Foreign Holdings of U.S. Currency

It was reported recently that Russians are holding $30 billion of US currency in the form of cash. It was also commented that this constitutes a form of interest-free loan to the US. Why?

The holding of 30 billion dollars in cash can be considered an "interest-free loan," but I would suggest expressing it in a slightly different way.

The Russians earn those dollars by selling Western buyers various real goods and services (oil, diamonds, timber, natural gas, rare works of art, and some marketable consumer items such as drugs and "ladies of the evening").

Normally trade is thought of as a reciprocal process in which the exporters of goods in country "A" turn around and use their receipts from foreign sales to import goods from country "B." Of course, the exporters in country "A" can choose not to buy finished consumer goods from its trading partners in country "B." Instead they may use all or part of their receipts from sales in country "B" to directly or indirectly invest in country "B." Direct investment would involve the purchase of land, the purchase and construction of production facilities, the hiring of workers, etc. in country "B." Indirect investment would involve the depositing of receipts earned in a financial institution in country "B," with that sum adding to the pool of savings in country "B." Exporters in country "A" would then earn an interest income on their deposits.

In the case of the Russians, part of their dollar proceeds are used to buy American or other foreign goods; and are also used to directly or indirectly invest in foreign countries. But they are also estimated to have retained approximately 30-35 billion dollars in cash, which has been transferred to Russia. It is used in Russia either as a substitute domestic currency or as a "store of value" (a cash "hoard"), given the continuing distrust in the Russian ruble.

This sum represents a claim against American goods, resources or services, since these 30-35 billion dollars could be spent in the United States. As long as this sum is not spent the claim is not made.

From the economist's point-of view, savings represents the deferring of consumption out of income earned. Two forms of savings are direct or indirect investment. A portion of income is spent to undertake an investment project. Or a portion of that income is deposited in a financial institution and is then lent to others desiring to undertake investment projects; the depositor receives an interest income as the compensation for forgoing consumption or other uses for which that portion of his earned income could have been spent.

Another form of savings is holding cash. Why is it a form of savings? Because in principle the amount of money held as a cash balance (or cash "hoard") could have been spent on the market for various consumer items. By not making such purchases, an individual is deferring consumption (i.e., forgoing the purchase of goods and services in the more immediate present), and therefore "saving."

The 30-35 billion dollars held in Russia represents, therefore, an amount of deferred consumption and non-interest earning investment in the United States equal to that amount. The resources that would have had to go into the manufacture of 30-35 billion dollars worth of goods to export to Russia as payment for that dollar sum of imports from Russia, are therefore "freed-up" to be utilized in alternative ways by consumers and producers in the United States. These resources and goods have been "saved" from having to be used to immediately pay for the goods and resources imported from Russia.

And the American producing and consuming community obtains the use of these goods and resources, that otherwise would have gone towards paying for Russian imports, without any required interest payment for their availability and use.

Suppose that, hypothetically, the Russians would have spent that 30-35 billion dollars on buying 1,000,000 U. S. automobiles at 30,000 dollars each. Rand labor necessary to manufacture 1,000,000 cars would have esources been tied up making an export commodity to pay for whatever goods equal to 30-35 billion dollars American importers had bought from the Russians.

By not spending this 30-35 billion dollars on American cars, but instead just holding it as a cash "hoard" in Russia, those resources are available to make automobiles for American car drivers, or to be used for starting new investment projects in America, or expanding existing enterprises in the U. S. or used for longer-term research and development projects.

And the American consuming and producing public is not required to pay these Russians any interest payment for the use of these resources for those various purposes.

It is in this sense that the 30-35 billions dollars held in Russia represents an interest-free loan to the United States.