Mars or Mercury? The Geopolitics of International Currency Choice

49 Pages Posted: 28 Dec 2017

See all articles by Barry Eichengreen

Barry Eichengreen

University of California, Berkeley; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

Arnaud Mehl

European Central Bank (ECB)

Livia Chitu

European Central Bank (ECB)

Date Written: December 2017

Abstract

We assess the role of economic and security considerations in the currency composition of international reserves. We contrast the “Mercury hypothesis” that currency choice is governed by pecuniary factors familiar to the literature, such as economic size and credibility of major reserve currency issuers, against the “Mars hypothesis” that this depends on geopolitical factors. Using data on foreign reserves of 19 countries before World War I, for which the currency composition of reserves is known and security alliances proliferated, our results lend support to both hypotheses. We find that military alliances boost the share of a currency in the partner’s foreign reserve holdings by 30 percentage points. These findings speak to current discussions about the implications of possible U.S. disengagement from global geopolitical affairs. In a hypothetical scenario where the U.S. withdraws from the world, our estimates suggest that long-term U.S. interest rates could rise by as much as 80 basis points, assuming that the composition of global reserves changes but their level does not.

Suggested Citation

Eichengreen, Barry and Mehl, Arnaud and Chitu, Livia, Mars or Mercury? The Geopolitics of International Currency Choice (December 2017). NBER Working Paper No. w24145. Available at SSRN: https://ssrn.com/abstract=3092993

Barry Eichengreen (Contact Author)

University of California, Berkeley ( email )

310 Barrows Hall
Berkeley, CA 94720
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Arnaud Mehl

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Livia Chitu

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

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