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John
B. Carlson and Benjamin D. Keen ask where is all the US currency hiding?
(emphasis mine) [my
comment]
Where
Is All the U.S. Currency Hiding?
by John B. Carlson and Benjamin D. Keen
April 15, 1996
[Although
this article is nearly thirteen years old, it is still relevant today.]
Introduction
The total amount of U.S. currency held by the nonbank public equals about
$375 billion [around 550 billion today], or
nearly $1,400 for every man, woman, and child in the country. Clearly, few
individuals ever hold this much cash at any point in time. On the surface, the
sheer volume of currency outstanding seems inconsistent with common sense.
Even if one considers currency balances held by businesses involved largely
in cash transactions—like retailers—and by participants in the
underground economy—like drug dealers—it is hard to reconcile the
difference between households’ holdings and total currency outstanding.
So where is this currency hiding?
Recent evidence suggests that a growing proportion of U.S. currency is
held outside the country by individuals who are uncertain about their own
currency’s future value [This is ironic:
nations which started using the dollars because of distrust for their own
currencies are going to experience a currency collapse when the dollar
crashes. For example, Zimbabwe has recently adopted the US
dollars to escape their domestic hyperinflation]. To
these people, the dollar is a refuge during times of political and economic
uncertainty. Knowing precisely how much currency is held outside
the United States, however, is no simple matter. Unlike checking accounts,
currency flows do not leave a paper trail. However, informal reports to
the Federal Reserve and the U.S. Customs Department regarding currency flows
abroad do provide a rough indicator of foreign demand.
Having some idea about the magnitude of overseas holdings is important for
several reasons. First, if the demand for currency is becoming driven largely
by foreign portfolio decisions, then fluctuations in the level of currency
outstanding may have little to do with domestic economic activity. Second, movements
in the narrow monetary aggregates—of which currency is a sizable
component—will not provide the same information as they have
historically. Third, to the extent that foreigners demand currency, which is
non-interest-bearing debt, the U.S. Treasury’s need to issue an
interest-bearing alternative is reduced.
To address these issues, we will examine why individuals hold currency and
why the U.S. dollar is so popular abroad. We will also discuss some recent
research on the share of currency held abroad and look at the implications
for policy.
Why Do People Hold Currency?
For most Americans, the answer to this question is simple: to make payments
when neither checks nor credit cards are convenient or accepted. The U.S.
dollar has the textbook qualities often used to define money. That is, it is
both a unit of account and a medium of exchange. Although stories about
currency stashed under the mattress occasionally come to light, most
Americans choose to hold cash only for transaction purposes. Since it bears
no interest, there is little incentive to hold currency when no transactions
are anticipated.
Textbooks also identify "store of value" as a quality of money. This
characteristic, however, applies to many nonmonetary assets as well. During
inflationary periods, houses are often considered good stores of value. Gold,
rare art, coins, and stamps can also serve this purpose.
The dollar, on the other hand, has some characteristics that make it
preferable to other stores of value. First, it is both compact and portable.
One can barely move a house across town, let alone abroad. Even carrying gold
can be cumbersome. Second, currency affords anonymity not offered by, say,
ownership of a Van Gogh. Third, the U.S. dollar is liquid in many parts of
the world. That is, it is easily converted to spendable forms with no (or
minimal) transaction costs and little risk of capital loss. And finally, unlike
most real property, currency is divisible. If the denomination of a bill is
larger than the price of an exchange, then change can be made.
Why Do Foreigners Hold U.S. Currency?
In contrast to domestic demand, foreign demand for the U.S. dollar owes
more to the store-of-value quality of money [This is going to
create problems. When the dollar loses its “store-of-value
quality”, foreigners will start sending them back]. The
dollar is preferred to many other currencies because it is a relatively
stable source of purchasing power, widely accepted, and reasonably secure
from counterfeiting. Another appealing feature is that unlike
some other currencies, which may be recalled with little notice or limited
opportunities for exchange, Federal Reserve Notes are ultimately exchangeable
at full face value, regardless of when they were issued. Moreover, because
shipments of less than $10,000 do not have to be reported, U.S. currency
maintains a degree of anonymity for its holder.
These favorable features of the U.S. dollar ultimately reflect the
political and economic stability we enjoy [thirteen years
ago. Today is a different story]. For countries
whose political situation is uncertain, the dollar offers a form of wealth
that may be put in a suitcase and carried should a resident need to flee.
