The temptation of dollar seigniorage
By Kosuke Takahashi
TOKYO - As the United States seeks to finance its ballooning budget deficits by
printing more US dollar bills, Japanese economists are increasingly concerned
that the excessive use of dollar seigniorage by US financial authorities will
further shake confidence in the US currency at a time when the world lacks an
alternative globally accepted currency.
The
US government projects that even
without the forthcoming US$825 billion fiscal stimulus package, the national budget
deficit to September 2009 will be $1.19 trillion, the biggest since World
War II, or 8.3% of gross domestic product (GDP). This amount is likely
to grow as the US government continues to rescue failed parts of the economy.
How will the US cope with its enormous and growing debt obligations?
Therein lies the issue of the dollar's international seigniorage as a savior
for the US national interest.
Seigniorage is the revenue that a government raises by printing money. Suppose
it costs one dollar to print a US$100 bill. As long as the world deems this
bill worth $100, the US government receives the revenue of $99 every time it
prints out a $100 bill (the difference being an approximation of the costs
related to producing the bills) and circulates it to the markets at home and
overseas. This is a perquisite of the US under the present world currency
system. Neither Europe nor Japan, among other major economies, can enjoy the
benefits of seigniorage globally because the euro and the yen have not become
international settlement currencies.
"The US is the only nation in the world, as the key currency nation, to have
privileges to earn huge seigniorage," Iwao Nakatani, a renowned economist in
Tokyo, wrote in his recent best-selling book Why did capitalism self-destruct?,
which is sparking a debate in Tokyo, the financial center of the world's
second-biggest economy, over United States-led global capitalism.
"If the FRB [Federal Reserve Board] or the US government issues dollar bills
and spreads them abroad, that's sufficient to earn enormous seigniorage - as
long as people around the world see the dollar's value as stable," he wrote.
In the book, Harvard-educated Nakatani made a "confession" by saying he had
been doing the wrong thing, surprising many Japanese by indicating that what he
had learned in the US had proved harmful to Japanese society. The easing of
regulations and the liberalization of markets in Japan had brought about an
American-style widening disparity between Japan's haves and have-nots and an
accumulated discrepancy between society's winners and losers, he pointed out.
Nakatani had been an ardent advocate of globalization and national structural
reforms since the early 1990s under the Morihiro Hosokawa and Keizo Obuchi
administrations. Nakatani's strong support of global capitalism later
influenced reform policies conducted by popular former prime minister Junichiro
Koizumi, a symbol of Japan's reformist policy, from 2001 to 2006.
Bernanke's views on seigniorage
It's intriguing to note what Federal Reserve chairman Ben Bernanke, then
Princeton University economics professor, said about seigniorage. He wrote in
his Macroeconomics textbook, co-authored with Andrew Abel, that the
government can print money when it cannot (or does not want to) finance all of
its spending by taxes or borrowing from the public. In the extreme case,
imagine a government wants to spend $10 billion (say, on submarines) but has no
ability to tax or borrow from the public. One option is for the government to
print $10 billion worth of currency and use this currency to pay for the
submarines.
If you replace the word "submarines" with "bailout funds", that will mirror the
present US situation.
Bernanke and Abel continue: "Governments that want to finance their deficits
through seigniorage do not simply print money but use an indirect procedure.
First, the Treasury authorizes government borrowing equal to the amount of the
budget deficit, and a correspondent quantity of new government bonds are
printed and sold. However, the new government bonds are not sold to the public.
Instead, the Treasury asks (or requires) the central bank to purchase the $10
billion in new bonds. The central bank pays for its purchase of new bonds by
printing $10 billion in new currency, which it gives to the Treasury in
exchange for the bonds."
This is what the Bernanke Fed is thinking of doing in the coming months and
years. It has already snatched up a big chunk of soured mortgage-backed
securities guaranteed by beleaguered mortgage-guarantors Fannie Mae and Freddie
Mac. Bernanke has also said the Fed may buy "longer-term Treasury or agency
securities on the open market in substantial quantities", using the Fed's
balance sheet and money-creation authority to aid the ailing US economy.
The latest Fed data showed the monetary base jumped to more than $1.7 trillion
this month, more than double from around $840 billion in August - a vertical
takeoff in the supply of dollars.
Temptation of seigniorage
The US economy has benefited from seigniorage by printing dollar bills to
finance a huge current-account deficit, for which the trade imbalance is by far
the greatest reason. This enabled Washington to take its expansionary monetary
and fiscal policy amid ballooning debts.
Unlike Japan, China and Europe, among other nations, the US did not have to tap
the market of its own goods and services desperately. Simply put, by just
printing money, it could get whatever it wanted from abroad, even without any
cash on hand. Instead, the spread of the US debt bubble overseas enhanced the
networking power of dollar hegemony, which in return boosted the power of
dollar seigniorage. This is all debt-forgiveness resulting from the dollar
key-currency system.
"Should the US Federal Reserve have properly managed money supply, being
conscious of the role of the world's central bank, today's financial crash
should have avoided," Nakatani wrote. "But in reality, Alan Greenspan, who had
served as Fed chairman for a long time, gave top priority to economic upturn
and accommodated the housing bubble. The dollar's oversupply continued. This is
the root cause of today's financial crisis."
The US dollar has strengthened against other major currencies, with the notable
exception of the yen, in the past months, even as the country has been at the
epicenter of the deepening financial crisis. Many currency analysts see risk
reduction among investors causing the money that US financial firms had
invested in the world to be repatriated to the homeland, triggering
dollar-buying.
But that dollar strength may not last. Once people around the world start to
think an excessive dollar supply will diminish the value of the currency, they
may start selling dollar-denominated assets all at once, causing devastating
damage to the world economy. This is why world leaders such as Japan's Prime
Minister Taro Aso have repeatedly expressed support of the dollar in the
international financial system, easing people's lingering concern over the
greenback.
Early signs of the worst scenario for the US are already beginning to show.
International demand for long-term US financial assets fell in November as
foreign investors sold Treasury, agency and corporate debt, a government report
showed on January 16. Net selling of all long-term assets in November was the
most since August 2007, as investors sold bonds issued by Fannie Mae, Freddie
Mac and other government-sponsored enterprises for a fourth month in the past
five.
"For the moment, governments around the world are supporting the dollar
key-currency system," said Masaki Fukui, senior market economist in Tokyo at
Mizuho Corporate Bank Ltd, a unit of Japan's second-largest financial group by
market value. "But there is still a deep-seated structural problem, causing
some concern. We can never say a dollar crisis won't come."
When risk aversion begins to abate, as will happen at some point, the Fed needs
to act quickly to drain excessive dollar supply, or money supply. Otherwise,
the dollar will be doomed and hyperinflation and economic bubbles will occur
once again, which could lead to a recurrence of the global financial crisis.
Should the US give in to the temptation of dollar seigniorage, as it has done
in the past, loosening money to feed debt bubbles, investors are well advised
to diversify their currency positions to hedge against dollar risk. This could
be yet another catalyst for undermining dollar hegemony, which the US for sure
does not want to see happen.
Kosuke Takahashi is a Tokyo-based journalist.
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