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Growing Popularity of U.S. Dollar Abroad Helps Taxpayers, Hinders Policymakers

About 80 percent of the growth in U.S. currency during the past decade has resulted from increased foreign demand. The growing popularity of the U.S. dollar abroad has reduced the tax burden of U.S. citizens. At the same time, it has made currency a less reliable policy indicator.

Writing in the Federal Reserve Bank of Cleveland’s Economic Commentary, economist John Carlson and senior research assistant Ben Keen discuss the implications of estimates that 50 to 70 percent of all U.S. currency in circulation is being held outside our borders. While Americans hold dollars primarily to make payments for goods and services, foreign demand owes more to the dollar's quality as a store of value against conditions of uncertainty. Many foreigners prefer to hold U.S. currency because it is a relatively stable source of purchasing power, is widely accepted, and is reasonably secure from counterfeiting.

Carlson and Keen say that changes in the demand for U.S. currency have important implications for the tax burden of U.S. citizens. Currency, like Treasury securities, is ultimately a government debt. But unlike these instruments, currency pays no interest. The implicit yield of currency, the authors say, reduces the annual U.S. tax bill by more than $15 billion. Thus, as foreign demand for the dollar increases, the tax burden of U.S. citizens is reduced.

While the dollar’s popularity among foreigners is good for U.S. taxpayers, it distorts economic signals for policymakers. Historically, there is a direct relationship between the demand for money and domestic economic activity. But to the extent that U.S. currency is becoming subject to the vagaries of foreign demand, the use of various measures of money as guides for policy will prove increasingly problematic.

For example, demand for U.S. currency fell sharply in 1995, following the announcement of a redesigned $100 bill. Because the currency slowdown most likely reflected foreigners’ concerns about the new money, the authors say it is doubtful that this deceleration portends a weakening economy, as it might have in years past. And, as the new money becomes more widely accepted, currency growth is expected to accelerate to near previous levels.

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