The International Role of the U.S. Dollar

Mike Kaiman: Thank you so much. And good evening to all of you, both here in-person and online. Welcome to the Federal Reserve Bank of St. Louis for this evening’s event, Dialogue with the Fed, the International Role of the U.S. Dollar.

My name is Mike Kaiman, I’m a senior economic education specialist here at the Fed, and we are so glad that you can join us here this evening. We have a great turnout from those of us who are in the room, as well as those who are joining us on Zoom as well.

Tonight, we are very excited to hear a presentation about the international role of the dollar, and how the dollar’s standing impacts everything from investments to borrowing costs, to everyday prices.

In just a few moments, I will turn things over to Chris Neely, who will give this evening’s remarks. Following his presentation, we will take questions from those of you in the room and online.

Before I get started, though, I do have a couple of housekeeping chores to attend to. First, in the coming days, you will receive an email with a link to complete an evaluation of tonight’s event. Your feedback is very important to us, to improve our programming. So, I’d like to encourage you to provide your thoughts.

For our in-person attendees, if anyone requires a hearing assistance device, please speak to one of the members of our staff. We’re all wearing gold badges this evening. We can assist you with that.

During the Q&A session, for those of you who are in-person here tonight, please raise your hand to ask a question. Once I call upon you, there is a little microphone on your counter. If you just tap it, it will change color from red to green. That way, then we can hear you in the room. And most importantly, our online audience can also hear your questions. So we thank you for your cooperation with that.

For those of you who are joining us virtually, you can submit questions using Zoom’s Q&A function. Enter your question into the Q&A box, and then click Send. We may not be able to respond to every question, and submitted questions may be edited for clarity and length.

And so, with those housekeeping chores out of the way, I’d like to introduce our featured speaker for this evening, Chris Neely. Chris is a senior economic policy advisor in the Research Division here at the St. Louis Fed. He joined the Bank in 1993. His empirical research focuses on international financial markets, financial volatility, unconventional monetary policy, and market efficiency.

Chris has been published in leading academic journals, and has served in editorial roles for prestigious publications, including the Journal of Money, Credit and Banking and the Journal of Banking and Finance.

While at the Fed, he has taught economics and finance at several universities, including Washington University here in St. Louis, Saint Louis University, the University of Iowa, UM St. Louis, and the University of Hawaii. It is my privilege and my honor. Will you all please join me in welcoming Chris Neely.

[APPLAUSE]

Chris Neely: Thanks very much, Mike, I appreciate that. So, I’m going to probably wander around as I talk. And I should start out by noting the disclaimer that the opinions expressed are my own and not those of the Federal Reserve Bank of St. Louis or Federal Reserve System.

So, if I tell you that U.S. monetary policy is set by the Royal Council of Mars, there is no need to write your Congressman. It’s just my stupid opinion.

Now, I also want to thank Anna Cole for research assistance.

All right, what is next on the agenda? So, today, I’m going to talk to you about not what is happening with the dollar, not whether it’s up against the euro or down against the yen or whatever. I’m going to talk more about the long-term international status of the dollar and about in what ways that status is good for Americans or perhaps bad for Americans.

And to do that, I’m going to have to talk about the dollar-- I’m going to organize my talk around the dollar’s status, the dollar’s role in the three roles of money. So, there are three roles of money-- a medium of exchange, as a store of value, or a unit of account. And then I’m going to talk a little bit about competitors to the dollar and benefits to Americans of the global roles of the dollar.

Now I’ll notice that on some of on some of my slides, you’re going to see highlighted text. When you see highlighted text, pay special attention to that because that’s getting to the bottom line, getting to the main message of the text.

Now the three roles of money-- the three roles of money are as a medium of exchange, a store of value, and a unit of account. And when I used to teach money in banking or macro, I would teach this. And the medium of exchange role is basically the idea that money allows you to avoid the so-called double coincidence of wants problem.

So, when I go to the grocery store, I don’t have to find a grocer who wants to listen to a lecture about economics. I can just give the grocer dollars and get dollars from my employer, who wants to hear things about economics or wants me to talk about economics. So, money allows us to trade with each other in an easy way that avoids having to find people who want what we have to offer. It avoids the problem that we would have to find barter.

Second, money serves as a store of value. So, we know there’s inflation, but mostly money holds its value. When you toss your wallet on the dresser at night, you don’t have to worry about whether the money in it is still going to have value tomorrow morning or, for that matter, next week.

The third thing is money acts as a unit of account. So, money defines prices of all sorts. So, when we talk about how much something is, we ask how many dollars it is. Sometimes, you can find prices denominated in other things.

Back during the 1980s, when they were first building the B-2 bomber, and the B-2 bomber came in at a very, very high price, every news story seemed to be accompanied by a discussion of how much some program or some item would cost in terms of B-2 bombers. So, this Medicaid problem would cost-- or this Medicaid program will cost, annually, 6 and 1/2 B-2 bombers. I’m not really sure why they thought a B-2 bomber was such a good unit of account. But usually we use dollars, and that’s a lot easier.

Now English speakers use the same word for all three, but that isn’t necessarily the case. In other languages, they use that they use different words for, for instance, the unit of account versus the medium of exchange.

Now I’m going to take just a moment to digress on the word "currency." So, the word "currency" has two related but quite distinct meanings. The first meaning is used in, for instance, foreign exchange markets. So, in foreign exchange markets, the dollar is a currency, the yen is a currency, the euro is a currency. So, it means a type of money.

And the second type of meaning is physical cash. So, if I opened up my wallet right now and took out the little green pieces of paper, that would be currency. So, these are related meanings, but they’re not the same meaning. I don’t think you folks are going to have a difficult time determining which I mean when I use the word currency in this discussion tonight, but I thought I would let you know that there are two different meanings. And I will be switching back and forth.

So, let’s first talk about the dollar as a vehicle currency-- that is, as a medium of exchange. So, what are you going to learn? So, this summarizes what you’re going to learn in the next ten slides or so. And what you’re going to learn is that the dollar is used disproportionately in international transactions. And the that disproportionate use of the dollar will allow the U.S. to sanction other countries because they have to use our payment system to do business in dollars.

And the third thing you’re going to find out in a few slides is that U.S. currency held abroad is a valuable thing to Americans because it’s basically an interest-free loan from the rest of the world to the United States.

