Answer the Question:

1.What is the world's most popular investment? What is the connection between the world's most popular investment and the U.S. dollar?

2. From the foreign demand standpoint, which of the following is the most popular dollar denomination--$1, $5, $10, $20, $50, or $100? Why do you think that's the case?

3. Explain why printing the U.S. currency is such a profitable activity for the American

government?

4. According to Mr. Applebaum, by making the U.S. dollar available to foreigners, the American consumers benefit, but American exporters suffer a negative consequence. Explain this negative consequence.

5. Discuss the reasons why the U.S. dollar is the world's leading reserve asset?

6. Brad Setser, a senior fellow at the Council on Foreign Relations, in a research paper states that "Absent a catastrophic U.S. policy error, I would expect the dollar to remain the most important reserve currency for the next several decades." In your opinion, what would be some examples of a catastrophic U.S. policy error?

Will the U.S. Dollar Lose Its Place as the World's No. 1

Reserve Currency?

BY SCOTT REEVES [Newsweek, 2/5/21]

Some fear stimulus spending to offset the worst of the economic shutdown during the COVID-19

pandemic and the Federal Reserve's injection of billions into the economy threaten the U.S. dollar's

standing as the world's reserve currency.

Some investors have moved out of dollars and into gold. While it's hardly a stampede, it could be seen as

further evidence of the dollar's increasing weakness. Others see Bitcoin as an inflation hedge, and last

month investors drove the price of the cryptocurrency to $41,973, an all-time high.

Relax, a Cornell University economics professor said, because the dollar's place in the world economy is

secure.

"During this period of economic uncertainty and human loss during the global pandemic, the U.S. dollar's

role as the reserve currency of the world has been reaffirmed," Andrew Karolyi, the Harold Bierman, Jr.

Distinguished Professor of Management at Cornell University said in comments sent to Newsweek.

"There remains robust demand for U.S. Treasury securities at every auction, and approximately 40% of

the world's debt is denominated in U.S. dollars," Karolyi said. "It is hard to see this reserve status being

unseated as long as the size and core engine of the U.S. economy remains strong and the dominance of

U.S. financial markets in the global system continues."

An 'Exorbitant Privilege'

Valery Giscard d'Estaing, French Finance Minister, in the 1960s, said the dollar's standing as the world's

reserve currency gives the U.S. an "exorbitant privilege."

Demand for dollars allows the U.S. to sell bonds at a lower cost, reducing the cost of borrowing. High

demand means lower interest rates, because it's not necessary to pay more to entice buyers. As a result,

some have said that U.S. bonds are actually the world's leading reserve asset. Two World Wars and a

dynamic, innovative economy led to the dollar's dominance.

Historians have noted that the American dollar surpassed the British pound as the world's de facto

reserve currency in the 1920s, as England's economy struggled after World War I while the U.S. economy

boomed in the Roaring '20sat least, that is, until 1929.

The dollar's standing as the global reserve currency was formally established in 1944 at the Bretton

Woods Conference, when 44 nations agreed to create the International Monetary Fund and the World

Bank.

The Bretton Woods Agreement created a system of exchange rates. Signatories agreed to peg their

currency to the dollar, which was at the time convertible to gold at $35 an ounce.

But by the 1960s, the U.S. no longer had enough gold to back the dollars in circulation outside the

country. This led to fear that a run on the dollar would deplete Uncle Sam's gold reserves. In response,

President Richard Nixon took the dollar off the gold standard in 1971. About two years later, the current

system of fluctuating exchange rates had replaced the Bretton Woods Agreement.

The dollar remains the world's pre-eminent currency, and is widely used in international trade. Basic

commodities such as oil and copper, which are produced worldwide, are generally priced in dollars.

The price of oil is a proxy for future economic activity. During the height of the COVID-19 pandemic last

summer, the price briefly turned negative because demand had collapsed.

Copper is widely used in manufactured products and is a proxy for factory output, an indicator of

consumer demand. Price tells the story, and pricing commodities in dollars provides a quick gauge of the

economy.

