# **Box 1:  Exorbitant Privilege**

The original conception of this term dates back to the idea that the dominant reserve currency country does not have to “earn” foreign exchange to pay for its imports or other obligations – something akin to seigniorage.<sup>a</sup> In other words, a certain amount of goods or services or assets were acquired simply by exchanging currency that foreigners wished to hold as a reserve asset. In the modern world, reserves are mostly held in government bonds, so exorbitant privilege is a much broader concept to take into consideration the ease (cost) of borrowing overseas and the advantages of being able to do in the country’s own currency.

From a pure seigniorage perspective, one simple measure of the _stock_ – not the flow of benefits—is the estimated $500 billion (about 3.5 percent of GDP) of US currency circulating overseas for which foreigners had to provide “free” goods and services (or assets) to obtain (Eichengreen, 2011a). This represents about half of the $1 trillion in total US dollar currency in circulation. A more contemporary definition – for a world where capital flows are dominating trade flows—is the excess returns to net foreign assets of the reserve currency country. In simpler terms, the status of a reserve currency issuer allows the country to borrow from abroad more cheaply than it lends. In addition, depreciations of the reserve currency improve the net foreign asset position of the reserve currency issuer, unlike developing countries that borrow in foreign currency. This creates the scope for depreciating (similar to inflating) one’s way out of debt on the global scale.

**Some Estimates of benefits and costs of reserve currency status for the United States** .   McKinsey Global Institute (2009) estimates only $10 billion in annual benefits to the US from pure seigniorage, $90 billion in lower borrowing costs, and -$30 to -$60 billion from exchange rate appreciation for a net annual benefit of $40 to $70 billion – or about 0.3 to 0.5 percent of GDP.  Studies cited in Eichengreen (2011a, page 118) point to interest rates that could be 50 to 90 basis points lower due to the dollar’s dominant reserve currency status.  McKinsey Global Institute (2009) uses an estimate of 50 to 60 basis points for the calculations cited above.  Warnock and Warnock (2006) arrived at an estimate of 90 basis points.  World Bank (2011, page 126) presents estimates of $15 billion per year in seigniorage (since the early 1990s) and $80 billion annual savings (in recent years) from lower interest costs—fairly close to the McKinsey Global Institute estimates.  In brief, the range of estimates for the net annual benefits to the United States– during normal times—of the dollar’s dominance as a reserve currency is in the range of $40 to $150 billion (the latter by nearly doubling the lower borrowing cost estimates if one were to use Warnock and Warnock estimates of the basis point savings).  During a regional or global crisis, these net annual benefits could be larger than normal times, since the US dollar-denominated assets often act as “safe-haven,” thus enjoying even relatively lower yields due inflows of capital into US financial markets.  In addition, in the aftermath of the global financial crisis, revenues from “pure” seigniorage , which is derived from the increase in real base money associated with increased demand for money due to increased economic activity and other factors, have risen sharply as monetary authorities in reserve currency-issuing countries  have substantially increased their balance sheets through quantitative easing and bank support.  IMF estimates that these revenues may have reached 8 percent of GDP (Fiscal Monitor, April 2012); however, it is not clear what portion of  this burden is born by non-residents.

Other authors use the excess returns on _net-foreign assets_ approach to analyze the benefits (Hausmann and Sturzenegger, 2006, Gourinchas and Rey, 2005, Lane and Milessi-Ferretti, 2007 and 2008, and Habib (2010)). Habib arrives an excess return of 330 basis points, which if applied as “savings” on the current US negative Net Foreign Asset Position of $2.5 trillion (2010), one gets an annual savings of $82 billion.

> a The term “seigniorage” dates back to the time when the artisan minting specie would take a small amount of the metal as payment for this service.  In more modern times, it refers to the value of goods and services that can be purchased from the simple creation of currency—without having earned income from sale of goods or services or assets.

b Another approach to measuring international seigniorage would be to look at the growth of US currency in circulation and assume that half ends up in the hands of foreigners: free imports. Since 2000, the total currency in circulation increased by $484 billion. If half was absorbed externally, that would imply cumulative “international” seigniorage of about $240 billion or about $20 billion per year.

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