Now, if you don’t understand all that so far, that’s fine. We’ve got another ten or 15 slides to get through and, hopefully, in ten or 15 slides, that’ll all be clear. But I thought I’d tell you what I was going to tell you before I told you.

So, the dollar is used disproportionately in international transactions. So, for instance, 88% of foreign exchange transactions involve the dollar. The euro is in second place at 31%.

Now, for those of you who are mathematically inclined, you’ll notice that 88 plus 31 adds up to a number more than 100. So, I see the fella in the fourth row. He’s nodding. He’s with me.

So, that makes sense. That’s not an error. And let me explain why. Suppose that there were only two foreign exchange transactions in a year, one for $100 against the euro and one for $100 against the yen. What percentage of those transactions is the dollar involved in? 100%. It’s involved in both those transactions, so 100%. The euro is involved in 50%. The yen is involved in 50%. So, the numbers add up to 200%, two currencies per transactions.

Now that’s a very large number, considering that the U.S. trade is only about 9% of world goods trade in 2019. So, what is true is that the dollar is used even when no U.S. goods or services are involved in the transaction. So, when Poland is going to buy military equipment from South Korea, buy howitzers or something, the Poles will generally pay the South Koreans-- will go through dollars to pay the South Koreans.

Now it could be that the South Koreans would accept zloty, or it could be that the Poles will purchase won to give directly to the South Koreans. But either way, they’re going to use dollars to do that.

So, what are the most traded currency pairs? Here, now the numbers add up to 100%, not 200%, because we’re not talking about one currency, we’re talking about currency pairs. So, in my example before, I had one transaction in the dollar-euro and one transaction in the dollar-yen. And they were each 50% of the market. So, that adds up to 100%

So, the dollar-euro is 28%. The dollar-yen is 13.3. The dollar-pound is 11.3. Now notice that between just these three currencies, they add up to more than 50% of all foreign exchange transactions in the market.

So, why is there so much trade in the dollar? Well, the short answer is that there’s trade in the dollar for the same reason that I find it convenient, and the Bank finds it convenient to pay me in dollars. And I find it convenient to use the dollar to pay for my groceries. I mean, the Bank could ship me cases of beer as my salary. And then I might have to figure out someone to sell the beer to. And maybe I’d bring my grocer a case of beer, although that would be a little silly, since grocery stores sell beer.

My point is just that the dollar is used internationally in international trade much the way that domestic monies are used in domestic trade. They just make things cheaper and easier. It reduces the mutual coincidence of wants.

So, between World War I and World War II, the dollar and the British pound shared the role of being sort of an international currency. The dollar became dominant, however, at the end of World War II. The U.S. economy was almost 40% of nominal world GDP in 1960. By 2023, that share had fallen to about 27% in nominal terms, or about 15% in what’s called PPP adjusted terms.

So, what PPP adjusted terms means is that you take account of the relative price levels in two countries. So, when we, for instance, would account for U.S. income in PPP adjusted terms, if you buy a bowl of rice for lunch in St. Louis, we would adjust the price to count the same as if you bought that bowl of rice in rural India or some place where rice is much cheaper.

So, basically, the 15% just accounts for the fact that U.S. prices for most goods and services are going to be higher than in most of the world.

The point, however, is the U.S. economy was very large after World War II, as a share of world GDP. It’s smaller now, but still pretty big. And the U.S. also has free and stable financial markets. So, if you’re engaged in international trade, whether it’s trades in goods and services or trade in financial products, it’s very convenient to use and keep dollars because dollars are very easy and safe to move around. And you can find easy places to park your money for the short term. You don’t have to worry too much about capital controls and things like that.

Also, there are what economists call self-reinforcing network externalities. And by this I mean that when a market gets big, the costs in that market to do business in that market tend to come down. And when the costs tend to come down, then it tends to attract more business. So, the fact that the dollar is used a lot contributes to the fact that it’s used a lot. Sort of sounds like kind of a self-licking ice cream cone there, doesn’t it.

So, the U.S. payment system-- the U.S. payment system is probably one of the least appreciated, least understood aspects of economics. And I have to admit that I’m one of the people who don’t understand it as well as well as I should. However, the bottom line is that the dollar-- and I’ll explain this in a little more detail later, but the dollar allows the U.S. to powerfully sanction other countries. So, payments are boring but important. The payment system is arcane. Control of payments is useful for sanctions.

So, let’s talk a little bit about the payment system. So, there’s three aspects of the payment system. The first is FEDWIRE, which is a Federal Reserve settlement system for interbank transfers. The second is CHIPS, which is a private U.S. interbank clearance and settlement system. And the third thing, which is not really a part of the payment system-- which is not really a payment system per se, but it does assist the payment system is called SWIFT. It’s the Society for Worldwide Interbank Financial Telecommunication.

Now the differences between FEDWIRE and CHIPS are kind of technical. Whether you use FEDWIRE or CHIPS for a particular transaction kind of depends on the nature of the transaction. FEDWIRE is used for domestic payments. CHIPS is used for crossborder payments. There are differences in liquidity. But all three of these things are part of the payment systems in U.S. dollars.

Now, the important part of these things is that U.S. dollars are used a great deal in international transactions. So, for instance, again, if South Korea wants to sell military equipment to Poland, they’re probably going to be using dollars in the intermediate steps of that transaction one way or the other. And those payments in dollars are probably going to have to go through the U.S. payment system. They’re probably going to have to go through CHIPS.

Because of the fact that a great deal of international trade is done in dollars, and because the U.S. can control important aspects of the dollar payment system, the U.S. can use this payment system to sanction countries like North Korea, Iran, and Russia, countries that are doing things that we disapprove of.

And the problem for those countries is that such a sanction would reduce them nearly to international barter. So, if the U.S. isn’t permitting India to pay Russia for oil in dollars, then they have to think of some other way to pay Russia that involves basically barter. They have to send them something.

Now there is concern over overuse of such sanctions. And the argument about the concern about the overuse of such sanctions generally goes like this. If the U.S. uses its payment system unilaterally or even sometimes multilaterally to sanction other countries, then those countries are going to seek to evade the payment systems, to set up their own payment systems, to set up their own financial services. And that’s true as far as it goes. And that can be done. It’s not particularly easy. It’s not particularly simple. If it were, it would have been done 60 years ago. But it can be done.

But the problem with that argument is that it’s kind of a use it or lose it argument. If you’re not going to use the sanctions to-- if you’re not going to use the payment systems to sanction countries because you fear that it will cause them to set up their own payment systems, then what good does the payment system really do for you?

