Capital crosses borders more today than ever before. While a small number of large firms issue bonds in foreign currency and borrow from foreigners to finance their operations, the vast majority of firms issue only in local currency and do not directly access foreign capital. That is, with the exception of U.S. firms. Since the 2008 financial crisis, according to new research from Columbia Business School, global portfolios have shifted dramatically away from the euro and toward the dollar – essentially cementing the dollar as the only international currency.
“Generally, investors everywhere only want to lend in their currencies,” said Jesse Schreger, Assistant Professor and Faculty Fellow at the Jerome A. Chazen Institute for Global Business at Columbia Business School.
“If a firm wants to borrow from foreign investors, this means they need to issue debt denominated in the investor’s currency, which exposes them to exchange rate risk or the need to use currency derivatives – a costly proposition for many companies.”
Schreger documents that American companies are currently tapping into international markets in ways that companies in other countries cannot because of the dollar’s predominant status as an international currency. This bias implies that when foreigners buy U.S. securities, they predominantly buy dollar-denominated securities, thus behaving similarly to U.S. domestic investors.
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In a newly-released NBER paper, Schreger and his co-authors, Matteo Maggiori of Harvard University and Brent Neiman of The University of Chicago Booth School of Business, establish that global portfolios are driven by an often neglected aspect: the currency of denomination of assets.
Using a dataset of $27 trillion in security-level investment positions, provided by Morningstar, one of the world’s largest providers of investment research to the asset management industry, the researchers find that, by and large, investor holdings are biased toward their own currencies. Indeed, each country holds the bulk of all securities denominated in domestic currencies, even those issued by foreign borrowers in developed countries. These patterns hold true across countries with the exception of international currency issuers, such as the United States.
Other than international currencies, such as the dollar, investors are much more reluctant than was previously thought to take on currency risk when buying the debt of foreign countries, even when those countries are developed countries like Canada or Great Britain. Companies can borrow from abroad by issuing in foreign currency, but the study suggests that it is costly to do so. Therefore, unless a country issues an international currency, many companies have to do without the security of foreign capital.
How the Dollar Pays Off for American Companies
The global willingness to hold the dollar, resulting in an international-currency bias, means that U.S. companies that borrow exclusively in dollars have little difficulty securing financing from abroad.
“This is not true for any other country in the dataset,” said Schreger. “Our work offers a novel perspective on the potential benefits that accrue to countries that issue an international currency like the dollar.”
Therefore, American companies should find it easier to finance their expanding operations and grow than companies from anywhere else in the world.
To learn more about the cutting-edge research being conducted at Columbia Business School, please visit www.gsb.columbia.edu.