But as the world's economy expands, the U.S. share of the pie grows smaller.

In 2016, Ben Bernanke, then chairman of the U.S. Federal Reserve, said the nation's declining share of a

growing global economy and the rise of the euro and yen mean nations other than the U.S. could also

borrow at low rates.

"The 'exorbitant privilege' is not so exorbitant anymore," he wrote.

But the rising wealth of other nations doesn't spell doom for the U.S. It doesn't mean the U.S. is getting

poorerjust that other nations are getting richer.

"Absent a catastrophic U.S. policy error, I would expect the dollar to remain the most important reserve

currency for the next several decades," Brad Setser, a senior fellow at the Council on Foreign Relations, a

Washington-based think tank, said in a research paper.

The world's major reserve currencies are the U.S. dollar, euro, Japanese yen, British pound sterling and

the Chinese yuan. Some reserves are also held in the Australian dollar, Canadian dollar and the Swiss

franc.

About 60% of foreign exchange reserves are held in U.S. dollars, the International Monetary Fund

reported. That suggests the greenback is likely to remain kingat least for the foreseeable future.

A Less Sanguine View

Gary Hufbauer, a nonresident senior fellow at the Washington-based Peterson Institute for International

Economics, a Washington-based think tank, said the dollar faces four long-term threats to its standing as

the world's key reserve currency.

The first is "profligate U.S. fiscal deficits," he said in comments sent to Newsweek.

Hufbauer called the second threat "the widespread use of dollar-based financial sanctions to punish

China, Iran and other 'bad boys' which in turn call into question the sanctity of dollar assets."

His last two threats come from overseas, with the third originating in the largest global rival to the U.S.,

with the "probability that China will take necessary steps to make the yuan a true rival to the dollar: free

convertibility, free capital flows, free floating, bank secrecy, cyber money."

Hufbauer's fourth threat is that the European Central Bank will take steps to make the euro an "attractive

reserve currency" challenging the dollar's dominance.

The Dollar's Current Strength

The strength of the greenback increases when investors exchange other currencies for dollars, and when

overseas investors buy American assets, including Treasury bonds and stocks.

During the 2007-2009 recession sparked by the collapse of the subprime mortgage market, the U.S.

economy recovered more quickly and more strongly than the rest of the world. As a result, U.S. Treasury

bonds were considered a safe haven, boosting prices and pushing interest rates lower, since bond prices

and yields move in opposite directions.

The dollar weakens when stagnant economy or heavy regulation leads investors to dump U.S.

investments and look elsewhere. In March 2020, the U.S. Federal Reserve, the nation's central bank, cut

interest rates to 0%-0.25% to encourage borrowing and consumer spending as the coronavirus pandemic

hit.

But there may be trouble, or at least a few bumps, ahead.

The Fed has said it will tolerate inflation of about 2% annually. Adjusted for inflation, that reduces the

interest paid on bonds and makes them less attractive to investors.

Tax revenue declined during the economic shutdown intended to curb spread of COVID-19,

while Congress spent billions on stimulus and the Fed injected billions into the economy by purchasing

mortgage-backed securities to keep credit markets working.

The Dow Jones Industrial Average, a measure of 30 major U.S. stocks, plunged about 8,000 points

between Feb. 12 and March 11, 2020 due to the COVID-19 pandemic. But stocks rebounded and the

Dow recently reached 31,138.41, close to an all-time high.

A bull market increased the wealth of many because more than half the U.S. population owns stocks

either directly or through a retirement plan. However, if the dollar loses its status as the world's reserve

currency, interest rates would probably increase and that might limit government borrowing. That and a

dose of inflation would drive up costs for consumers and businesses, increasing the price of cell phones,

housing, new construction and foreign vacations, for example.

When compared with most other currencies, the U.S. dollar has remained stable or gained value recently.

Some believe it's over-valued, but a minor decline wouldn't signal Armageddon.

However, the U.S. trade balance is worsening, especially with China, and the Federal Reserve continues

its policy of easy money.