U.S. currency held abroad-- breaking out of the payment system and going to U.S. currency held abroad. So, here, by currency, I mean green physical pieces of paper. Now, about 45% of all U.S. currency, U.S. cash was held abroad in 2025 Q1. Now that 45% was a little bit over $1 trillion, and that was amounted to $3,033 for every American-- every man, woman, and child.

Now, if you do a little math, you can see that if 45% is $3,000, you can see there must be something close to $6,500 dollars of cash outstanding for every American man, woman, and child. And so if you’ve got a household of four or five people, that means, let’s see, 6,000 times 5, that means $30,000 in cash. I doubt very many people have $30,000 in cash sitting around their household. So, how do we explain this?

All right, first, let’s forget about Americans holding cash, and let’s just concentrate on the rest of the world. This is still quite a lot of money to be held in the rest of the world, and it’s held in cash. And why do people in other countries hold so much U.S. currency?

Well, basically, because they don’t trust their own domestic currency. They’re worried about domestic inflation. They’re worried about instability. They’re worried about their government doing something that will make their domestic money worthless.

Now, I should also note, don’t confuse this holding of cash with foreign exchange reserves. Foreign exchange reserves that we’ll talk about more later in the talk are basically government and corporate bonds that governments hold, central banks hold for emergencies. This is completely different. This is actually green pieces of paper stuffed under somebody’s mattress or stuffed in a trunk buried in the backyard, something like that.

Now how do they get this cash? Well, the cash is obtained basically through trade with the United States, either through U.S. tourists who come through, they maybe spend U.S. currency. Or maybe people sell exports to the United States, and they get a bank deposit and they exchange the bank deposit for currency, something like that. In any case, they’re giving us real goods and services in some fashion in exchange for green pieces of paper.

Now, this is a good deal. If the currency simply circulates in Peru or Iran or wherever it’s circulating, if it circulates forever there, they’ve simply given us goods and services for basically nothing. If it comes back someday, they’ve given us an interest-free loan for as long as they held the currency because you can think of currency as a special kind of federal debt, a special kind of bond that you can use to pay for things but that doesn’t pay interest. So, the United States as a whole gets an interest-free loan from people in other countries holding our currency.

Oh, and the value of the loan-- I don’t think I mentioned that-- the value of the loan currently is about $40 billion per year. So, in other words, if you take the amount of money that’s held abroad, which is about $1 trillion-- let’s use a nice round number. It’s about $1 trillion. And you take the amount of money that the government is paying on its debt, which, let’s say, it’s about 4%, 4% of $1 trillion, the interest that it doesn’t have to pay on this special debt, 4% of $1 trillion is about $40 billion. That sounds slightly more casual than the actual calculations I’ve done, but when you do a little bit more careful calculations, you get about the same number.

So, the dollar is a reserve currency. So, the dollar is used disproportionately for foreign exchange reserves. Now what are foreign exchange reserves? Well, foreign exchange reserves are safe assets denominated in liquid currencies. And by liquid currencies, I mean bonds. So, they’re mostly sovereign or investment-grade bonds held in case of war emergency or fiscal crisis.

Now gold and a special ersatz IMF currency called the special drawing right can also be part of foreign exchange reserves. So, the special drawing right-- you probably have never heard of it, but it’s kind of like an IMF accounting vehicle, where the IMF can give countries money and keep track of who pays who. It allows countries to basically borrow and lend in this IMF ersatz currency. And they don’t ever have to use real currencies like the dollar.

Quick story about the special drawing right-- a long time ago, I taught a business course at the University of Hawaii. And in this international finance course, all semester long, for some reason, I’ve got no idea, but I had a mental glitch that the special drawing right was called a strategic drawing right. I’m not really sure how I made that error, but I did all semester long.

Anyway, nobody ever raised their hand and said, “Uh professor, in my textbook, it says special drawing right, not strategic drawing.” But on the comments that I got at the end of the semester, one person was so mad about this whole strategic drawing right thing, you’d think I’d come to his house and killed his dog.

[LAUGHTER]

He was really mad about it. So, I want to get it right tonight because I don’t want anybody leaving here mad, slashing my tires, or anything like that.

So, special drawing rights are also-- gold and special drawing rights are also parts of foreign exchange reserves-- but mostly, they’re sovereign or investment-grade bonds. By sovereign, I mean government bonds. Now, countries that provide these foreign exchange reserves are usually countries with large, deep, and open economies and financial markets.

We’re going to talk about foreign holdings of U.S. assets. And you can split this problem up a couple ways. So, you can think about talking about two types of U.S. assets. You could think about talking about treasuries, or you could think about all U.S. assets.

And then you could think of two holders of the assets. You could think of foreign governments and their central banks. And you can think about all foreign holders, including those governments and central banks.

First, we’re going to talk about this square on the little table. We’re going to talk about foreign governments and central banks holding foreign exchange reserves, which could be treasuries but could be other types of U.S. assets. And then, later, we’ll talk about treasuries held abroad. So, I wanted to get that clear. For the next few slides, we’re going to be talking about foreign exchange reserves, which are U.S. dollar assets or other assets of other reserve currencies held by governments and central banks.

So, the total amount of U.S. securities in foreign exchange reserves, according to the IMF, is about $6.6 billion. And the total amount of foreign exchange reserves of all types are about $12.36 billion. Now, not all of that $12.36 billion is identified by currency. So, reserves identified by currency were $11.47 trillion. By the way, these aren’t billion-- did I say billions? trillions. This is another strategic special drawing right--

[LAUGHTER]

--faux pas. So, these should all be trillions. So, reserves identified by currency were basically $11.5 trillion. Now the U.S. dollar share of foreign exchange reserves has declined from 71% in 2000 to 58% most recently. And what sort of gained the difference? Well, gains by the Chinese currency, the renminbi, and gold and a smattering of emerging currencies explain the drop.

So, here’s a time series graph going from 2000 to, more or less, the present, late 2024 of foreign exchange reserves in various currencies. These are in billions of dollars. So, this is $2,000 billion. $2,000 billion is $2 trillion. $4,000 billion is $4 trillion and so on.

Now you can see that foreign exchange reserves rose substantially from 2000 to about 2015. And then they’ve kind of flattened out. Both dollar reserves and euro reserves have flattened out. And the reserves of these smaller reserve currencies, such as the yen and the pound sterling, have also kind of flattened out.