Political instability is often associated with economic turmoil and a
debasing of a country’s currency. Despite the episodes of double-digit
inflation in the 1970s and early 1980s, the United States has never [yet]
experienced a hyperinflation. [The US’s
lack of experience with hyperinflation is a big negative for the dollar. It
leaves Americans with an imaginary fear of deflation when the true threat
lies somewhere else.]
Trends in Foreign Holdings of U.S. Currency
Foreign demand for the U.S. dollar is particularly strong in certain parts
of the world. In Liberia and Panama, the dollar is the official currency.
Large amounts of currency are known to be circulating in Central and South
America, especially in Argentina, where it is often used to settle real
estate and auto transactions. The dollar is also very popular in Eastern
Europe, especially in the former Soviet Union, where inflation, declining
exchange rates, and currency recalls have made the ruble a poor store of
value. U.S. military personnel stationed overseas and many international
travelers likewise rely on the dollar.
Measuring the flow of U.S. currency abroad is extremely difficult.
Cash is often sent in the mail, and, as mentioned above, individual shipments
of up to $10,000 do not have to be reported to the Customs Department.
Customs does keep records of shipments above $10,000, however, and these
provide some information on currency flows abroad. Another major source of
data is found in the informal reports that commercial banks submit to the
Federal Reserve regarding their overseas currency shipments. These reports
suggest that since 1988, about half of all U.S. currency sent overseas has
gone to Europe (Russia is the most likely destination), 30 percent has gone
to the Middle East and Far East, and around 20 percent has gone to Central
and South America, with a fair amount of that ending up in Argentina.
Determining the total stock of currency held abroad is even more
difficult. In fact, the only available data are shipment numbers from
informal reports to the Customs Department and the Federal Reserve.
Currently, many analysts believe that a substantial portion of all U.S.
currency is held overseas.
Researchers at the Federal Reserve Board have examined this issue in depth. A
preliminary study conducted in 1993 estimated that more than 70 percent of
all U.S. currency is held outside our borders, with most of the outflows
occurring since 1970. Recently, a broader examination
set that figure at between 50 and 70 percent, with about 80 percent of all
currency growth since 1980 tied to increased foreign demand.
Figure 1 illustrates two estimates of the level of currency held abroad.
Both are based on statistical approaches that exploit the similarity between
seasonal fluctuations in the domestic demands for U.S. and Canadian currency.
Because the seasonal factor in currency for both countries is largely driven
by similar seasonal fluctuations in retail sales, one approach adjusts for
differences in the seasonality of retail sales between the two countries.
Figure 1: Estimated Share of U.S. Currency Held Abroad
SOURCE: Richard D. Porter and Ruth A. Judson, "The Location of
U.S. Currency" (footnote 1).
Some Recent Issues
The strong international demand for the dollar inevitably makes it a target
for would-be counterfeiters. Although the current design of U.S. currency is
sufficient to prevent mass counterfeiting, photocopying technology may soon
reach the point where nearly perfect copies can be easily produced. The
Treasury anticipated this potential problem in 1983 and began working on a
plan to redesign the currency. Even though Treasury officials believe that
the amount of counterfeit currency in circulation is minimal, recent rumors
of an almost-perfect counterfeit produced in the Middle East—the
so-called supernote—gave added incentive to the redesign effort.
Because most foreigners prefer to hold $100 bills and most counterfeits are
found overseas, the Treasury decided to redesign that note first and set a
release date of March 1996. To avoid disturbing foreign economies and to
protect the special anonymity feature of the dollar, officials announced that
the old currency would not be recalled and would always be accepted at 100
percent of face value. To spread the word, the department is spending
millions of dollars on advertising and on setting up toll-free hot lines
around the world. Nevertheless, promises about cash are often viewed with
deep suspicion by foreigners who have watched their own currencies become
virtually worthless. [Americans have never “watched
their own currency become virtually worthless”. If they had, then they,
like Germans, would fell very differently about the endless billions of
bailout money being pumped into Wall Street.]
In early 1995, as news of the soon-to-be released $100 bill spread abroad,
currency growth plummeted, from about 8.5 percent over the last two decades
to about 3 percent in 1995 (see figure 2). Many analysts believe that this
slowdown largely reflected foreign holders’ concerns about the new currency.
Moreover, now that the redesigned note has been released, currency growth
is expected to accelerate to near previous levels. Preliminary data since
the March introduction reveal no sharp rise in the currency numbers, but it
must be stressed that this information is very limited (see figure 3). Only
time will tell if the currency growth rate will return to a level more
consistent with its previous trend.
Figure 2: U.S. Currency Growth
SOURCE: Board of Governors of the Federal Reserve System.
