The Innocent Greenbacks Abroad: U.S. Currency Held Internationally

The U.S. dollar has been the most widely used international currency since 1945.The word currency has at least two related meanings that might confuse some readers. The first is that currency is a system of money used in a country or monetary area. For example, the U.S. dollar, Canadian dollar and Japanese yen are different currencies. Currency’s second meaning is money in the form of paper notes and coins. Under the second meaning, a $20 bill would be currency, but money in your bank account would not be currency. The dollar is the most traded currency on international financial markets, dollars comprise 60% of official reserves (i.e., foreign exchange reserves), and many traded goods, such as oil, are commonly invoiced in dollars. In addition to these commercial uses of the dollar and dollar-denominated assets, individuals in many parts of the world hold U.S. currency, i.e., paper money, both as a store of value and as a medium of exchange.These holdings of U.S. currency by individuals shouldn’t be confused with foreign government or corporate or individual holdings of U.S. assets, such as bank deposits, stocks and fixed-income securities. This blog postThe title of this post plays on Mark Twain’s book, “The Innocents Abroad,” which described his 1867 travels in Europe and the Mideast. explains the widespread use of U.S. currency and provides some simple, back-of-the-envelope calculations on the size of some of the benefits to Americans.

The rest of the world holds a great deal of U.S. currency, i.e., cash. Although the amount can’t be precisely tracked, the Federal Reserve Board of Governors recently estimated that foreigners held $950 billion in U.S. banknotes at the end of the first quarter of 2021, or about 45% of all Federal Reserve notes outstanding, including two-thirds of all $100 bills. Overall holdings of U.S. currency have grown rapidly, however, and overseas holdings of Federal Reserve notes would now be worth closer to $1.1 trillion if such holdings are still half of all U.S. currency.

Foreigners hold a lot of U.S. currency because they see it as a safer alternative to holding their local currency, which might be subject to high and variable inflation. So residents of countries that have less reliable institutions and more political and economic instability tend to hold more U.S. currency. This is good for them, as they get a reliable store of value and medium of exchange.

Americans Benefit from Foreigners Holding U.S. Cash

Foreign holdings of U.S. cash also benefits Americans because those foreign users must get that currency by selling U.S. residents labor, goods or services. If the cash never comes back to the U.S., then Americans have just exchanged pieces of green paper—which cost almost nothing to print—for valuable goods. This is a good trade for Americans. If the foreigner eventually uses the cash to buy goods and services from an American in the future—say in 10 years—then the foreigner has given America an interest-free loan for 10 years. This is also a good deal for Americans.

The benefits to Americans—the trade of goods and services for green paper—accrue directly to the Federal Reserve System, to which Congress has given the authority to create money, but indirectly to the U.S. government, to which the Federal Reserve System returns its earnings, net of expenses and dividends, and ultimately to the U.S. taxpayer. That is, foreigners’ holdings of U.S. currency allow the U.S. government to either increase spending or reduce taxes or borrowing.

Because foreign holdings of U.S. currency amount to an interest-free loan to the U.S. government, one can do a back-of-the-envelope estimate of the benefit to Americans of such foreign cash holdings. The quantity of foreign cash holdings is the annual size of the interest-free loan while the interest rate that the U.S. government debt typically pays would approximate the interest saved on that loan amount.

The U.S. currency supply has increased rapidly in recent years to about $2.28 trillion in September 2022.Government stimulus and precautionary demand from individuals during the COVID-19 pandemic likely drove some of the rise in cash holdings since 2020. If 45% of that is held abroad, foreigners are currently giving the U.S. government an interest-free loan of $1.03 trillion each year.

In the figure below, the green line plots the estimated benefit to U.S. taxpayers—interest that didn’t have to be paid on bonds—from currency held abroad by foreigners.The benefit equals the product of the interest rate, the foreign share of U.S. currency, and U.S. currency holdings outstanding. Changing interest rates and foreign currency holdings have shifted the benefit (green line) over time from about $14 billion to about $30 billion per year. The plunge in interest rates during the Great Financial Crisis produced the decline in 2007-2010 while the post-2010 growth was driven both by a fast-increasing total stock of currency, from $1 trillion in 2011 to $2.14 trillion in 2021, and by an increase in the share of currency held abroad, from 35% in 2011 to 45% in 2021.I infer the annual interest rate that the U.S. government pays on debt from the ratio of the annual interest expense to the publicly held debt. Of course, this ratio just provides an approximation. For example, the Fed’s bond purchase programs will effectively substitute the interest rate on reserves for the interest paid on some Treasury securities. The measure used here ignores that small inaccuracy, among others. Thus, the annual benefit from foreigners holding U.S. cash—in the tens of billions of dollars—is modest for an economy the size of the United States, but it is a real benefit.

Foreign Holdings of U.S. Currency Benefit American Taxpayers

SOURCES: FRED (Federal Reserve Economic Data), Federal Reserve Board of Governors and author’s calculations.

The Potential Costs from Foreigners’ Holding U.S. Currency

What about the potential costs? Wouldn’t the currency stimulate the U.S. economy if it stayed here? Might shifts in foreign cash holdings destabilize the economy? What happens if foreigners spend the currency on U.S. goods?

The answers to all these questions hinge on the fact that the Federal Reserve, like other central banks, can use open market operations—purchases and sales of securities—to offset movements in currency and keep providing the right monetary conditions to achieve the Congressionally mandated goals of price stability and maximal sustainable employment.Of course, central bankers can make mistakes in the amount of stimulus they provide because they misunderstand the true state of the economy or misjudge the effect of their desired monetary conditions on the economy. But trying to keep U.S. currency within U.S. borders would not help to avoid these mistakes.

Currency held abroad doesn’t change the amount of stimulus that the Federal Reserve provides because the Federal Reserve’s operating procedures will naturally tend to offset movements of currency into or out of the country. For example, in the unlikely event that foreigners decide to buy American goods and services with their dollars, thereby returning the cash to the U.S. economy, the inflow of cash would tend to temporarily raise demand for U.S. goods and reduce U.S. short-term interest rates, which the Fed would automatically offset under its normal procedures to maintain desired conditions in money markets.

Notes

1. The word currency has at least two related meanings that might confuse some readers. The first is that currency is a system of money used in a country or monetary area. For example, the U.S. dollar, Canadian dollar and Japanese yen are different currencies. Currency’s second meaning is money in the form of paper notes and coins. Under the second meaning, a $20 bill would be currency, but money in your bank account would not be currency.
2. These holdings of U.S. currency by individuals shouldn’t be confused with foreign government or corporate or individual holdings of U.S. assets, such as bank deposits, stocks and fixed-income securities.
3. The title of this post plays on Mark Twain’s book, “The Innocents Abroad,” which described his 1867 travels in Europe and the Mideast.
4. Government stimulus and precautionary demand from individuals during the COVID-19 pandemic likely drove some of the rise in cash holdings since 2020.
5. The benefit equals the product of the interest rate, the foreign share of U.S. currency, and U.S. currency holdings outstanding.
6. I infer the annual interest rate that the U.S. government pays on debt from the ratio of the annual interest expense to the publicly held debt. Of course, this ratio just provides an approximation. For example, the Fed’s bond purchase programs will effectively substitute the interest rate on reserves for the interest paid on some Treasury securities. The measure used here ignores that small inaccuracy, among others.
7. Of course, central bankers can make mistakes in the amount of stimulus they provide because they misunderstand the true state of the economy or misjudge the effect of their desired monetary conditions on the economy. But trying to keep U.S. currency within U.S. borders would not help to avoid these mistakes.