Now, when I say that these have flattened out since 2015, keep in mind that prices have still been rising. And this is in nominal terms. So, in real terms-- that is, inflation adjusted terms-- this would be falling.

Now here is the share of the allocated reserves. So, these numbers should add up to basically 100 or something-- actually, not quite 100 because I don’t have all the possible reserve currencies on here. But they should get close to it.

Anyway, so the dollar has fallen from 71% here in 2000 to about 58% here most recently. The euro share climbed initially but has come back down to about 20%. And the shares for the pound sterling, the Japanese yen, are hovering around 4% or 5%, and the renminbi is hovering at 2% or 3%.

So, I just showed you which currencies foreign exchange reserves are denominated in. And next, I’ll show you which countries hold the most foreign exchange reserves. So, we go from who supplies the reserves to who holds the reserves.

Now the People’s Republic of China, Japan, and Switzerland are the largest holders of foreign exchange reserves. Now, this, to some extent, makes sense. The People’s Republic of China and Japan are very big economies, I think, probably depending on how you measure it, they’re typically the second and third biggest economies in the world. Also, Japan is effectively running a sovereign wealth fund. That is, it’s basically using-- it’s basically investing in foreign assets in order to grow to make money. So, that’s one reason that it holds substantial foreign exchange reserves.

China holds substantial foreign exchange reserves, partly, maybe even largely, because it intervenes in its foreign exchange reserves. However, it probably also wants to hold reserves in case of emergency or war.

Switzerland holds very substantial foreign exchange reserves, and it’s a very small country, much, much smaller, of course, than either Japan or the People’s Republic of China. But it wants a very substantial reserves, basically, to be able to control its exchange rate.

So, here are the relative sizes of foreign exchange reserves. So, these numbers should add up to 100. So, China is about 40%, the People’s Republic of China. Japan is 14%. Switzerland is 10%. India is 7%, and so on. So, you can see, even by themselves, China and Japan hold the majority of the foreign exchange reserves in the world.

Now we’re going to switch to shifting to talk about all foreign holdings of treasuries. So, you guys remember before, when I showed you this table before, and we had just talked about foreign exchange reserves, now we’re going to talk about treasuries held abroad. We’re going to talk about by all foreign holders.

So, let’s talk about all foreign holdings of U.S. treasuries. So, most foreign holders of U.S. treasuries are governments or central bank. Private foreign parties can also hold U.S. treasuries. So, foreign parties hold about 35% of so-called privately-held Treasury debt. Now I want to warn you a little bit about the nomenclature here.

So, I’m going to use words like privately-held and publicly-held because this is what the U.S. Treasury calls these categories of holdings. If I were making up these words, this is not how I would describe them. But I’m going to try and explain what the Treasury means by them. I sort of feel obligated to stick to the Treasury’s nomenclature because if you folks go out and try to learn about this yourself, you’re going to run into the Treasury’s nomenclature, and you should know what it means.

So, foreign parties hold about 35% of privately-held Treasury debt. Now, what is a privately-held Treasury debt? Well, that’s debt held by the public minus Federal Reserve holdings. So, debt held by the public-- you might think the public is just like you and me and Microsoft Corporation, maybe. But you might not think it includes foreign governments, state, and local governments, but it does. So, debt held by the public includes debt held by foreign governments, state and local governments, and their pension funds.

Privately-held is basically excluding intra-U.S. governmental holdings. So, when they say privately-held, it means Treasury debt that isn’t held by another branch of the U.S. federal government or the Federal Reserve-- anyone but that. That’s what privately-held means.

So, foreign parties hold about 35% of privately-held Treasury debt. That figure was almost 60% in 2014. Now, that might sound kind of alarming to have such a big fall in foreign holdings of U.S. Treasury debt. And it might suggest to you that there’s a big decline in confidence in the U.S. government abroad.

I would argue that that may be true, but I don’t think that that’s evidence for it. What was going on was that there was a very high demand for safe, liquid assets, such as U.S. treasuries, in the mid-teens after the Great Financial Crisis of 2008-2009. That’s what was going on.

So, here’s a graph of that, that I just told you, with my yellow circle in the wrong place. I could explain to you how it got in the wrong place at the, but sorry. It should be around these two circles. It should just be a little few inches higher because I’m just trying to point out to you where we are now.

So, back here, in 2015, say, we were at about 60% of-- foreign holdings were about 60% of privately-held U.S. Treasury debt. But then that’s declined reasonably steadily since then. And it had increased since 2010 when it was just over 50.

Now, here’s foreign holdings of treasuries by country. I believe that this only includes foreign government and central bank holdings. So, the green line is kind of a residual category. It’s all the countries that aren’t otherwise on this graph. The dark red line is the People’s Republic of China. The blue line is Japan. The yellow line is the U.K. . And purple is Canada. So, you can see that foreign holdings of treasuries, especially for the People’s Republic of China, kind of peaked in, say, 2014 or so and has declined a lot since.

Now again, this doesn’t take into account inflation. If it took into account inflation and we were to adjust these numbers for inflation, this decline would be even bigger. Any questions? No?

Here’s a table with far too many numbers for a public presentation.

[LAUGHTER]

I really don’t know what I was thinking when I made this table.

[LAUGHTER]

But if the previous picture was a time series graph of many numbers, this next table is a-- it’s more of a snapshot at a point in time. So, what this is, as of June ’25, Japan was holding $1.1 trillion, so basically $1,148 billion worth of treasuries. And what percentage of total foreign holdings of treasuries is that 15%? It was 3.2% of treasuries outstanding and 4.7% of non-Fed, nongovernment-held treasuries, so privately-held treasuries.

So, if you look, the next one is the People’s Republic of China, $775 billion of treasuries. That’s 10% of foreign holdings, 2.1% of treasuries outstanding, and 3.2% of non-Fed, nongovernment-held treasuries.

So, what’s the point of all these numbers? Well, here’s the point: a lot of times, you’ll hear the argument that we should be worried in case, say, China calls in the debt that we’ve sold them. A couple of things wrong with this argument. First, Treasury debt isn’t callable. They can’t call us up and demand their money now. It gets paid out on a schedule, over time, and they can’t hurry it. They can sell the debt to someone else, but then that someone else has to wait. That’s one thing wrong with it.