Figure 3: U.S. Currency Levels
a. Growth rates are percentage rates calculated on a fourth-quarter over
fourth-quarter basis. Annualized growth rate for 1996 is calculated on an
April over 1995:IVQ basis.
NOTE: Dotted lines represent growth ranges and are for reference only.
SOURCE: Board of Governors of the Federal Reserve System.
Policy Implications
Large swings in overseas holdings of U.S. currency typically have little
impact on the current level of domestic economic activity [In
other words, if foreign demand for dollars can affect the US money supply,
boosting or depressing prices, regardless of what is happening with US
economy.]. Rather, such movements distort the historical
relationship between currency and the economy, making currency a less
reliable indicator. Although the level of currency has never received much
attention in policy analysis, it is a substantial component of the monetary
base (about seven-eighths currency) and of M1 (about one-third currency [Today
it is over half of M1]), which are watched closely by some
analysts.
Events such as the introduction of the new $100 bill can thus create
misleading signals in the narrow money measures, making them less reliable
for policy purposes. For example, the slowdown in currency growth in early
1995 accentuated the decline in both the monetary base and M1.
Because the currency slowdown most likely reflects reduced foreign demand, it
seems doubtful that deceleration in the narrow money measures portends a
weakening economy, as it might have in years past. Moreover, foreign
demand tends to be induced by unpredictable events. To the extent that U.S.
currency is becoming increasingly subject to the vagaries of foreign demand,
the use of narrow money measures as guides for policy will prove problematic.
Another important implication concerns the federal budget. U.S. currency
pays no interest, yet is ultimately a debt of the federal government.
Essentially, it is an interest-free loan. The greater the level of currency
outstanding, the less the level of interest-bearing debt outstanding and
hence the smaller the interest bill of the U.S. Treasury. This implicit yield
of currency—known as seigniorage—reduces the annual tax bill by
between $15 and $20 billion. To the extent that foreign demand for the dollar
increases, the tax burden of U.S. citizens is further lightened. [The
opposite is also true: if foreigners start sending dollars back, the treasury
would ultimately have to issue new debt to absorb those returning dollars.]
My reaction: The
550 billion dollars now circulating around the world outside the US has
serious implications for the US.
1) At least 70 percent (around 550 billion) of all US currency is held
outside the country, with 80 percent of currency growth since 1980 tied to
foreign demand:
2) Foreign demand for the U.S. dollar has been due to the dollar’s
store-of-value quality:
A) It is both compact and portable.
B) Dollars affords anonymity
C) The US dollar is liquid in most of the world
D) Unlike other real property (houses, paintings, etc...), currency is
divisible.
3) With the US supply of dollars highly dependent on the vagaries of foreign
demand, narrow money measures (M0, M1, M2) have become flawed guides to the
US money supply. (see graphs below).
4) Dollar notes pay no interest, yet are ultimately debt of the federal
government, making them essentially interest-free loans. In other words, if
50 billion dollars came back from overseas, the fed would have to sell 50
billion treasuries to keep the domestic money supply stable. This would have
two impacts:
A) US government pays interest on treasuries held at the fed. The fed keeps
what it needs to finance its operations and then sends the extra back. If the
fed is forced to sell 50 billion dollars of treasuries, it will have a lot
less money to send back to the treasury, increasing the US budget deficit.
B) If fed sells 50 billion of treasuries, this would also drive up treasury
yields, making it more expensive for Americans to borrow.
Conclusion: If the dollars held by foreigners start coming back, it
will make life very difficult for the fed. The fed has started buying toxic
mortgage backed securities and will soon be buying treasuries. Faced with the
return of dollars from abroad, the fed would faced with choice of either
controlling interest rates (keep buying assets) or controlling the money
(start selling assets). Politically speaking, the fed will be forced to try
to control interests rates, which will allow the base money supply to
explode, fueling hyperinflation.
To truly understand the implications of the 550 billion dollars held abroad,
it is necessary to look at a few graphics. Below is a chart of the US money supply.
Notice how currency outstanding is bigger than M1.
US money supply
This is not normal. M1 is usually several times larger than currency portion
of a country’s money supply. To see what I mean, look at the graphs of
the euro’s and Australian dollar’s money supply:
By subtracting the dollars held abroad from the chart of the US money supply,
we get a normal looking chart of the US domestic money supply:
US
money supply minus physical dollars held abroad:
Finally, below are three graphs of the US monetary base which should drive
home the dangerous implications of dollars held abroad.
US Monetary Base
US Monetary Base minus physical
dollars held abroad:
US Monetary Base if foreigners lose confidence in the dollar:
Eric
de Carbonnel
Market Skeptics
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