The Dollar Reserves

The question of inhibitions on U.S. policy due to the dollar's role as a reserve currency raises a host of related questions about the very desirability of being a reserve currency.

If it is crippling to action to be a reserve currency, why be one?

When it is pointed out that devaluation might disqualify the dollar for future reserve status, two answers appear.

Devaluation dos not (or should not) disqualify a currency from reserve currency status, especially if central bankers match their interest earnings over the years from holding currency obligations against their capital loss from devaluation.

These arguments are usually couched in terms of the cost versus the benefit of being a reserve currency, and apply not only to the dollar but also to the pound, or to any nation's currency that attains reserve status.

It may be remembered that no nation in the past has consciously chosen to be a reserve currency country, nor it has been elected to this position.

Rather, it happens to become one because other countries choose to hold its currency in the settlement of international balances and for the buying and selling of their own currencies.

Being a reserve currency carries with it both benefits and costs. The principal benefit is greater flexibility.

In this context, flexibility means that American deficits can be financed in part through increases in the dollar reserves held by foreign monetary authorities.

To the extent that U.S. deficits result in additional dollar reserves of surplus countries, the loss of gold by the United States is smaller than it would otherwise be.

One aspect of this advantage is that long-term investments with relatively high rates of return can be and are made while short-term debts costing less are incurred.

Much of the action of government officials in the last few years was designed to convince foreign governments that they should indeed hold dollar assets rather than gold.

The gain in flexibility which is said to result has been cited by former Under Secretary of the Treasury Roosa and other officials in testimony to Congress.

On the other side are the costs of being a reserve currency, which of course are constraints on economic policy.

When foreign monetary authorities hold large reserves of dollars, they do so without any commitment to keep them in that form. The threat is always present that they will convert these holdings to gold.

A reduction of the foreign-held dollars will of course drain gold from the United States and perhaps precipitate the very devaluation which it is feared would shake the entire international system.

Moreover, the threat of conversion to gold is a powerful factor in inhibiting the United States from following internal policies aimed at higher levels of employment and economic growth.

These policies may prove inflationary or, equally important, foreign governments may think they are going to be inflationary with a consequent worsening of the balance of payments position, and a further run on the dollar.