Introduction and Literature Survey
There are two ways to transfer wealth involuntarily among economic agents. There is the petty way of direct physical theft, and there is the sophisticated method of devising systems that automatically and tacitly transfer resources from one agent to another. The contemporary global reserve currency regime, as one tool of the existing financial imperialism centered in the West and Japan, has been one of these global sophisticated wealth transfer devices. The imperial Western powers and Japan, through a long march of conquests and seizing of monopoly on global economic activity and trade, have pushed the rest of the world to use their currencies as foreign reserve assets. The countries of the rest of the world may use these foreign exchange reserves to engage in international trade, finance other balance of payment needs, intervene in foreign exchange markets, provide foreign exchange liquidity to domestic economic agents, and signal confidence in the domestic currency to facilitate foreign borrowing and investments. The most notable contemporary measure of pressure to use a specific currency as a global reserve currency is the Petrodollar scheme that the US managed to construct by influencing OPEC countries to agree to export petroleum products in exchange for USD in the mid-1970s. This scheme, which started after the Nixon Shock that ended the Bretton Woods dollar-gold peg, has kept up the status of the US dollar as the world reserve currency given that petroleum is the most internationally traded commodity. The reserve currency position has always yielded privileges to its issuing country. However, since the end of the Bretton Woods dollar-gold standard system in 1971, reserve currency-issuing states have been producing fiat currencies for a negligible cost, while the rest of the world has been providing real economic resources in exchange for these reserve currencies. This regime means that reserve currencies in the post-gold standard regime yield substantial rents to their issuing countries.
The economic and political benefits of reserve currency to its issuing country are well recorded in the literature and evidenced by observation. Canzoneri et al. (2013), Wang and Chin (2013), Wang and Pauly (2013), Eichengreen (2011), and Cohen (2012) acknowledged that the world reserve currency status of the US dollar has been a strength for the US economy in what is framed as exorbitant privilege, which has given the US dollar stability of value, provided the US financial markets with liquidity, lowered the external transaction costs, and granted the US a capacity of international seigniorage. Rogoff and Tashiro (2015) showed that Japan has enjoyed an exorbitant privilege thanks to the reserve currency status of the Japanese Yen. Cova, Pagano, and Pisani (2014) argued that the increased global demand for Euros would boost aggregate demand in the Euro area by lowering interest rates. A paper released by the European Central Bank (2019) confirmed the existence of an exorbitant privilege that benefits all reserve currency-issuing states by lowering government borrowing costs and estimated that the term premia on government bonds are reduced by 0.93 for the US, 0.13 for Japan, 0.74 for the UK, and 1.38 for the Euro area. The benefits enjoyed by the reserve currency-issuing states (hence RCISs) are the ability to borrow in their currencies, which means lower borrowing costs, the existence of a high level of immunity against the balance of payment shocks, the means to maintain low interest rates which is a stimulant to economic activity, and the competitive edge which the financial institutions, firms, and consumers of RCISs hold over their counterparts in non-reserve currency-issuing states (hence NRCISs) in international and domestic markets.
On the geopolitical front, reserve currencies endow their issuing states with a coercive international political power. For instance, the US, through its leverage on the IMF as the largest quota holder, may have a substantial influence on government policy in states that are in need of hard currency through IMF loans due to balance of payment shocks, therefore, there is a political incentive to preserve the status of “hard currency” vs other currencies in order to maintain this tool. Chey (2014) showed how the US took advantage of Panama’s dependence on the US dollar-based bank clearing network as a foreign policy instrument during the US invasion of Panama in the late 1980s. It is also clear how RCISs use the payment systems of their currencies in applying sanctions against people, institutions, and governments of states that they consider geopolitical threats such as: Russia, China, Venezuela, Syria, Cuba, Syria, and North Korea. Moreover, the global primacy of a currency enhances RCISs’ soft power in a psychological manner, as a currency’s reserve status is a symbol of the country’s global power and dominance. While this article focuses on the economic benefits that accrue to RCISs in the form of a global imperial rent, mentioning the political benefits highlights that the reserve currency regime is not simply economically driven by the economic size, the financial market development of a RCIS, or only because of the confidence in the stability and the transactional networks of the reserve currency, nor is it, coincidentally, yielding economic gains and geopolitical leverage to RCISs. Incentives exist for RCISs, especially for the US, the primary beneficiary of the international reserve currency regime, to exercise a level of coercion on the world to adopt this regime, through economic, political, and military pressures because of the geopolitical powers that RCISs enjoy on the top of the mentioned economic yields. This conviction may justify the paper’s depiction of the economic benefits that accrue to RCISs as an imperial rent.
