Monday, July 15, 2013

WaPo Smacks Down a Krugman Theory

WaPo's Zachary Goldfarb writes:
Last week, Paul Krugman offered a different reason than I had suggested for why the amount of U.S. currency in circulation has been skyrocketing. Rather than fear driven by financial uncertainty – as I argued, based on an essay by San Francisco Federal Reserve president John Williams and other research – Krugman suggested the driving factor is low interest rates.
“What has changed is that with zero interest rates, the opportunity cost of holding cash has gone way down,” Krugman wrote. “[I]t’s not fear, it’s despair: there’s nothing to invest in, so why not keep stuff under your mattress?”
It makes sense that both low interest rates and fear are driving holdings of U.S. currency – namely in the form of $100 bills – to historic levels. And the whole dynamic seems self-reinforcing, as economic uncertainty or financial duress in the world tends to push down interest rates in the United States. So, yes, as Krugman says, interest rates are probably an important factor.
But I’m not so sure they’re the most important factor — for a few reasons. For starters, a lot of the demand for U.S. currency is coming from abroad. If you’re in another country with high inflation or severe instability, one of your main concerns is going to be preserving your purchasing power. When you’re worried about your local currency rapidly losing value, or getting access to your cash if your banks fails, it seems unlikely that a major factor in your decision-making will be whether you get a modestly higher return on your cash holdings in a U.S. account or investment. Many of these savers (particularly those who come by their dollars illicitly) likely don’t even have access to interest-paying forms of dollar savings such as Treasury bonds or U.S. bank accounts.
About 70 percent of U.S. currency today – in the form of $100 bills – is abroad, compared to about 50 percent two decades ago, according to this landmark paper on this topic by Ruth Judson of the Federal Reserve.

1 comment:

  1. That 70% figure often thrown around is a myth.