"In my opinion, in the short to medium terms, rumors of the dollar's demise as reserve currency are

greatly exaggerated," Usha Haley, the W. Frank Barton Distinguished Chair in International Business and

Director of the Center for International Business Advancement at Wichita State University, said in

comments sent to Newsweek.

"Currently, no alternative safe havens exist for foreign investors," she said. Though gold has risen in

popularity, it serves primarily as a hedge against volatility: The price of gold has stayed roughly the same

over decades. Negative interest rates in Europe and Japan have made other major currencies

unattractive investments as well."

America's Most Profitable Export: Money

The world has a growing appetite for small green pieces of paper with Benjamin Franklin on the

front.

By Binyamin Appelbaum [New York Times]

America's most profitable export product is not oil or medicine or Hollywood movies or Boeing

airplanes. It is a small green piece of paper with Benjamin Franklin on the front.

Last year, the United States exported $65.3 billion of its currency mostly $100 bills.

The world needs an international currency, and the dollar is the obvious candidate because the

United States, for all its economic troubles, remains the hub of the global economy. United

States government debt is the world's most popular investment, and the bonds can be

purchased only with dollars. Oil is the world's dominant trade good, and it also is priced and sold

in dollars. Much like Facebook, everybody uses dollars because everybody uses dollars.

The popularity of paper dollars, however, requires a little more explanation. Most modern

money is notional: Wealth is stored on computers; payments are made electronically.

I cannot remember the last time I owned or even held a $100 bill.

Yet foreign demand for the bills known as Benjamins has surged even as the domestic use of

dollars has declined. The number of $100 bills in circulation roughly doubled between 2008 and

2017, and experts estimate a vast majority are in foreign hands.

Remarkably, the Federal Reserve recently reported that at the end of 2017, the number of $100

bills in circulation exceeded the number of $1 bills for the first time.

The available evidence suggests large numbers of $100 bills are stuffed in mattresses or other

hiding places particularly in nations where people lack confidence in the value of the domestic

currency, or the integrity of the financial system, or the safety of private property. Dollars are

hoarded like diamonds, except dollars are easier to spend.

Even America's enemies hoard American money: American soldiers searching one of Saddam

Hussein's palaces in 2003 found about $650 million in fresh $100 bills.

The $100 bill is the preferred currency for illegal transactions: gambling, drug deals, sales of

weapons. The economist Barry Eichengreen, the nearest thing to a biographer of the dollar, has

noted that movie villains usually demand payment in greenbacks.

There is obvious efficiency in using large denominations for the types of transactions where

payment must be delivered in a suitcase. But the 200 euro note, considerably more valuable

than the $100 bill, remains the least common euro note. Criminals want dollars.

Still, it is not clear why demand has doubled. The collapse of the Soviet Union drove a surge in

demand for American currency in the 1990s. Nothing comparable has happened recently. And

the dollar would appear to face growing competition from the euro, the currency of a region

with a larger total economic output than the United States, and the yuan, the currency of a

country whose economy is on pace to soon surpass the United States'.

Some experts predict the dollar's days of dominance are numbered. But experts have been

making that prediction for half a century. Meanwhile, the United States continues to crank the

printing presses at its plants in Washington and Fort Worth and to distribute dollars from

licensed warehouses in financial centers including London, Frankfurt and Singapore.

Printing dollars, after all, is a very profitable business. Ranked by value, greenbacks finished

second on the list of America's most valuable export products, just behind refined petroleum.

But exporting money is much more profitable. It costs the federal government around 14 cents

to produce a $100 bill, and a few more cents to send it overseas.

In exchange for each of those bills, the United States gets an interest-free loan of $100. At the

end of 2018, foreign holdings of American currency totaled $773.9 billion.

Demand for American currency hones a double-edged sword. By driving up the exchange value

of the dollar, it allows Americans to buy foreign goods and services more cheaply. But that

makes American exports more expensive for foreign buyers.

So far, it is a trade the United States remains more than happy to make.