The second thing wrong with it is that if they did do that, if there was a mass sale of U.S. Treasury debt, the first thing that would happen would be that the price of that debt would plunge. And so they’d be losing money on their own portfolio. They’d lose a lot of money that way. But you can see that, with all of these foreign holdings, basically, all these foreign holdings are only a pretty modest percentage of the Treasury debt outstanding.

Now here’s a question. So, you might think-- so the U.S. dollar and U.S. dollar assets are held disproportionately overseas for liquidity, for safety, and so on. And it would seem logical that these large holdings of U.S. debt pushed down U.S. yields. And it does seem logical to me. But when I use simple methods to look for evidence of this, I find it hard to see. So, I still suspect that the answer is yes, but I suspect that the effect isn’t huge.

Let me show you the simple methods that I used. So, to compare yields across countries, we would want to consider where the country is in the business cycle, what the expected inflation is, what the default risk is, and so on. So, to do a serious comparison would be somewhat difficult. But sort of an easy go around would be to compare long-term averages of yields across the yield curve for the U.S. government and for peer governments, governments of similar countries.

So, I was able to find this in the literature. And the data that I’m about to show you go from 1999 to 2020 and 2004 to 2020. So, what they did was they went out and they computed average yields on, for instance, 2-year, 5-year, and 10-year bonds for the U.S. in green, the euro area in blue, the U.K. in dark red, and Japan in this lighter red. So, you can see this group of bars here is all 2-year bonds from the yields on 2-year bonds, the average 2-year bonds for those countries. And you can see that, among these countries, the U.K. has the highest yields. The U.S. is second highest at about 2.6% or 260 basis points. And Japan has, by far, the lowest.

Now what’s the message to take from this? Well, looking at the 2-year, the 5-year, and the 10-year bond groups, one message is that it doesn’t look like the green line is particularly low compared to the other lines. In fact, it looks high-ish.

Now what if we adjust for inflation? One way to adjust for inflation is to take real yields. So, taking real yields compensates for expected inflation. Now, again, 2-year, 5-year, and 10-year bonds, now the green line not only doesn’t look short, it positively looks tall. So, this kind of simple exercise suggests that the U.S. doesn’t have lower yields but, in fact, it has somewhat higher yields than peer countries.

Now, I should tell you that the fact that the U.S. has such high yields in this is almost certainly due to the fact that the U.S. has higher expected growth than those other countries. Because if you look at how these countries line up in almost everything except for the 10-year, the U.S. has the highest yields, the euro area has the second highest average yields, and then the U.K. is third, and Japan is typically fourth except for the 10-year. And that lines up with expectations of growth in those areas.

So, there’s been a conventional wisdom that there’s been a Treasury yield premium. But using simplistic methods, I don’t find much evidence that U.S. yields are lower than those of their peers. There’s almost certainly expectations of higher growth in the U.S.. And there may be expectations of higher expectations of default. But it’s sort of hard with at least these simple methods to really show that U.S. yields are abnormally lower than they would be otherwise. I still believe it, but I just find it hard to show it with simple methods.

Now what to take away from this? Well, we don’t really know how much foreign holdings of U.S. bonds affect U.S. yields. Seems logical that they do, but hard to show how much. One thing I would caution you is that any U.S. Treasury yield premium would benefit taxpayers significantly. So, the total non-Fed-held nonintragovernmental-held U.S. debt-- in other words, what the Treasury calls privately-held debt-- is about $22 trillion in 2025. Now 10 basis points of interest rate on $22 trillion debt is $22 billion per year. So, 10 basis points is 1/10 of 1% interest rate. So, if U.S. Treasury bonds on average go from 4.5% to 4.4%, that saves $22 billion a year.

Here’s a thought experiment that I hear all the time. So, what if the People’s Republic of China decides to dump its dollar assets? Well, the motivation could be economic or it could be political. It could have something to do with some conflict. Such a decision would be very disruptive to bond markets in the short-term-- that is, over days or weeks. However, over months or years, it’s really not a big deal.

I did a sort of a back of the envelope calculation. I’ll skip my assumptions and how I did it, but I sort of took some simple estimates that were based on Fed announcements of quantitative easing that were done 15 years ago or so, and I used those, and I calculated that a $1 trillion treasury sale by the People’s Republic of China might raise U.S. interest rates by maybe five basis points across the yield curve, which isn’t a lot.

Commodities priced in dollars-- dollars as a unit of account. So, another thing that people are spend too much time worrying about, in my opinion, is that oil prices are priced in dollars. So, it’s not just oil prices, though. It’s prices of lots of commodities and lots of goods otherwise. So, people talk about oil a lot, but it’s really more than oil. It’s a lot of different commodities and prices.

Now why should this matter? Well, if oil prices were perfectly flexible, it wouldn’t matter at all because whether you price things in dollars or in yen or in oranges or whatever, if prices are perfectly flexible and they’re moving all the time, it doesn’t really matter.

However, prices aren’t totally flexible. There is some stickiness in how prices move. And so commodity prices tend to be a bit more stable in dollars than they would be otherwise. But I would add that, that doesn’t really matter. That’s not much of a benefit. I mean, if you’re going to the local gas station, and you see gas for $3.50 a gallon, and one week, it’s $3.75, and the next week, it’s $3.25, and then it’s $3.90, and then it’s $3.40, and then it’s $3.60, and you contrast that to where it’s $3.55 for all of those weeks, doesn’t really matter to you much, does it? It just kind of washes out, as long as the average is the same. The volatility doesn’t really matter much.

Competitors to the dollar-- so there are several competitors to the dollar. One is the yen. The yen is unlikely to rise rapidly and become a much more important competitor to the dollar in the near future, or even in the medium term, because Japanese markets are unusual. So, the Japanese have traditionally-- the Japanese authorities, the Japanese government, have traditionally resisted international use of the yen. So, while a lot of Americans are concerned that the international of the use of the dollar not decline, the Japanese weren’t all that excited about international use of the yen going up.

And the Japanese financial markets are kind of peculiar. They tend to be more regulated than most Western financial markets. So, the Japanese are just not all that interested in having the yen become a much more important currency. Now, of course, that could change in the future, but this has been true for the past 40 years or 50 years.

The euro came into being January 1, 1999. It was the great hope of the 1990s and early 2000. I cannot tell you how many articles I read in the financial press, how many papers I read that were explaining how once the euro came along, it was the end for the dollar, and everybody was going to use euros, and you guys better all start learning French or Portuguese or whatever.

