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Opportunities and Challenges of the US Dollar As an Increasingly Global

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Opportunities and Challenges of the US Dollar As an Increasingly Global Opportunities and Challenges of the U.S. Dollar as an Increasingly Global Currency: A Federal Reserve Perspective Michael J. Lambert and Kristin D. Stanton, of the DEMAND FOR US. CURRENCY. Board's Division of Reserve Bank Operations and Payment Systems, prepared this article. The Federal Reserve measures demand for U.S. cur- rency by the amount of currency in circulation. Over the past two decades, demand for U.S. currency, From 1980 to 1998, currency in circulation increased especially the proportion estimated to be held abroad, an average of 8 percent per year—from $124.8 bil- has increased markedly. As a result, U.S. bank notes lion to $492.2 billion. In December 1999, in prepara- are now the most widely recognized and used cur- tion for the century date change, currency in circula- rency in the world. Businesses and households out- tion increased 22.1 percent from its December 1998 side the United States have long held U.S. currency level, to $601.2 billion. Uncertainty associated with for savings, especially during times of crisis. Over the century date change increased the public's pre- time, businesses and households abroad are increas- cautionary demand for cash, but as the event passed ingly turning to dollars for transactions purposes. without incident, the public returned much of the The rapid growth of demand for U.S. currency has currency it had amassed to depository institutions. posed challenges for the Federal Reserve in meeting Depository institutions, in turn, returned excess cur- its congressionally mandated responsibilities for cur- rency to the Reserve Banks. Thus, in the first quarter rency availability and distribution. Those challenges of 2000, the Reserve Banks received record levels of lie in making certain that the Bureau of Engraving currency from depository institutions, and currency and Printing (BEP) prints adequate amounts of cur- in circulation declined to $535.4 billion, a level more rency; that overseas distribution channels have suffi- consistent with the historical trend (chart 1). cient capacity to distribute U.S. currency when and Domestic demand for currency is largely based on where it is needed; and that the integrity of U.S. the use of currency for transactions and is influenced currency is maintained by monitoring counterfeiting primarily by income levels, prices for goods and activity. In the process of meeting these challenges, services, the availability of alternative payment meth- the Federal Reserve has improved its methods of ods, and the opportunity cost of holding currency in forecasting demand for U.S. currency, expanded lieu of an interest-bearing asset. In the United States, currency distribution channels, and worked with the demand (in terms of number of notes) for smaller BEP and the U.S. Secret Service to protect against denominations ($1s through $20s) exceeds demand counterfeiting threats. for larger denominations ($50s and $100s). Con- This article gives an overview of the evolution sumers frequently use smaller-denomination notes of the Federal Reserve's responsibilities for U.S. cur- for small transactions and alternative payment meth- rency, particularly in relation to the increase in for- ods (for example, checks and credit cards) for large eign demand over the past two decades. It also dis- purchases. cusses work on counterfeit deterrence and concludes In contrast, foreign demand is influenced primarily with a brief note on the future of currency and coin. by the political and economic uncertainties associ- ated with certain foreign currencies, which contrast with the U.S. dollar's high degree of stability. The [Note: 1]. The Federal Reserve Act of 1913 established the Board of Governors and the twelve Federal Reserve Banks as the nation's central bank and provided that the Federal Reserve function as mone- [note: 2]. Currency in circulation is the public's cash holdings and deposi- tary authority to establish and issue currency for the United States. By tory institutions' vault cash; it excludes Federal Reserve and BEP 1920, the Federal Reserve's role had expanded, as the Department of vault cash. the Treasury closed Subtreasuries around the country and delegated 3. In the first quarter of 2000, Federal Reserve Banks received responsibilities for distributing currency and coin to the Federal 9.3 billion notes, compared with 6.8 billion notes during the same Reserve Banks. [end of note.] period in 1999. [end of note.] Chart 1. Currency in circulation, June 1997-May 2001 [Graph of currency in circulation in billions of dollars from June to May. It plots four lines: 1997 to 1998, andIn1998 the about to beginning 1999, $540 1999 billion of Juneto 2000,in there 2000. and is In about2000 early to$430 July 2001. billionthere is in a 1997,small abouthump $460each yearbillion raising in 1998, the totalabout about $505 $10billion billion. in 