Board of Governors of the Federal Reserve System

July 05, 2022

The Fed’s Inaugural Conference on the International Roles of the U.S. Dollar

Ricardo Correa, Linda S. Goldberg, Robert Lerman, and Bo Sun

The U.S. dollar has played a preeminent role in the global economy since the second World War. It is used as a reserve currency and the currency of denomination for a large fraction of global trade and financial transactions. The status of the U.S. dollar engenders important considerations for the effectiveness of U.S. policy instruments and the functioning of global financial markets. These considerations include understanding potential factors that may alter the dominance of the U.S. dollar in the future, such as changes in the macroeconomic and policy environments or the development of new technologies and payment systems.

On June 16 and 17, 2022, the Federal Reserve Board and the Federal Reserve Bank of New York jointly hosted an inaugural conference on the International Roles of the U.S. Dollar, with the aim of garnering the insights of researchers, policymakers, and market experts on the evolving roles of the U.S. dollar, the consequences of these roles for the mandate of the Federal Reserve, and future prospects. The general view of conference participants was that the current status of the international roles of the dollar remains largely unchanged, consistent with prior updates in this Liberty Street Economics post, Goldberg and Lerman, and Bertaut, von Beschwitz, and Curcuru. Still, the importance of this strategic asset cannot be taken for granted.

Important Roles and Key Drivers

In his welcoming remarks, Federal Reserve Chair Jerome Powell discussed multiple benefits that the dollar's international role confers, including lowering transaction fees and borrowing costs for U.S. households, businesses, and the government. In addition, the dollar's broad use helps contain uncertainty and the cost of hedging for domestic households and businesses. For foreign economies, the wide use of the dollar allows borrowers to have access to an extensive pool of lenders and investors, which reduces their funding and transaction costs.

Chair Powell additionally noted that the global role of the dollar also creates financial stability challenges that can materially affect households, businesses, and markets, especially in periods of acute financial stress. In this regard, the Federal Reserve plays a key role in supporting the use of dollars internationally through its international liquidity facilities—the central bank liquidity swap lines and the Foreign and International Monetary Authorities (FIMA) Repo facility.

Providing a historical perspective, Professor Barry Eichengreen's keynote address focused on his research showing that the share of nontraditional reserve currencies has risen from almost nothing at the turn of the century to their current share of about 10 percent. Only a quarter of that share is accounted for by holdings of the Chinese renminbi, while the rest consists of currencies such as the Canadian dollar, the Australian dollar, and the Korean won. His research identifies three factors contributing to these changes. First, improvements in technology enable more foreign exchange market liquidity in nontraditional currencies, facilitating direct trades. Second, central bank reserve managers with larger portfolios have become more interested in actively seeking larger returns. Lastly, the low yields of traditional reserve currencies have incentivized such shifts.

A panel moderated by Linda Goldberg also focused on the status of the dollar as a reserve currency and on other important issues around the drivers and implications of the dollar's different international roles. The discussion started by noting that the dollar is a strategic asset of the United States. As such, U.S. financial and regulatory policy considerations since the Global Financial Crisis, as well as liquidity interventions, have taken into account the international roles of the dollar and the safe-haven status of U.S. Treasury securities.

The panelists, Hélène Rey, Menzie Chinn, Jeffry Frieden, and Arvind Krishnamurthy, raised diverse perspectives. Among the points highlighted is the multipolarity of the global trade network—with the United States as one of the key poles—while the international financial network has the United States as the single pole. In addition, the U.S. dollar's dominance makes the Federal Reserve's policy actions materially important for the global financial cycle.

The discussion also focused on the key properties of international reserve currencies and, in particular, their importance as hedges during episodes of economic disasters. The U.S. dollar is in this group of international reserve currencies, with material demand for U.S. dollar-denominated safe assets in good times reflected in capital inflows to the United States. However, the need to satisfy the demand for safe assets can lead to tensions if increases in sovereign debt levels affect the safety of such assets. Besides economics, the status of the U.S. dollar is also reinforced by geopolitical factors. Although fragilities in the bloc of countries in the West could affect the safety of dollar assets, U.S. dollar dominance is likely to prevail because of the self-reinforcing nature of the interactions between geopolitics, geoeconomics, and the dollar's financial dominance.

