2017 article (original source) about US dollar hegemony and its impact on America's balance of payments
"Exorbitant Privilege" - the fact that the US can run trade deficits and current account deficits without worsening its "external position"
"Exorbitant Duty" - the fact that the US acts as an insurance policy to the rest of the world; US foreign reserves dropped dramatically during great financial crisis in 2008 and eurozone (greek) crisis in 2011
The US takes the long position on risky assets and the short position on safe assets
"Our interpretation of the International Monetary System is therefore one as a structure in which the hegemon provides insurance to the rest of the world in exchange for an insurance premium"
US balance sheetstructure:
- External assetsare (mostly, about 2/3rds) measured in foreign currency while external liabilitiesare measured in dollars -> Inflation of dollars lowers real (as opposed to nominal) US liabilities -> US dollar depreciation causes wealth transfers from the rest of the world (ROW) to the US
- External assets are riskier (i.e. more prone to default/depreciation) than external liabilities (e.g. the US government debt sold in the form of treasury bonds) -> Economic crises lower the price of risky assets -> Economic crises cause wealth transfers from the U.S. to ROW
- Economic crises also appreciate the value of USD, raising the US's real external liabilities -> Economic crises cause wealth transfers from the U.S. to ROW
Between 1956-2016 U.S. gets on average about 2-3% excess total return annually of gross external assets over its gross external liabilities
U.S. external assets are comprised mostly of direct investment, equity, and banks while U.S. external liabilities are mostly government and private debt
since 1952, the share of risky assets have gone from 40% to 65% of total assets, while safe liabilties have dropped from 80% to 50% of total liabilities <-> the volatility (risk) of America's external balance sheet has gone up after Bretton Woods
"In a nutshell, the external leverage of the United States has increased massively since the 1990s, which coincides with a period of intense financial globalization"
Theoretical/Mathematical Model:
- Imagine two countries, named "Home" and "Foreign"
- Each have an equal population size = 1/2
- Each produce a random amount of a single good over a given time period, with each country's output being "independent and identically distributed" (the total number of goods produced by each country per year/month/etc. have the same expected value, but are independent)
- "Foreign" households are more risk averse than "Home" households
-> When the global output is low (below the expected value of global output), "home" consumption falls more than "foreign" consumption
-> When the global output is high, "home" consumption is higher than "foreign" consumption