1999, about1997, $4601998, billion and 2000 in 1997, don't abouthave much $500 changebillion inuntil 1998, late and October about then $570 a billionslow increase in 2000. to 1999 the end was of having December a steeper to century$550increase at thedate than end change the of other Novermber effect. years All did and four starting peaked lines indecrease at late about August. throughout$600 Startingbillion January, the at aboutend 1998of $515 December. going billion from Thisin aboutSeptember is attributed $460 itto reached aboutto the about $5052001$449 billiongoingbillion, from and 1999 $570about from billion $570 about torespectively $500 about to $550 about by billion. $480the end billion, 1998, of May. 1999, 2000 2000 andgoing ended2001 from slowlyat about about rose $600 $540 to to aboutbillion.] about $460 $540 billion, billion, and NOTE. The data are daily. For the definition of currency in circulation, see text note 2. dollar remains a stable currency backed by a highly on estimates of net payments, international demand productive economy with low inflation and by the for U.S. currency increased 219 percent from 1989 to assurance that it will not be demonetized, recalled, 1990 during the Gulf War. As another example, from or devalued. Because U.S. currency is held abroad 1993 to 1994 international net payments increased primarily as savings, foreigners tend to hold high- 24 percent during the Mexican peso crisis (chart 3). denomination notes. According to one estimate, about Other countries have induced their residents to three-fourths of $100 notes in circulation are held substitute from the local currency to U.S. dollars, outside the United States. both as a store of value and as a medium for trans- The foreign component of the amount of currency actions. In the extreme, some governments have in circulation is estimated to have increased signifi- adopted the dollar as legal tender. Schuler and Stein cantly beginning in the late 1980s and continued categorize this process of dollarization as official, to grow through most of the 1990s (chart 2). Because semiofficial, or unofficial. According to this classifi- about 90 percent, on average, of the $100 notes cation, official dollarization, also known as full dol- ordered by the Federal Reserve Bank of New York larization, occurs when a country adopts the U.S. appear to be paid out to foreign banking organiza- dollar as both legal tender and as its predominant—or tions to satisfy foreign demand, net payments (that exclusive—currency. Recent examples of officially is, shipments to depository institutions in excess of dollarized countries include Ecuador (January 2000), receipts from depository institutions) of $100 notes El Salvador (January 2001), and Guatemala (May from the Federal Reserve Bank of New York form 2001); other countries, such as Panama (1904), have one basis for estimating international demand. Based been dollarized for many years. Schuler and Stein define semiofficial dollarization as the use of U.S. [Note: dollars as legal tender, while4] .bot Porteh rth ane dloca Judsol ncurrenc argue thay t the dollar's nearly unchanging physical appearance and the U.S. policy of never recalling older-series and U.S. currency are used in daily transactions. notes, in addition to the extraordinary strength and stability of the U. S. economy and the dollar, have given rise to near-universal recognition Examples of countries with semiofficial dollarization and acceptance of dollars. See Richard D. Porter and Ruth A. Judson, include the Bahamas, Cambodia, and Haiti. Finally, ''Overseas Dollar Holdings: What Do We Know?'' Wirtschaftspoli- unofficial dollarization occurs when citizens of a tische Blatter (April 2001), pp. 431-40. [end of note.] [Note: 5]. See Richard D. Porter and Ruth A. Judson, ''The Location of U.S. Currency: How Much is Abroad?'' Federal Reserve Bulletin, [Note: 7]. Federal Reserve net payments data suggest that in both episodes, vol. 82 (October 1996), pp. 883-903. [end of note.] the dollars were returned to the United States after a relatively short [Note: period. [end of note.] 6]. As opposed to the overall issuance of currency, the amount held abroad must be inferred from a variety of sources, including reports [Note: 8]. See Kurt Schuler and Robert Stein, "The International Monetary from currency shipments, the denomination of bank notes, and evolv- Stability Act: An Analysis'' (paper for the North-South Institute ing seasonal patterns. Porter and Judson use several methods for Conference, "To Dollarize or Not to Dollarize?'' Ottawa, October 5, estimating the foreign component of total U.S. currency in circulation. 2000). Schuler and Stein define legal tender as currency that is legally The current foreign estimates range from one-half to two-thirds of the acceptable as payment for all debts and differs from forced tender, total value of currency in circulation. See Porter and Judson, ''The which requires that people accept a currency in payment even if they Location of U.S. Currency.'' [end of note.] would prefer another currency.
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