A second panel moderated by Lorie Logan addressed issues related to digital assets, with speakers Neha Narula, Hyun Song Shin, Rebecca Patterson and Paul Mackel. Panelists discussed questions such as whether certain technological aspects of digital assets, including central bank digital currencies (CBDCs), could change the advantages of the U.S. dollar or reinforce its various roles. Panelists generally agreed that technology by itself would not lead to drastic changes in the global currency ecosystem, as other factors such as the rule of law, stability, network effects, and the depth of markets are crucial for the advantages held by dominant currencies.

The current landscape for digital assets has tended to be more centered on retail investors for speculative purposes with movement toward institutional investors constrained by the lack of a regulatory framework. The development of CBDCs has also tended to be focused on domestic retail sectors and thus is not a threat to the U.S. dollar's international status, with the scope of cross-border CBDCs still quite limited. Panelists did not express material threats to the international roles of the dollar arising from digital assets in the short run, and suggested that digital assets could actually reinforce these roles over the medium run if new sets of services structured around these assets are linked to the dollar.

New Academic Research Expands on Conference Themes

Several academic presentations expanded on the themes of the conference. A number of the papers considered the role of U.S. Treasury securities as safe assets and arguments that are sometimes made about foreign investors being willing to receive lower returns on these securities to obtain liquidity and safety. Alexandra Tabova and Frank Warnock presented evidence repudiating the commonly held belief that foreign investors are willing to forego large returns in order to hold onto U.S. Treasury securities. Foreign investors do not earn lower returns on their U.S. Treasury securities holdings relative to U.S. investors after adjusting for risk.

Ester Faia, Juliana Salomao, and Alexia Ventula Veghazy examined granular European investors (PDF) and their demand for home and for international bonds, finding important differences in the securities holdings across private investors. For example, mutual funds and investment funds in the euro area are major investors in dollar denominated bonds. By contrast, pension funds and insurance companies tend to be nearly fully invested in euro- denominated bonds. These differences in portfolio composition may result from differences in investor mandates and regulatory hurdles. Differences in assets holdings and investments are also found among managers of official reserve portfolios, as R. Jay Kahn with coauthors find that countries that use reserves to manage their exchange rate (e.g., oil exporters) may be more likely to sell U.S. Treasury securities when demand for their exports decline.

The liquidity and safe asset roles of the U.S. dollar have been reinforced by some of the crisis period interventions of the Federal Reserve and other central banks, including the central bank swap lines and FIMA Repo facility. Prior research by Goldberg and Ravazzolo, using data from the U.S. perspective, shows that these international facilities supported the stabilization and normalization of financial market conditions, giving foreign officials and private market participants confidence to hold U.S. dollar-denominated assets. At the conference, Gerardo Ferrara presented results from work with coauthors using granular data from U.K. financial institutions and foreign exchange derivatives, showing that the central bank swap lines were effective at reducing dollar funding stress in March 2020 and benefitted U.K. households and businesses.

Monetary policy issues can also be related to the roles of the U.S. dollar, including the use of currencies in international trade transactions. In the paper by Sylvain Leduc with coauthors, an open-economy model is used to provide conditions for when cooperation and coordination among central banks could change the distribution of macroeconomic consequences for countries. In this setting, the country with the dominant currency does not internalize monetary policy spillovers across borders, which could result in greater exchange rate volatility, inflation, and output gaps in foreign countries.

As noted previously, the international roles of the dollar could be altered by the rise of other currencies or developments in digital assets. Christopher Clayton, Jesse Schreger, and coauthors note that foreign investors increasingly treat renminbi denominated assets as a substitute for safe developed-market government bonds, a theoretical result of a government strategy to build its reputation as an international currency issuer, while minimizing the cost of potential capital flight as it gains credibility. Still, the discussion of this paper emphasized that there remains considerable uncertainty regarding the Chinese government's stance in opening its bond market and commitment to be an international currency issuer. Asani Sarkar and Jiakai Chen focus on digital assets and argue that part of the demand for some cryptocurrencies, like Bitcoin, is driven by the desire to evade capital controls. Using information for China, the research shows persistent and statistically significant differences between Bitcoin prices in multiple exchanges and that it trades at a premium on Chinese exchanges relative to foreign exchanges.

These dynamic engagements at the Federal Reserve's inaugural conference on international roles of the dollar underscored the importance of this topic by highlighting key themes in research, financial markets and policy circles. Focus on this topic going forward will likely remain strong and center on how the U.S. dollar's international role is evolving, as well as key drivers and economic and policy implications for the United States and other economies.