By Mathis Richtmann

 Steffen Murau (@steffenmurau) is political economist and researcher at Global Development Policy Center of Boston University.

The current structure of the global economy is often associated with a “dominance of the US-Dollar”. What do you make of this term?

We have established names for various historical regimes in the international monetary system, such as the Gold Standard or the Bretton Woods System. But so far there is no good name for today’s international monetary system, partly because it is politically unplanned and difficult to conceptualize. In an article that two co-authors and I have just published in the Journal of Institutional Economics, we propose the label “Offshore US-Dollar System”. This is supposed to stress that the US-Dollar does indeed have a dominant position, but as a currency that is not only used but also created outside of the United States.

The structures of the Offshore US-Dollar System are primarily based on private institutions. These have emerged in the 1950s through the so-called Eurodollar market, where “Euro” is just an old-fashioned word for “offshore”. After the collapse of the Bretton Woods System in the early 1970s, these private offshore markets have taken over the functions of the global monetary system.

What exactly does “offshore” refer to here?

In our terminology, “offshore” means that bank deposits and other financial products such as bonds are created denominated in US-Dollars, but outside of the US. This may go against our intuitions: We are prone to think that the US-Dollar is the currency of the US, and hence its creation should be limited to the US. However, the US-Dollar is primarily a nominal unit of account that can also be used outside the US. Remember: What we are talking about ultimately boils down to accounting records on balance sheets. The question is where a financial institution is legally located. If an institution denominates its instruments in US-Dollars but is not legally located in the US, it typically has more leeway and can circumvent regulations and in our understanding issues “offshore US-Dollars”.

If we now think again about the dominance of the US-Dollar, the main issue from my point of view is the extent to which the US-Dollar is used as a unit of account for balance sheet operations outside the US. In this respect, the US-Dollar is the undisputed global ‘key currency’. The frequently used term ‘reserve currency’ is a bit misleading here. It refers to the currencies that central banks hold as foreign exchange reserves, which they traditionally needed to influence exchange rates. This was crucial in the Bretton Woods System when central banks had to maintain a fixed exchange rate system and intervened on daily basis in the foreign exchange market using their foreign exchange reserves. In today’s Offshore US-Dollar System with flexible exchange rates among the major currencies, the more important question is what unit of account private institutions use for global lending and within global supply chains. That is the crux of the matter when we talk about the internationalization of a currency.

If offshore US-Dollar creation is as central as you say, what is the quantitative relationship between onshore and offshore US-Dollars?

The extent to which instruments denominated in US-Dollars are created offshore is very difficult to measure. The most important institution for empirically investigating the Offshore US-Dollar System is the Bank for International Settlements. Its researchers have access to the data and impressive figures, but even their quantitative knowledge of the offshore world is limited. Depending on how you define offshore dollars, the volume of offshore dollars exceeds that of onshore dollars. There are different accounting standards, the quality of reporting varies and not all dollar instruments are reported on-balance-sheet. For example, foreign exchange swaps can be interpreted as offshore US-Dollar instruments. But since they are regarded as derivatives for accounting purposes they are not recorded in balance sheets. 

Is the current financial crisis, which broke out in the wake of the COVID-19 pandemic, also a crisis of the international dollar?

It is primarily a crisis within the Offshore US-Dollar System. Global supply chains, which in many sectors are financed by offshore US-Dollars, have collapsed. Companies lose their income streams and are unable to repay their loans. This, in turn, puts international banks in trouble that have extended loans in offshore US-Dollars. Not only do they not get their loans repaid, but they also have to lend more offshore US-Dollars to help companies get by.

If these banks had extended the loans in their local currency, they could go to their national central bank, which would then extend bridging loans in that local currency. But since the banks need US-Dollars, the national central banks can at best lend their own US-Dollar foreign exchange reserves. But these are rarely sufficient in major crises. The only central bank that can create US-Dollars to an unlimited extent as emergency liquidity is the Federal Reserve. The Fed, however, is not allowed to interact directly with private banks outside the US. This is a central structural problem in the global Offshore US-Dollar System.

In response to this problem, since 2008 the Fed has started to lend US dollars to other central banks on a large scale in crises through so-called swap lines. This enables non-US central banks to replenish their US-Dollar reserves and lend them to their national banks that temporarily need support from the central bank. Since March 2020, this is happening again on a massive scale. As the Fed’s measures are effective—certainly for now—it is not (yet) a crisis of the Offshore US-Dollar System.

However, the question is for how long the Fed is able to continue doing this without coming into conflict with the US government. President Trump has long tried to exert more influence on the Fed. Chairman Powell is a thorn in his side. If the medical emergency subsides somewhat but the consequences of the global economic and financial crisis remain, we will have to see how this will affect the Fed’s international activities. Bear in mind that its mandate is purely national. Its activities are already on the fringes of what it is legally mandated to do.

Is it fair to say the Federal Reserve controls the global supply of US dollars?

The Fed “controls” the supply insofar as it provides emergency loans during crises. These are the moments when financial institutions that operate globally and create offshore US-Dollars depend on the Fed. In the absence of a crisis, however, the Fed has limited ability to influence what private offshore institutions do. Put differently: The Fed can help put out a fire when it burns. But its ability to prevent fires is limited. Doing that would require a level of cooperation in the international monetary system that doesn’t exist at the moment.

Things could have turned out differently: In the early 1970s, central bankers held international negotiations to regulate offshore money creation more strictly. At that time, sophisticated concepts were on the table, but they were not implemented. There was no agreement among the world’s leading central banks to act together on regulating offshore money creation. When the Bretton Woods System collapsed, central banks instead courted private institutions to quickly provide an alternative, but privatized, international monetary system.

Most likely, the key central banks at that time even issued implicit lender of last resort guarantees to private banks involved in offshore money creation, to support and stabilise the new system. Seen from this perspective, there is a continuity running from the implicit guarantees in the 1970s to the swap lines of 2008 and 2020. Apparently, it was easier to stabilize private offshore money creation ex post than to regulate it publicly and internationally ex ante. Only in acute crises does it appear possible to push through such far reaching decisions.

Part 2 of the interview, turning to questions around the euro and its internationalisation, will be published next Friday