and Steve, I am a big champion of dollar dominance. That's why I brought you on, because I love the paper, but there are folks out there who are very critical of dollar dominance. They want to actually tax, maybe, people investing in the US, buying Treasuries, which I think is not a great idea. But they raise concerns about things like, "Oh, we're hollowing out the manufacturing base," or, at a minimum, we are unnaturally channeling our economy toward over financialization, more finance industry at the expense of, say, manufacturing or our tradable sector. And I'm curious as to what you think about those arguments.

Responding to Criticisms of Dollar Dominance

Sobel: I'll make one point on it that resonates with me because of my career at Treasury, [since] I had to deal with a different set of problems than Steve, at the Fed, did. We mentioned earlier the foreign exchange report, which, for me, was often a way to say, "Country X, you're behaving badly," without necessarily saying that you're manipulating, but whatever. So, the dollar is generally thought of as an overvalued currency.

Sobel: Those are impossible things to measure, but let's just go with it, it's overvalued. And what happens is that, in part because of the success of the dollar as a global currency, we run these current account deficits, and there's protectionist pressure that periodically arises, particularly when the current account deficit rises. We had challenges with China, but also massive German current account surpluses. And these were things that we had to deal with at Treasury, not the Fed.

Sobel: And so, we were dealing with these issues in the currency context, but it relates to the dollar's global role, in part. Now, the dollar could be overvalued because the United States is running a bad fiscal-monetary mix and whatnot. But it also could be because other countries are following harmful currency policy. So, that was an issue that we had to deal with in this context, one was, acutely, always on my brain.

Kamin: Let me start by noting that I think that, in my entire 33 years at the board, I don't know if I ever once helped to calculate the degree of overvaluation of the dollar. We actually never used that concept. We had a floating dollar, so there was no question of defending a peg, and modern economic science actually has no way of really identifying, with any certainty, whether a currency is overvalued or not, or even what that means.

Kamin: My guess is that a dominant dollar, again, because it raises the demand for holding dollars, would lead the dollar to be valued more highly than it might be otherwise. But, again, I'm not convinced that it would be by a very great margin. So, if you look at the history of US current account deficits, they averaged around 3% of GDP in the couple of decades before the pandemic; less than Turkey and Australia, a little bit more than the UK and South Africa, none of those countries having particularly dominant currencies. So, to the point of its impact on our manufacturing base, I'm skeptical that the overvalued dollar by itself would have led to that much of a loss of those types of jobs.

Sobel: Absolutely. And, of course, the process of de-industrialization has been going on in advanced economies for decades, to be fair, to the point you just made.

Kamin: Exactly. And most economists would attribute that— the loss of manufacturing jobs— to both technological progress and increased competition from China, their low-wage economies, more than dollar overvaluation. Then, you raised this other issue of whether it had contributed to the financialization of the US economy. And all I can say is that I think a lot of other economies, like the UK and Switzerland, have gotten a lot farther down that path than we have, again, without having particularly dominant currencies.

Sobel: You and I agree that the exorbitant privilege isn't exorbitant, there's a net benefit, but perhaps not great, and it's overdone. Both of us heard, throughout our careers, concerns about the dollar, dollar dominance, and whatnot. But, is it a net benefit to the world, to have dollar dominance?

Kamin: Well, I would argue yes, because… Well, let's step back. In a perfect economic world, every country would have its own floating currency, okay? But, they would transact fluidly with each other through foreign exchange markets. You wouldn't need a single currency, okay? Global trade and investment would grow, promoting prosperity around the world, if you like globalization. But that’s not the world we live in. Apparently, companies and financial institutions, for one reason or another, actually prefer, if they can, to deal in a single currency.

Kamin: And that single dominant currency has been the dollar, because that single dominant currency offers such safety and security of savings, of reserves, and because it offers a common unit of account in order to measure prices, as well as a means of transaction, it has promoted globalization, increased trade, increased investment, and I think that has redounded to the benefit of the global economy. Now, that need did not need to have been the dollar, per se. Some other currency [like the] pound sterling could have been the dominant currency, and the global economy might have gotten equally good benefits. But, the point is, it seemed to need one, and the United States provided it.

David: Well, I like that positive note. I agree with that, and I think we play a role to the world. We're a banker to the world. We provide financial intermediation to the world so that they can do what they do and escape poverty. Again, in Asia, over a billion people [were] lifted out of poverty. Now, maybe it would have happened with another currency or without the dollar, but we know for sure that it did happen with the dollar. And so, I think when you look at this big picture— Mark, so I'm glad you brought that up, what is the big net global picture for humanity, not just one industry in the US versus an industry outside? So, [this is] a great way to end the show. Our guests today have been Mark Sobel and Steve Kamin. Gentlemen, thank you for coming on the program.

Sobel: Any time.

Kamin: It's been a real pleasure. Very enjoyable discussing these important issues with you two.

About Macro Musings

Hosted by Senior Research Fellow David Beckworth, the Macro Musings podcast pulls back the curtain on the important macroeconomic issues of the past, present, and future.