And that never happened. And the reason that it never happened is that the euro debt crisis in 2011-2012 revealed a fundamental weakness in that European governments only collectively control the euro, and they don’t have a-- because all European governments are fiscally at least somewhat independent-- yes, there are treaty strictures and supposed to be guidelines and rules and so forth, but in practice, they’re all somewhat independent.

They all issue their own bonds. French bonds don’t have the same default risk as Greek bonds. Greek bonds don’t have the same default risk as German bonds. So, there are fragmented bond markets. That reduces the appeal of the bond markets because remember, we talked earlier and said how if you have a big market full of homogeneous goods, you can get transactions costs down quite low. But if you’ve got heterogeneous goods, then you’ve got different products, and so costs are going to stay up.

So, the fragmented bond markets reduce its appeal. And another thing that reduces the appeal of holding euro-denominated bonds and instruments is that it matters where the instruments are or who issues the bonds or what banks the accounts are in.

The renminbi, the Chinese currency-- so traditionally, People’s Republic of China-- financial markets are highly regulated. And there’s a big fear of capital controls. There’s a limited bond market. If it weren’t for the great political strength of the Chinese government, you wouldn’t even hear any discussion of the renminbi being talked about as an international currency. It is included in, for example, the IMF’s basket for the special drawing right-- don’t say strategic drawing right-- the special drawing right. And that was done for basically political purposes because the Chinese government said we would be highly offended if you did not include it. So, it is included as a small proportion of the SDR basket.

But it’s a highly controlled currency. The financial markets are highly-regulated. Until that changes and until there’s perhaps greater trust in the Chinese government, then it’s not going to become a serious competitor to the dollar.

Crypto-- everybody’s favorite. Crypto was invented in 2008. You know what the total crypto market cap is? It’s $3.3 trillion. So, I can’t remember what the S&P 500 or what the NYSE market cap is. But it was something like $60 or $70 trillion in that area. And that’s just one market in one country-- one equity market in one country and so on. So, $3 trillion is like nothing.

And I give this argument to people, and people say, well, crypto is very young. When the iPhone first came out, you didn’t know what it was going to do. And then, a year or two later, three years later, you’re using it for everything. And you don’t know what you do without it. Fair enough. Absolutely true. However, this came out at about the same time as the iPhone, and by 2010, I knew what I was going to use my iPhone for most of the time. I still don’t know what I’m going to use Bitcoin for. And by the way, this total market cap of $3.3, that’s all cryptocurrency. Bitcoin, which is easily the largest, is only $2.2 trillion.

All right, benefits to Americans of the global role of the dollar-- so we get an interest-free loan from people in other countries holding U.S. currency. I was about to say foreigners, but that seems kind of rude. People in other countries holding U.S. currencies-- that’s about, I would say, about $40 billion per annum at current interest rates and current levels of holding.

Because the dollar is used so much in currency trading, we have slightly lower transactions costs in currency trading. I want to emphasize that that’s only a very marginal advantage because you know I was giving you the example of Poland buying howitzers from South Korea before? Well, I haven’t looked at this in many years, but 10 or 15 years ago, currency bid ask spreads were for large transactions, like you’d do for a commercial transactions, currency bid ask spreads were down to 1/100 of 1%. They’re razor thin. So, they’re not quite 0, but it’s not much.

We have probably moderately more stable commodity prices than if they were measured in another currency. And there might be slightly lower yields on federal borrowing, maybe, although it’s hard to find evidence for that. And we have the ability to sanction adversary nations through the payment system, which is one of the less understood but probably one of the more important-- perhaps one of the more important advantages.

All right, summary-- finally got to the end. So, the dollar plays an outsized role in international economics. It’s the main vehicle currency. It’s used in 88% of foreign exchange transactions. Dollar-denominated assets comprise 58% of foreign exchange reserves. It is, however, difficult to see an obvious reduction in U.S. Treasury yields. I tend to think it’s there, but I tend to think it’s probably pretty modestly sized.

U.S. currency-- cash is widely used. About $1 billion is held abroad. And that’s of some use to us because it constitutes an interest-free loan. Many commodities and tradable goods are priced in U.S. dollars, which is good because it saves us a little bit of money in trading costs.

However, the overall benefit of the dollar’s status to the U.S. is pretty modest-- even, you might say, marginal. So, when people say that it would be a disaster if the dollar were to lose its preeminent status, I would say that that’s sort of true, but the reason it’s true is that if the dollar did lose its preeminent status, the reason it would do so is because crazy policies by the U.S. government caused it to lose its preeminent status. So, the circumstance that caused it to lose its status would be the real problem, not the loss of the status itself.

And I’ve also heard the argument that says something like, well, look at Britain. Before World War II, Britain was pretty rich. And then the pound was important. Or maybe they go back to World War I, and the pound was important. And then after that war, the pound was no longer important. And they became, at best, a middle income country. And they no longer have the global empire and so forth.

Well, that’s conflating a whole lot of different things. It’s conflating destruction from the war. It’s conflating huge expenditure on the war. It’s conflating the loss of their empire. So, I don’t really find that argument all that persuasive.

So, here is some readings if you’re interested in the dollar. There’s an essay on the dollar by people at the Board of Governors. There’s this book by Paul Blustein on King Dollar that I reviewed, and then I’ve got a few of my own pieces thrown in there. Ken Rogoff wrote a book about the dollar relatively recently. And Juan Zarate, if you’re particularly interested in the payment system and the use of sanctions, probably the best place to go right away would be to Juan Zarate’s book.

So, all of these slides should be somewhere on our website. And the data, to the extent that we can provide it, to the extent that it’s publicly available data, will also be with the slides.

[APPLAUSE]

Mike Kaiman: So, we’re going to take questions for a couple of minutes. Remember, if you are watching online, go ahead and put those questions in the Zoom Q&A. Make sure you hit Enter. And Ellen will be moderating those and getting my attention here in just a little bit.

For those of you who are in the room, we will take questions in just a moment. I’ll recognize you. Please make sure that you hit your little microphone button, and that it goes from red to green. That way, then everybody online and in the room can hear you.

But before I do, since I am moderating, I guess I do get to ask the first question. So, rank has its privileges. So, you basically spent an hour saying, “oh, don’t worry about China selling off debt.” “Don’t worry about if oil is not using dollars.” All of that’s well and good and very reassuring. What does worry you when it comes to the dollar and its role in the international?

