William C Dudley: Panel remarks at the 7th High-Level Conference on the
International Monetary System
Panel remarks by Mr William C Dudley, President and Chief Executive Officer of the Federal
Reserve Bank of New York, at the 7th High-Level Conference on the International Monetary
System, Zürich, 10 May 2016.
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Linda Goldberg and Joseph Tracy assisted in preparing these remarks.
It is a great pleasure to have the opportunity to participate in this panel. To me, the question
posed for discussion seems relatively straightforward: Will more reserve currencies
strengthen the international monetary system? My answer can be summed up in one word:
"yes." I believe that a reserve currency - or at least an enduring and important one - has to
have a number of demonstrated attributes. These include that the reserve currency country
has a strong and credible institutional structure; that its policymakers follow a sustainable
fiscal regime as well as a monetary policy that keeps inflation low and stable over time; and
that the currency is readily convertible and serves as a stable store of value. These are good
attributes for any country - reserve currency or not. The greater the number of countries that
have such attributes, the more stable and sound the global financial system is likely to be.
Also, such a regime is desirable because it provides an environment that should encourage
international trade and an efficient allocation of resources, which, in turn should lift
productivity and living standards.
As always, what I have to say today reflects my own view and not necessarily those of the
Federal Open Market Committee or the Federal Reserve System.
Although a reserve currency can formally be defined as any currency that is part of a foreign
country's foreign exchange reserve holdings, I do not think this is what we have in mind
when we talk about a reserve currency.
While the status of being a reserve currency can be conferred, the stature of being a reserve
currency must be earned. As I see it, a successful reserve currency needs to satisfy a
number of conditions. First, the currency needs to be fully convertible - with no risk of
restrictions that could limit the ability to convert such holdings into cash denominated in the
investors' domestic currency. Second, the reserve currency country needs to have deep,
liquid and transparent capital markets so that the sovereign debt instruments and other
highquality debt obligations can be bought and sold at narrow bid-ask spreads and easily
converted to and from cash. Third, the assets in the country must be governed by a
wellunderstood, consistent and enforceable legal regime. This is to ensure that investors' rights
will be well protected, regardless of short-term political developments or changes in the
governing regime. Fourth, the financial system in the country must be strong and stable to
ensure that liquidity will be available even during times of stress. Fifth, the risk of default on
the country's sovereign debt must be viewed as negligible, to ensure both that the currency
is a stable store of value and that continuous, deep liquid domestic markets will be available
regardless of the economic circumstances. Sixth, the country must have a credible central
bank that is insulated from political interference and committed to keeping inflation low and
stable - a necessary condition for a reserve currency to be a reliable store of value.
I think that the U.S. dollar satisfies these general criteria. That is why over 60 percent of
foreign exchange reserve holdings are denominated in dollars - a share that has been quite
stable in recent years. The dollar's share has remained steady despite the presence of a
number of currencies that broadly satisfy the attributes that I have just discussed.
But should the U.S. be concerned if more countries satisfy the attributes needed to be
successful reserve currencies? Would it be problematic for the United States if the U.S.
dollar share of foreign exchange holdings slipped over time because of progress made
elsewhere?
I think the answer to both of these questions is "no." It would seem positive to me if a decline
in the U.S. market share reflected the following developments: a greater number of stable
and effective central banks and fiscal authorities, more investors who are reassured about
countries' institutional arrangements and financial stability, and deeper and more liquid
capital markets outside the United States. These attributes are a prerequisite for a vibrant
international financial system and are supportive to global trade. A regime with many reserve
currencies would imply a well-governed international economy. This should facilitate global
investment, resulting in rising productivity growth and improving standards of living. In other
words, I don't see this as a zero-sum game. If other countries' currencies emerge to gain
stature as reserve currencies, it is not obvious to me that the United States loses. This is
assuming, of course, that the emergence of alternatives is being driven by their progress,
rather than by the U.S. doing a poorer job in satisfying the attributes that I discussed earlier.
Having more countries achieve the stature of having a reserve currency may also be
desirable for other reasons. First, with more reserve currencies available, portfolio
diversification opportunities are enhanced. This is desirable because, all else equal, it would
allow investors to move further out on the risk/return frontier. Second, more currencies are
likely to be close substitutes, which could dampen currency volatility. With many viable
reserve currencies available, no particular one would necessarily have to bear the bulk of
any adjustment.
The dollar's dominant reserve currency status has sometimes been referred to as the United
States' "exorbitant privilege," implying that the U.S. benefits extraordinarily from this
privileged status. I'd argue that the situation is much more nuanced. Yes, this status does
allow the U.S. to benefit from seigniorage. More than half of all U.S. currency outstanding is
held abroad. But, there are also costs of being the dominant reserve currency. For example,
this can lead to shifts in the valuation of the dollar that are due primarily to developments
abroad that affect risk appetites and international capital flows. In such cases, the dollar's
valuation can be pushed to levels inconsistent with U.S. economic fundamentals.
For the United States, I believe that the most important goal must be to keep our own house
in order. If we do this, then I expect that the U.S. dollar will earn the right to remain the most
important reserve currency in the world.
The United States has a number of advantages in sustaining the dominant reserve currency
status of the U.S. dollar. First, there is a first-mover advantage. As the leading reserve
currency in the world, there is no strong incentive for countries to move to other currencies
as long as the dollar continues to have the attributes I discussed earlier. The history of
reserve currency usage is characterized by considerable inertia. The U.S. dollar emerged as
the leading reserve currency quite a bit after it became the world's largest economy.
Typically, the loss of dominant reserve currency status requires either substantial economic
decline or political instability that motivates foreign counterparties to shift to a new reserve
currency. Second, the U.S. has the deepest and most liquid capital markets in the world. This
is important in making U.S. Treasuries and agency mortgage-backed securities attractive
holdings as part of countries' foreign exchange reserve portfolios. Third, the U.S. has an
independent central bank - the Federal Reserve - which has been successful in keeping
inflation low and stable. As a result, the dollar has been a reliable store of value in recent
years.
Another point in the United States' favor is the considerable steps taken to shore up areas of
weakness revealed by the financial crisis. In particular, the safety and soundness of our
financial system has been enhanced. Capital and liquidity requirements for U.S. banks have
been raised significantly. Stress tests have been imposed to enhance the viability of large
systemic institutions even in very adverse economic and financial environments. Reforms
have been enacted to facilitate the recovery and resolution of troubled institutions. This
includes living will requirements for the major systemically-important financial institutions,
and the development of an improved resolution regime to ensure that institutions that do get
into difficulty can be resolved without disrupting the stability of the financial system.
In conclusion, I welcome other countries' progress toward achieving the preconditions
necessary for their currencies to attain the stature of a reserve currency. However, we should
not act as if this is sufficient to achieve a well-functioning global financial system. In
particular, the current regime is inefficient in a number of important ways. Countries have
found it necessary to self-insure against the risk of large capital flow reversals. This has led
to a very sharp rise in aggregate foreign exchange reserve holdings. This form of
selfinsurance is very expensive - especially when the return on the foreign exchange reserve
portfolio is less than the cost of the domestic liabilities that fund these holdings. As I have
said in the past, I encourage more work to examine whether there are other more efficient
regimes that, for example, would economize on required foreign exchange reserve buffers. In
this regard, I think expanding the capacity of the IMF's resources and working to further
destigmatize drawing on the IMF's liquidity facilities could be worthwhile steps in this direction.
Thank you for your kind attention.