The Exorbitant Privilege in a World of Low Interest Rates
by Joseph Joyce
The Exorbitant Privilege in a World of Low Interest Rates
The U.S. dollar has long enjoyed what French finance minister Valéry Giscard d’Estaing called an “exorbitant privilege.” The U.S. can finance its current account deficits and acquisition of foreign assets by issuing Treasury securities that are held by foreign central banks as reserves. The dollar’s share of foreign reserves, while falling, remains over 60%. But in a world of low interest rates, how exorbitant is this privilege, and is it solely a U.S. phenomenon?
John Plender of the Financial Times has pointed out that U.S. Treasury bonds offer a rate of return that matches or is higher than that of other government bonds with similar risk ratings. This is true whether we look at nominal returns or real rates of return. The nominal returns reported below are those available on the ten-year government bonds of Germany, Japan, the U.K. and the U.S., while the changes in prices are those reported for their Consumer Price Indexes :
Nominal Return | Change in Prices | Real Return | |
Germany | -0.05% | 2.0% | -2.05% |
Japan | -0.06% | 0.5% | -0.56% |
U.K. | 1.13% | 1.9% | -0.77% |
U.S. | 2.47% | 1.9% | 0.57% |
The bonds of other advanced economies offer higher yields but more risk. The rate of return on ten-year Italian government bonds is 2.68% and on Greek bonds 3.49%. An investor in government bonds can do better in Brazil (8.76%) or Mexico (8.09%), but these securities also come with the risk of depreciation.
Private foreign investors also hold U.S. Treasury debt as well as U.S. corporate securities. John Ammer of the Federal Reserve Board (FRB) , Stijn Claessens of the Bank for International Settlements (BIS), Alexandra Tabova (FRB) and Caleb Wroblewski (FDB) analyzed the foreign private holdings of U.S. bonds in “Home Country Interest Rates and International Investment in U.S. Bonds,” published in the Journal of International Money and Finance in 2018 (working paper here). They collected data for 31 countries where private residents held both U.S. Treasury securities and corporate bonds during the period of 2003-2016. They found that low domestic interest rates led to increased holdings of U.S. bonds, and in particular, corporate securities. The corporate share of foreign-held U.S. securities in these countries had risen to about 60% by the end of their sample period.
The “long equity, short debt” structure of the U.S. external balance sheet is not unique to the U.S. Robert McCauley of the BIS in “Does the US Dollar Confer an Exorbitant Privilege?”, also published in the JIMF in 2015, shows that foreign holdings of Australian government bonds have allowed that country to accumulate foreign currency assets. Some of these holdings were attributed to the desire of foreign central banks to hold safe and liquid assets.
U.S. Treasury securities possess an appeal besides their relatively attractive rates of return in a world of low interest rates. They are seen as safe assets, and given the size of the U.S. economy and the liquidity of its capital markets, it is not surprising that they hold a predominant role in the global financial system. But Pierre-Olivier Gourinchas of UC-Berkeley, Hélène Rey of the London Business School and Maxime Sauzet of UC-Berkeley have pointed out in “The International Monetary and Financial System” (NBER Working paper #25782) that the mounting size of the eternal debt of the U.S. may lead to a loss of confidence in the U.S. government’s ability to service it without engaging in inflationary finance or triggering a depreciation of the dollar. At the same time, the relative size of the U.S. economy in global output is shrinking while the demand for dollar liquidity is growing. They conclude that this may be the basis of a “New Triffin Dilemma.”
There is, however, another, more immediate danger. The U.S. reached its debt ceiling of $22 trillion on March 2. The Department of the Treasury can engage in various measures to continue paying the government’s bills until next fall. The White House wants to obtain a rise in the debt ceiling this spring before it has to engage in budget negotiations with Congress. But given the toxic relations between the Trump administration and the House of Representatives, the danger of a lack of agreement cannot be dismissed. The Trump administration promised to disrupt the global order, and the full extent of that disruption may have only begun.
The Eurasian oligarchs represented by Putin, the KSA represented by the crown prince(or the clown prince, you take a choice) with the UAE and Egypt in line, Lukud in Israel want the US to give up the world reserve currency status. A proxy trade war with China is the trigger right when corporate debt has peaked. A run on junk bonds sans a “trade war” with China was likely to happen anyway. Now it could happen this summer.
China leaves the dollar zone and allies with the oligarchs, KSA and Lukud to create a new world reserve currency with China using Japan as its filter. Much like Toyota saying the US is hostile to them, that is all newspeak. Japan will be isolated from the US on purpose.
The next phase is demolishing the pax americana via dissolvement of the IMF,World Bank and WTO syndicate while liquidating capital markets under the dollar. The amount of contraction the US will need to balance its books would be immense. At least a 25% in rGDP and 66% of all non-social insurance spending. All countries would be hit, but the US the hardest along with its little bundle in Europe taking it on the chin as well.
The US had a 20 year window of free liquidity while the chicks were for free…….they wasted it on self-gratification. Which fits Donald J Trump to a t.