Chris Neely: So, the first thing I should say, China selling off U.S. debt doesn’t worry me in the long run. It would worry me a lot, for two reasons, if it actually happened. First, it would just be a giant event in bond markets. And it would cause financial markets to seize up. And U.S. monetary and fiscal authorities, I imagine, would probably have to intervene if they did it rapidly. And the second reason it would worry me is that it would indicate severe political tensions between the U.S. and China.

So, I don’t want anybody to leave here saying, “oh, the guy from the Fed said it’s no big deal if the Chinese decide to sell off all their treasuries.” That’s not quite what I’m saying. I’m saying that in the longer run, after the hubbub dies down, it’s not that big a deal economically. It would still be, certainly a big deal in the short run.

What does worry me? The U.S. fiscal situation worries me. And it worries me primarily because there doesn’t seem to be any sort of off-ramp It isn’t just how big the U.S. debt is, although it’s gotten quite big. There are developed countries that have bigger debts, like Japan and Italy. What really worries me more is that there’s no off-ramp There’s no plan to reduce the deficit, get the debt under control and so on. That worries me.

Kaiman: All right, questions in the room. I saw a couple of hands. Sir, go ahead. There you go. There you go.

Audience Member #1: Is BRICS adversely affecting the international use of the dollar? And would the inception of BRICS account for why China is not buying as many of our treasuries? And does BRICS also limit our ability for sanctions?

Neely: So by BRICS, our questioner means the group of Brazil, Russia, India, China, and South Africa. And they have formed a bit of an economic, informal organization that has expressed resentment about the U.S. dominance in the economic system.

Now, in terms of the questions, are they affecting the international use of the dollar? No, not really. They have, I think, attempted to get together their own payment system, which probably will continue to grow, but doesn’t really matter all that much. If you didn’t know it existed, you couldn’t find it in the data. Am I missing a question?

Audience Member #1: Does it affect the ability of the U.S. to wage sanctions, like against Russia?

Neely: Well, it helps them trade with each other. So a payment system that they would have amongst themselves would certainly help them trade with each other. I don’t know how effective that payment system is. I assume it’s somewhat effective because there’s nothing magical about payment systems. So it helps them trade with each other.

On the other hand, it doesn’t help them trade outside of each other. And I’m just making this up, but if Russia can only sell oil to one country, say to India, then that limits its market. It limits the price it can get for that oil.

Questions online before we go back to the room?

Ellen Amato: Yeah, we’ve got a few. And I’m just going to go ahead and start with this one because I understand, from my limited understanding of this, this is a unique situation. “Can you explain the Federal Reserve’s arrangement with Panama and Ecuador to use the U.S. dollar as their currency?”

Neely: No.

[LAUGHTER]

Amato: Thanks so much, Chris.

Neely: I couldn’t tell you what’s involved in the arrangement. In some sense, they don’t need our permission to use our currency. They can just get cash.

Amato: Apparently, we ship them money.

Neely: Yeah, no, I believe that. It’s good for us if we ship them money. But I don’t know exactly what’s involved in the arrangement.

Kaiman: So a hand. Yes, sir.

Audience Member #2: I’ll follow up on this gentleman and maybe this lady’s comment, too. So right now, the Federal Reserve, the United States government, enjoys this dominance in foreign currency reserves and foreign currency FX transactions, and dare I say, not only enjoys the dominance, but maybe a dependence on those same functions as a place that’s going to hold our dollar in the way of non-interest bearing reserves of United States government Federal Reserve notes, the $20 notes, and all the accumulation of those.

So that’s a statement, not a question. But I think you stated earlier, I think in slide 10 and then again--

Neely: Could I interrupt you? Because it may affect your question. So foreign exchange reserves are interest bearing. They’re bonds. When I was talking about non-interest bearing, I meant literal currency.

Audience Member #2: Most of the foreign currency reserves come from the fact that we run huge budget deficits, maybe $50 billion a month, and the accumulation of those huge budget deficits, so eventually - so if you’re like China, and you get a whole bunch of $50 billion months of negative trade with the United States, how long do you want to own Federal Reserve $20 notes that don’t pay you interest, so you exchange them for United States government treasuries, as opposed to Federal Reserve $20 notes that do pay interest?

And so they decide to hang on to reserves because as you said in your illustration, they get 4% interest, where $20 notes don’t pay interest. So it’s a voluntary conversion of our pieces of paper-- quoting you-- our piece of paper to interest-bearing pieces of paper, electronic registries probably, but nonetheless, pieces of paper. So I’d rather have 4% than nothing.

I’m interested in your comment about using sanctions, though, because I think one of the benefits that you go over several times is liquidity and use of U.S. currency as reserves, both in reserves and in some tweaking of the interest we pay, maybe. But then the actual hundred dollar bills floating around in other people’s backyards, we get interest-free loans with that.

If we mess with the SWIFT too much or the other currency exchanges, and we use some sort of sanctions, won’t that essentially encourage people, like the aforementioned trading blocks, to develop, as you said, alternative systems for international trade, and if so, limit our liquidity, ability to function in international markets more than we are today-- how much, I don’t know, but more than we are today-- by forcing people into alternative trading systems? If we kick Russia out of SWIFT, they’re going to find someplace else to do.

Neely: Yeah. So. the answer to - so let me try and rephrase--

Audience Member #2: Please.

Neely: --see if I understand it correctly. So your question is, by using the payment system to impose sanctions on countries, won’t that encourage them to develop their own payment systems, and perhaps use the dollar less for international trade? Yes, it will. And they may do that. And that kind of, will only, will have barely any effect on the United States.

Audience Member #2: Your analysis suggests maybe 10 basis points advantage. And maybe this is only another 10 basis points, and only another basis points here or there. And pretty soon, we have real money because we’re dealing with trillions of dollars.

Neely: So, so having an alternative payment system wouldn’t be ... there are several different ideas floating around here. Let’s see if we can decompose them because I think your question’s involving three different things. And I want to make sure we’ve got those separate in our heads. The first is, people in other countries holding green pieces of paper under their mattress or using those things for transactions.

That’s an unalloyed good for us. All it means is, we’re getting an interest-free loan, that’s probably a permanent interest-free loan, okay - so that’s good. And we’re about done talking about that.