Reserve currency may come with a cost to its issuing country, it inflates its value, and this may affect its export competitiveness. It limits the independence of the monetary policy of RCISs, as the maintenance of the reserve currency status requires a perpetual need for a prudent monetary policy to and this responsibility limits the scope of monetary policy in unconventional times such as in war or economic recession periods. RCISs have to face a tradeoff between expansionary monetary policy and the preservation of their currencies’ values and international statuses. Cohen (2012) suggested that there are risks associated with currency internationalization, which include the possibility of unneeded currency appreciation, external constraints on domestic monetary autonomy, and a burden of policy responsibility that could go with the privilege of the international reserve currency status. Aliber (1964) argued that the reserve currency role limits the choice of US policies to eliminate or reduce the external payments’ deficit, and thus restricts the choice of measures to achieve full employment. The low interest rate regime required for a currency to remain an international reserve currency may fuel asset bubbles and government debt inflation, which is detrimental to the economic conditions of RCISs. However, it seems that the economic and political benefits have outweighed the costs, given the observed pressures pushed by RCISs to keep the reserve status of their currencies, such as the IMF and the World Bank Group global lending in hard currency, under the auspices of the US and its allies in the West and Japan. Therefore, analyzing the economic benefit, namely, the income benefit of international reserve currency is the concern of this article.
While the respective literature highlighted the economic and political benefits that accrue to RCISs, due to their currencies’ international reserve statuses, the literature has not presented this global reserve currency regime as a cost to the rest of the world and has not discussed or attempted to quantify the cost imposed for participating in that system. What I plan to add in this article is tackling the issue from the angle of framing the economic privilege enjoyed by RCISs as a global imperial rent that accrues from the rest of the world to RCISs, and I provide a mathematical model that estimates the reserve imperial rent’s cumulative amount. Instead of presenting the reserve currency’s exorbitant privilege as a benefit to RCISs, I intend to present it as a cost to the rest of the world. The status reserve of a currency inflates its value, rendering its issuing state able to live beyond its means, in other words, reserve currency transfers wealth from the rest of the world to RCISs in what I call a reserve imperial rent, which is realized through providing an inflation buffer to money supply growth in RCIS, which I detail later in the article. The world has been witnessing how central banks of RCISs increased the money supply by staggering amounts since the second quarter of 2020, to stimulate the economy that went into a deep recession as a result of the COVID-19 pandemic. A comparable monetary expansion in RCISs took place in response to the 2008/2009 global financial crisis. These sudden and large increases in money supply growth have not induced proportional inflation. This lack of proportionality between money supply growth and inflation manifests the existence of an imperial rent realized through the current world monetary system of reserve currency dependence. This paper does not intend to argue about whether or how the use of reserve currency is voluntary or involuntary with tacit or explicit political and military pressures, but rather the paper provides an empirical manifestation of the existence of an imperial rent obtained through the channel of reserve currency, how this rent is accrued to the issuing states, and provides a method to estimate the cumulative value of this rent.
Empirical Manifestation of the Existence of the Imperial Rent of Reserve Currency and of How This Rent Is Realized by RCISs
As Table 1 shows, the amount of the allocated worldwide holdings of foreign exchange reserves doubles in the last decade. The amount of the official 1 foreign exchange reserves held worldwide at the end of the fourth quarter of 2021 is equivalent to 12.937 trillion USD, which is equivalent to 14% of world GDP of the same year (World Bank Data 2021); 60% of the allocated official foreign exchange reserves are held in USD alone and it represents 30% of the US annual GDP, followed by the Euro with 20% of total world foreign exchange reserve holdings, and it represents 18% of the Euro area annual GDP (World Bank Data 2021). Other significant reserve currencies (with more than 200 billion USD held worldwide) include the Japanese Yen, the Pound Sterling, the Chinese Renminbi, the Canadian Dollar, and the Australian Dollar. However, for the Chinese Renminbi, as Table 2 shows, worldwide reserve holding represents only 2% of China’s GDP (World Bank Data 2021) so this reserve holding’s influence on China’s economic conditions may be negligible.
World Official Holdings of Reserve Currency in Trillion USD
Source: IMF Macroeconomic & Financial Data. Accessed March 7, 2022. https://data.imf.org/?sk=E6A5F467-C14B-4AA8-9F6D-5A09EC4E62A4.
World Official Holdings of Reserve Currency in Billion USD
Source: IMF macroeconomic and financial data. Accessed March 7, 2022. https://data.imf.org/?sk=E6A5F467-C14B-4AA8-9F6D-5A09EC4E62A4.
