Vhe French finance minister at the time, Valéry Giscard d’Estaing, spoke of an “exorbitant privilege” more than half a century ago. What was meant was the role of the dollar as the world’s leading trading and reserve currency. Much has been written since then about the role and extent of this privilege. However, the United States does not only enjoy a primacy with regard to its currency. Their government bonds also know no serious competition in their function as safe capital investments. The political, economic and military dominance of the United States, combined with the vast size of the market, creates a very favorable environment for its bonds relative to the bonds of other countries.
Even occasional reports of falling liquidity in times of crisis have not been able to shake the reputation of “Treasury Bonds”. One such episode played out in the spring of 2020, when news of a dangerous spread of the pandemic circulated, prompting many investors to sell securities. Over the past few weeks, foreign investors (including central banks), mutual funds and hedge funds have divested themselves of American government bonds to an extent not seen before in the financial crisis of 2008.
Because the sudden supply was not matched by sufficient private demand, government bond prices fell significantly, causing yields to rise sharply between the 9th and 18th of March. The American central bank (Federal Reserve) then quickly helped to calm the market by announcing a new bond purchase program.
Insights into the reserves
A look at the official currency reserves of foreign central banks, about which the International Monetary Fund regularly provides information, also sheds light on the considerable importance of American government bonds. According to this, the dollar’s share of the world’s foreign exchange reserves reported to the IMF is around 59 percent – no other currency can compete with the dollar as a reserve. Of the currency reserves calculated by the IMF at the end of March 2022 as $7.1 trillion, $4.1 trillion was in US government bonds. The statistics of the IMF underline the actual demand, because not all central banks give the fund insight into their reserves.
What motivates foreign central banks to build significant holdings in dollar-denominated assets? The specialist literature distinguishes between a mercantilist and a caution-driven motive. The mercantilist motive refers to the varying degrees of desire of some governments over time to prevent their currency from appreciating too much on the foreign exchange market in the interest of their export economy. The instrument of choice is then usually the sale of one’s own currency on the foreign exchange market – mostly against the dollar as the leading international currency.