Second thing is, the U.S. is running trade deficits, and very large ones, too. And the counterpart of those trade deficits ... a trade deficit is when we get more goods and services from abroad than we send them. And the question is, “why in the world would people in other countries send us goods and services and not expect equal stuff back?” Well, the answer is, we’re sending them assets back. We’re sending them stocks and bonds and claims on future income back.

That is not necessarily an unalloyed good because in the future, we’re going to have to, at some point, pay off on these assets. So that’s true. And I want to make sure everybody understands: I’m not claiming that when the U.S. runs trade deficits sets that it’s an unalloyed good or that that’s somehow a freebie for the U.S. economy. It’s not. We’re going to have to pay it back in the future.

The third question that you asked was about the payment system, and whether having a payment system, using this payment system to sanction other countries, won’t encourage other countries to develop their own international payment system. Yes, it will. I’m not sure that’s really a reason to not do it though, because having them in our payment system is not really, necessarily, that helpful. It doesn’t&mellip;

Having them develop their own payment systems is primarily bad for us because it allows them to evade our sanctions, not because it actually does anything bad to our economy. I’m trying to think of an analogy, but I’m having a hard time coming up with an analogy. Having them develop their own payment system is bad for us because it helps them evade sanctions. It doesn’t really hurt us economically, though.

Kaiman: We’ll take more questions in the room in just a moment. We did ask for questions when people registered. And there was one thing—

Neely: Maybe we—

Kaiman: Oh, yeah, yeah. Go ahead.

Audience Member #3: Professor, tell us: walk us through. You mentioned Italy. And so countries with high deficits as a function of GNP tend to have higher interest rates. So the U.S. has higher interest rates because the level of our debt is greater than our GNP. Look at the anomaly of Japan, and walk us through the sovereign wealth fund.

They have large deficits as a function of GNP. But the two-year rate is almost negative according to your graph. Walk us through what that’s about and what the sovereign wealth fund actually does to give them the opportunity to have low interest rates in an environment with very high debt to GNP.

Neely: All right. I don’t have any graphs or anything here. So you guys will just have to bear with my verbal description. I literally said this yesterday, in a seminar, to a speaker here. And he agreed with me. He knew it before I said it.

The first rule of international comparisons is that whenever you do an international comparison, Japan is an outlier. Japan’s always unlike other groups of countries. And it’s also unlike other groups of countries because people think of Japan as having a strong, highly developed economy. And it does. And it has a high standard of living.

It also has an enormous debt. I would have to look up what the size of the debt is. And it depends on how you measure it, but it’s enormous. It is somewhere in the neighborhood, depending on how you measure it, of twice the U.S. debt-to-GDP ratio. And we all know how worried we are about ours. It’s the biggest in the world with the possible exception of Italy.

OK, so how does that work? Well, Japan’s different. Japan is able to sell a high proportion of its debt domestically. It has a high savings rate. It has an unusual demographic structure. And this debt, by the way, predates this sovereign wealth fund.

The sovereign wealth fund’s maybe about 12 years old. And I’m not sure that they actually call it a sovereign wealth fund. But it’s functioning like a sovereign wealth fund. But it’s only about 12 years old. And the debt long precedes that.

Japan, despite this enormous debt, has very low interest rates. And the reason why it should, in some sense, not have very low rates is that with such a high debt-to-GDP ratio, there should be concern that Japan is going to default on its debt.

But for some reason, whether it’s because of the high ratio of debt held domestically or because of just high confidence in the Japanese government, despite the high debt, Japan has very low interest rates.

Part of the reason it has very low interest rates is that it has very low growth prospects. So, it’s got shrinking demographics. It’s got an aging population, a shrinking population, frankly.

So, it ends up with very high debt-to-GDP ratios, but at the same time, practically 0% inflation for long periods of time and very, very low interest rates. There would be a lot to unpack there. And I don’t have a ready-made lecture on this. But it’s a very interesting case study.

Audience Member #3: Thank you.

Kaiman: Ellen, question online. I think we got time for one more. You know what? I’ll take a question.

Neely: By the way, for people who missed their questions here, I’ll sit here until everybody’s gone. So, I’ll sit here and talk to people until everybody’s gone.

Kaiman: Yes, ma’am. You’ve been patient. Go ahead.

Audience Member #4: Sure, yeah. Thank you, Chris, for the great presentation. I’m Jenny from Washington University in St. Louis. You talked a lot about how you’re concerned about the large debt balance in the US. So going back to that question, what’s been talked a lot about, I guess the debt balance in the U.S., especially this year, it’s how AI can potentially solve the issue via the increase in productivity. So I’m just curious about your view on the role that AI plays in the U.S. debt balance, as well as, maybe how the issue concerning AI can potentially be similar to the earlier dotcom bubble.

Neely: So it’s interesting that you ask that question because I’ve been thinking a lot about AI for the past week. But I haven’t been thinking about it in economic terms. I just read a book called If Anyone Builds It, [Everyone] Dies. And it’s about super-intelligent AI and what a danger it is to everybody.

So leaving aside the possibility that AI is going to kill us all in the next few years, if it doesn’t, then yeah, I would think it would be a tremendous productivity boom. It’s going to solve problems that we weren’t able to solve. It’s going to do many jobs that people weren’t able to do, do many jobs that people are able to do, but do it for a fraction of the price. And of course, then you get into the question of well, isn’t it going to cause massive unemployment then?

Well, whenever there’s productivity increases, there’s going to be unemployment in the sector that’s hit by the productivity increases. And the economist in me says that those resources should be shifted to other sectors that AI can’t do relatively well, sectors that involve working directly with people, working with your hands, maybe.

But really, this is going to be a huge dislocation, probably a huge gain in productivity. And maybe it’ll kill us all, too.

Kaiman: Well, on that happy note, I’d like to thank everybody. Please give them a nice warm round of applause. Chris Neely, everyone.

[APPLAUSE]

Kaiman: We do have just a couple of notes here before we wrap up for the evening. Once again, for those people in the audience, we were so pleased that you could come here this evening. I hope you enjoyed the presentation. If you missed any part of the program or want to listen to it again, the recording will soon be available on our website, stlouisfed.org.

As I mentioned at the beginning of my remarks, at the beginning of the session, please watch your email for those details, that survey, and some follow-up materials that we have from tonight’s event. And once again, thank you so very much for coming. Have a lovely evening. And we will see you next time.

[APPLAUSE]

Kaiman: Thank you, Chris.