The contemporary global reserve currency regime, despite its utility in facilitating global economic transactions by the unification of currency, which provides a level of price certainty and stability, comes with a wealth transfer mechanism that I call an imperial rent of reserve currency that goes to RCISs. Demanding the reserve currency means providing real economic value in exchange for the reserve currency, whose production costs are negligible. The Quantity Theory of Money (hence QTM) suggests that there is a strong link between money supply growth and inflation. According to QTM, holding everything else constant, an increase in the money supply induces an increase in the price level. Cagan (1956) established the high correlation between inflation and money supply growth during hyperinflations in Germany, Greece, Hungary, and Poland. Lucas (1980) showed that annual inflation is closely correlated with annual money supply growth in Germany, the US, Japan, the UK, and Brazil. Moroney (2002) concluded that cross-section inflation rates in 81 countries for the period 1980–1993 are explained almost entirely by the average broad money growth rates. Duck (1993) overtook an empirical analysis with data from dozens of countries to conclude the validity of the strong relationship between money supply growth and inflation. The QTM may be expressed as follows:
The other variables in the QTM equation, besides money supply and the price level, are real GDP and the velocity of money, which may serve as buffers that mitigate the effect of money supply growth on inflation in the country in question.
Taking logs and differentiating with respect to time, the equation resolves to:
Money Supply Growth = Inflation + Real GDP Growth. 2
This implies that the money supply growth rate minus real GDP growth rates estimates the inflation rate. RCISs have increased their money supply substantially in the last decades, especially with the monetary expansion that followed the 2007/2008 global financial crisis that led to the Great Recession, in 2010/2011 European debt crisis, and since the second quarter of 2020 in response to the economic recession induced by the COVID-19 pandemic, and despite RCISs’ relatively sluggish economic growth since the crisis of 2007/2008, their inflation rates remained low between 0–2%. This observation violates the predictions of QTM. It seems that there exists an inflation buffer that mitigates the effect of money supply growth on inflation. This inflation buffer, as I argue, is provided through the international reserve currency regime, and it is the essence of the imperial rent of reserve currency. Figure 1 shows how the inflation rates in RCISs have not been proportional to increases in money supply as predicted by QTM, while the inflation has been higher and more proportional to money supply growth in NRCISs as shown in Figure 1.
Figures 1 and 2 show the disparity in the inflationary outcome that results from increases in money supply growth illustrated by data on central bank total assets. 4 Figure 1 shows the vast increases of nearly nine-fold for the US and the Euro area, more than ten-fold for the UK, and more than seven-fold in Japan in their central bank total assets since 2007. The increases in central bank total assets, which have been driven almost entirely by increases in money supply to stimulate the economy since the 2007–2009 Great Recession, happened through fiscal stimulus packages and a protracted regime of monetary expansion, which is a monetary policy known as quantitative easing, and in the case of the US, to maintain a massive military budget that has averaged 40% of global military expenditure in the past decades despite the recessions of 2008/2009 and 2020. 5 However, and in spite of the relatively slow average economic growth for the period, there have not been increases in the price levels that are proportionate to the increases in money supply as predicted by QTM. For the period 2000–2021, inflation rates averaged 2% for the US, the Euro area, and the UK, and 0 for Japan. For the similar tenure, Figure 2 shows disproportionally higher inflation rates for a sample of NRCISs, despite having comparable growth rates in the money supply with often higher GDP growth rates. For example, both the US and Brazil had a nine/ten-fold increase in central bank total assets in the period 2005–2021, and they both had similar economic growth rates. However, the annual inflation rate in Brazil was 2.7% higher than that of the US. In India, central bank total assets increased by five-fold in the period 2007–2021, the same period when the UK central bank total assets increased by more than ten-fold. However, and despite India’s GDP growth rate having been substantially higher than that of the UK, India’s annual inflation rate has been 4.6% higher than that of the UK. In South Africa, between 2007 and 2021, the central bank total assets increased by four-fold, less than that of the UK for the same period, but the annual inflation rate for South Africa averaged 4% higher than that of the UK, even though both economies grew at a similar rate for the same period. Similar findings occur if we look at Egypt’s central bank total assets, which increased by five-fold in the period 2010–2021, which is similar to the increases in total banks assets in RCISs, while Egypt’s average inflation was 11.8%, notwithstanding its higher real GDP growth than that of all RCISs in that tenure. Overall, and despite the existence of other factors of friction standing between money growth and inflation that may differ from one country to another, the average trajectory of inflation in RCISs is distinctly lower than that of NRCISs, in spite of both parties’ comparable money supply growth in the last few decades.
Central Bank Total Assets, GDP Growth, and Inflation for a Sample of NRCISs from Asia, Africa, and Latin America
This discrepancy shown in data on inflation as an outcome of money supply growth in excess of economic growth between RCISs and NRCISs indicates the existence of a mechanism that mitigates the effect of money supply growth on inflation in RCISs. This mechanism could be described by the existence of an inflation buffer provision that alleviates the effect of money supply growth on inflation, which is activated by the contemporary world reserve currency regime. This inflation buffer is provided by the free resources that flow to RCISs in exchange for their currencies, whose production does not inflict any significant costs, and these free resources that flow to RCISs are what translate into lower predicted inflation as an outcome of money supply growth, and they are what constitute the imperial rent of reserve currency. The inflation buffer is provided through a worldwide strong and sustained demand for the reserve currencies, which preserves their value and inflates the purchasing power of the nations that produce these reserve currencies.
