Exorbitant privilege

The term exorbitant privilege (privilège exorbitant in French) refers to the benefit the United States has due to its own currency (i.e., the US dollar) being the international reserve currency. Accordingly, the US would not face a balance of payments crisis, because it purchased imports in its own currency. Exorbitant privilege as a concept cannot refer to currencies that have a regional reserve currency role, only global reserve currencies.

Academically, the exorbitant privilege literature analyzes two empiric puzzles, the position and the income puzzle. The position puzzle consists of 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 consists of the fact 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.[1]

Origin

The term was coined in the 1960s by Valéry Giscard d'Estaing, then the French Minister of Finance.[2] It is frequently mis-attributed to Charles de Gaulle, who is said to have had similar views.

Opposition in France

In the Bretton Woods system put in place in 1944, U.S. dollars were convertible to gold. In France, it was called "America's exorbitant privilege"[2] 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] In February 1965 President Charles de Gaulle announced his intention to 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. As it resulted in considerably reducing U.S. gold stock and U.S. economic influence, it led U.S. President Richard Nixon to end unilaterally 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.[3][4]

Research

Different attempts have been made across time to assess the validity of the exorbitant privilege hypothesis by estimating whether a statistically significant difference between the return on U.S. assets and liabilities exists. These endeavors encountered a major empirical problem in the unavailability of long time series on capital gains, which are required due to capital gains' volatility. In response to this issue, two approaches have developed: (1) the construction of long time series based on historical assumptions and (2) the focus on specific categories for which high-quality data exists.

In the academic literature, three waves of research trying to assess the existence of exorbitant privilege are distinguished by Curcuru et al. (2013). The first wave occurred during the pre-crisis Great Moderation[5] and found, following the first research approach, significant annual return differentials favoring U.S. claims in a range between 2.7% and 3.7%, with Gourinchas and Rey (2007a) and Lane and Milesi-Ferretti (2005) finding particularly large differences for returns on both equity and debt assets. The first wave method consists of estimating capital gains by calculating the difference between the annual change in the U.S. international position and U.S. net capital outflows. The residual change not explained by capital flows is assumed to correspond to the capital gain.

The second wave of research on the returns differentials literature, written during pre-crisis times and published during the crisis, emerged due to criticism of how the data was handled.[6] This criticism alleged inconsistencies in data revisions between stocks and flows, which were then (mis-)attributed to "Other changes". Consequently, it was argued that this estimation approach would not calculate capital gains, but rather the sum of capital gains and other changes. Another problem is the extent of gains in the FDI category, wherein data is estimated. The second wave addresses these issues and finds substantially smaller differentials, ranging from -0.7% to 0.6%, using the second research approach.

The recent availability of new data finally spawned the third wave of research on returns differentials.[7] This literature found comparatively high return differentials ranging up to 6.9% (Forbes (2010)) and attributed the difference more to differentials in capital gains than in yields (Habib (2010)). These findings have however since then come under criticism by Curcuru et al. (2013) who criticize Forbes (2010) for her focus on a sample situated in a period of solely dollar depreciation and Habib (2010) for using a first wave methodology. Revised estimates for Forbes (2010) accounting for the exchange rate effect find a difference of 4.6%, especially in FDI. More recent research by Curcuru et al. (2013) and Gohrband and Howell (forthcoming) estimates overall return differentials of 1.9% and 1.7%, respectively.

The phrase became the title of a 2010 book by economist Barry Eichengreen, examining the future prospects for the US dollar's dominance in international trade.[8]

See also

References
  1. Curcuru, S. E., Thomas, C. P., & Warnock, F. E. (2013). On Return Differentials. International Finance Discussion Papers, 1077, Board of Governors of the Federal Reserve System.
  2. Barry Eichengreen, Exorbitant Privilege: The Rise and Fall of the Dollar and the Future of the International monetary system
  3. Eugène White, Dominique Simard, Michael Bordo, La France et le système monétaire de Bretton Woods
  4. Margaret Garritsen de Vries, The International Monetary Fund, 1966–1971
  5. Cf. Obstfeld & Rogoff (2005), Lane & Milesi-Ferretti (2005), Meissner & Taylor (2006), and Gourinchas & Rey (2007)
  6. Cf. Lane & Milesi-Ferretti (2009), Curcuru, Dvorak & Warnock (2008), Curcuru, Thomas & Warnock (2009), and Gourinchas & Rey (2007b).
  7. Cf. Forbes (2010), Habib (2010), Gourinchas, Rey & Govillot (2010), and Gohrband & Howell (2010).
  8. Exorbitant privilege: The Rise and Fall of the Dollar and the Future of the International Monetary System http://www.oup.com/us/catalog/general/subject/Economics/International/?view=usa&ci=9780199753789

Literature
  • Curcuru, S., Dvorak, T., & Warnock, F. (2013). On Returns Differentials. International Finance Discussion Papers, 1077, Board of Governors of the Federal Reserve System.
  • Curcuru, S., Dvorak, T., & Warnock, F. (2008). Cross-Border Returns Differentials. Quarterly Journal of Economics, 123(4), pp. 1495-1530.
  • Curcuru, S., Thomas, C.P., Warnock, F.E. (2009). Current account sustainability and relative reliability. In J. Frankel and C. Pissarides (ed.). NBER International Seminar on Macroeconomics 2008. University of Chicago Press, pp. 67-109.
  • Gohrband, C.A., Howell, K.L. (forthcoming). U.S. International Financial Flows and the U.S. Net Investment Position: New Perspectives Arising from New International Standards, in: C. Hulten & Reinsdorf, M. (eds.). Wealth, Financial Intermediation, and the Real Economy. NBER.
  • Gourinchas, P.-O., Rey, H. (2007a). From world banker to world venture capitalist: The U.S. external adjustment and the exorbitant privilege, in: R. Clarida (ed.). G7 Current Account Imbalances: Sustainability and Adjustment. Chicago: University of Chicago Press, pp. 11-55.
  • Gourinchas, P.-O., & Rey, H. (2007b). International Financial Adjustment. Journal of Political Economy, 115(4), pp. 665-703.
  • Lane, P., Milesi-Ferretti, G.M. (2005). A Global Perspective on External Positions. NBER Working Paper Series, 11589.
  • Lane, P., Milesi-Ferretti, G.M. (2009). Where did all the borrowing go? A forensic analysis of the U.S. external position. Journal of the Japanese and International Economies, 23(2), pp. 177-199.
  • Lane, P., Pels, B. (2012). Current Account Imbalances in Europe. CEPR Discussion Papers, 8058.
  • Meissner, C.M., Taylor, A.M. (2006). Losing our marbles in the new century? The Great Rebalancing in historical perspective. NBER Working Paper Series, 12580.
  • Rogoff, K.S., Obstfeld, M. (2005). Global Current Account Imbalances and Exchange Rate Adjustments. Brookings Papers on Economic Activity, 36(1), pp. 67–146.
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