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August 5, 1993
"Currency Choice - Various Economists have Estimated that Between Two-thirds and Four-fifths of U.S. Currency is Circulating Abroad"
San Jose Mercury News
By Timothy Taylor
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THE WORLD economy is being dollarized. Buy a radio in Hong Kong, a hotel room in Rio de Janeiro, or a candy bar in Moscow -- just about anywhere you shop, U.S. dollars are not only acceptable, but welcomed.

Of course, the dollar isn't the only attractive mazuma in the world. German marks, Swiss francs, and Japanese yen all have their allure. I personally have never met a currency I disliked, at least not if the denomination was large enough.

But with the recent turmoil in European exchange rates, Europe's currencies look somewhat less attractive. Historically, Japan has not been eager for its currency to be used in other countries. At least for now, the good old U.S. greenback is the world's gelt of choice.

In fact, various economists have estimated that between two-thirds and four-fifths of U.S. currency is circulating abroad. Since the total outstanding U.S. currency is about $300 billion, these estimates imply that from $200 billion to $240 billion is in foreign hands.

For the developing economies of Latin America, eastern Europe, and Asia, dollarization offers a useful economic stability, at a price.

Many of these countries have experienced on-and-off hyperinflation. In this setting, businesses and workers can't focus on productivity or efficiency, and no one can plan for the long term. When inflation is reducing the buying power of currency by, say, 40 percent a month, that quickly becomes the only important issue in day-to-day economic life.

A stable currency is the grease that lubricates the economic machinery; relying on the stability of U.S. dollars makes it easier for these economies to function. In fact, Argentina has managed to reduce its inflation rate from 84 percent to 12 percent in the last two years by officially tying its currency to the dollar, according to a report on dollarization in Business Week.

But using another nation's money doesn't come free. These dollars circulating abroad once were used by Americans to buy something: perhaps something as everyday as a cab ride or house cleaning services; perhaps something more illegal or exotic. But at least so far, this means that foreign countries have provided goods or services to the U.S. in exchange for pieces of paper.

Of course, at some point in the future, those dollars may be used to purchase American products. There's an economic term for the situation where you receive something from someone, but have to pay it back in the future: It's called a loan. In effect, the rest of the world has loaned $200 billion or so in goods and services to the United States.

Nor do matters stop there. When the foreign circulation of the world's other major currencies is added up -- Japanese yen, German marks, Swiss francs, and so on -- the total loan from the developing nations to the industrialized countries of the world may climb as high as $800 billion.

Here's the kicker: The industrialized countries of the world need not pay any interest on this loan they have received from the poorer nations of the world. If the relevant interest rate is, say, 8 percent, then this interest- free loan of $800 billion is worth something like $64 billion each year to the First World economies.

Dollarization confers other benefits on the U.S. economy as well. Just as American firms have something of an advantage because their home language, English, is generally the language of international business -- or just as American firms suffer to some extent because their home market insists on using an idiosyncratic and peculiar system of weights and measures, rather than converting to the metric system used everywhere else -- having a globally acceptable currency simplifies business life considerably.

Since American businesses and consumers have the luxury of operating within the world's largest unified market, they tend not to think about its benefits. But imagine for a moment the inefficiency and complexity of the U.S. economy if every state had its own unpredictably fluctuating currency. Even simple transactions like taking a trip to Seattle or ordering from L.L. Bean would take on new levels of complexity; businesses that buy and sell in different states would have to devote teams of analysts to analyzing the fluctuations of 50 currencies.

Serving as the world's currency brings a certain amount of confusion and added responsibility, along with its benefits. When policy makers speak today of controlling the U.S. "money supply," they are no longer actually referring to coin of the realm. After all, the overwhelming majority of U.S. currency is outside America's boundaries and control.

Instead, the "money supply" usually refers to a statement about the willingness of banks and the financial system to make credit available to borrowers. In fact, the Federal Reserve announced recently that it was no longer going to set a certain goal for the growth of the money supply, and will focus instead on assuring that interest rates stay at certain levels.

As the world's largest economy, and the strongest supporter of free and open markets, the United States has long been the linchpin of the world economic growth. As dollarization proceeds, the United States becomes the keeper of the world economy in yet another way.

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