Estimation Method for the Imperial Rent of Reserve Currency
After I have provided a manifestation of the existence of an imperial rent of reserve currency, and indicated how this rent is obtained by RCISs through the provision of an inflation buffer, I provide a method to estimate the cumulative quantity of this form of imperial rent.
The formula to estimate the imperial rent of reserve currency (hence IRRC) cumulatively at a given point in time is as follows:
where Y is the nominal GDP in national currency, R is the official global reserve holding of the currency, and M is the broad money supply of the country in question.
The model estimates how much overvalued a reserve currency is by measuring the official reserve demand (R) relative to the existing broad money supply (M) in (R ÷ M), and then uses this over-value and applies it to the nominal GDP to estimate the cumulative amount of IRRC. The formula lays the current value of nominal GDP (Y), which is inflated due to the reserve currency privilege, less the hypothetical value of nominal GDP without the reserve currency privilege (Y * (1 – (R ÷ M)), to yield the amount of the IRRC accumulated until a specific point in time. The formula of the IRRC resolves to R * Y ÷ M.
Predictions of the Model
The model expects that IRRC increases with the increase in the world foreign exchange reserve holdings since this would directly increase the resources at the disposal of the RCISs, but expects that IRRC decreases if broad money supply grew faster than nominal GDP, as that erodes the inflation buffer.
This model predicts that the cumulative value of IRRC subsides during global recessions because the money supply of reserve currencies grows faster than nominal GDP of the countries in question (Y ÷ M drops), as shown in Figure 1, and a sizable part of the increase in money supply is used by RCISs to bail out their economies in times of recession, or to put it plainly, some of the hard currency that was destined to get free resources in exchange for foreign exchange reserve provision is used in the economic bailout process, therefore the cumulative value of IRRC should slow down or drop in times of recession.
The model anticipates that IRRC enlarges with quantitative tightening, which is a realistic expectation because when money supply drops, the currency’s global value should appreciate as a consequence, ceteris paribus.
Application of the Method to Obtain the Cumulative IRRC That Accrues to the Major RCISs for the Period 2016–20216
I used annual data of broad money, average annual global official 7 foreign reserve holdings across the four quarters, and nominal GDP, all in the denomination of the national currency of the country in question. Data is extracted from the data sources of IMF, FED, ECB, Bank of Japan, Bank of England, World Bank, and OECD. 8
Table 3 shows the cumulative amount of IRRC in trillions of national currency each RCISs has obtained from the global use of its reserve currency by the end of the mentioned year.
As the results in Table 3 show, the US is the primary beneficiary of this global wealth transfer scheme with more than 60% of the total official global foreign reserve holdings by the end of 2021. By 2021, the world incurred a cost of 7.95 trillion USD that was accrued to the US for the use of the US dollar as a foreign exchange reserve through the official channel only. However, the US’s IRRC peaked at 9.71 trillion USD at the end of 2019. The Euro area is the second beneficiary of the current international regime of reserve currency. The world official reserve use of the Euro yielded 2.19 trillion Euros (2.58 trillion USD) from the rest of the world to the Euro area by the end of 2021, down from its peak of 2.41 trillion Euros in 2018. The UK comes in third place with a cumulative yield of 0.27 trillion Pound Sterling (0.37 trillion USD), down from the 2019 peak of 0.3 trillion Pound Sterling, and Japan is fourth with a cumulative yield of 26.75 trillion Yen (0.24 trillion USD) by the end of 2021, down from the 2019 peak of 27.24 trillion Japanese Yen. The results show that the model depicts how the cumulative value of IRRC is affected during recessions, exemplified by the recession of 2020. With broad money supply excessive increases, a part of which has been used to stimulate the economy, coupled with weakened global demand for foreign exchange currency in the ongoing global economic recession since 2020, IRRC for all the four RCISs dropped from its peak in 2018/2019, and it has not recovered yet as of the end of 2021.
The model estimates that the total amount of wealth extracted globally through the IRRC since the end of the gold standard in 1971, though only the formal foreign exchange reserve holdings, to the four major beneficiaries accumulated to a value equivalent to 11.1 trillion USD by the end of 2021, and 71% accrued to the US alone. 10 These resources that are transferred from the rest of the world to these four RCISs beneficiaries out of the reserve currency scheme enable them to undertake massive monetary expansions to save their economies in times of recessions without incurring a proportional inflation, and warrant the RCISs, especially the US, to keep consuming substantial military budgets that are used to maintain the state of the contemporary global imperial geopolitical balance.
