Thoughts on Exorbitant Privilege

City states are best equipped to bear the exorbitant privilege, and the Sornette Plan to fully exploit the advantages of the privilege.

If the problem of being the nation whose currency is adopted as the reserve currency amongst the nations is that your exorbitant privilege will necessarily depress and hollow out your manufactoring basis, does it not stand to reason that the nations best suited to bearing the burden of the exorbitant privilege, is that of city states, where they can have no manufacturing anyway?

Here, we are flipping the Triffin Dilemma into a spatial-economic optimization problem: if the reserve currency status necessarily imposes structural current account deficits and deindustrialization, then let it fall on entities that have nothing to lose industrially. In other words, delegate the burden to economic entities that are structurally incapable of supporting manufacturing to begin with.

Let’s unpack this.

What is “exorbitant privilege”? It refers to the benefits a country enjoys when its currency is the world’s reserve currency, which include:

• The ability to run persistent current account deficits without balance of payments crises.

• Global demand for its currency and bonds, keeping interest rates low.

• Control over global liquidity, giving strategic leverage.

The issuing country of the reserve currency, the US, must provide liquidity. It must exports its currency, which is to say it must buy foreign goods more than it sells domestic goods to foreign markets, so there’s a net flow of dollars out. If it does not, then the inflexible demand for the dollar will cause the dollar to appreciate and make American goods uncompetitive. In other words, if the US does not voluntarily run a trade deficit, the dollar will appreciate until there is a trade deficit.

The upshot are the following:

• Those trade deficits undermine domestic industries as the US domestic market is now flooded with cheap goods.

• The capital inflows push up asset prices and strengthen the currency, further weakening exports.

• Over time, the economy financializes, and manufacturing dies a slow death.

• Asset price inflation and the death of blue collar manufacturing end in chasming wealth inequality, eventually inducing constitutional crisis.

Hence: the exorbitant privilege is also an exorbitant burden.

Enter the City-State, and Switzerland.

But suppose somebody else took up the mantle of reserve currency issuance. What kind of state would be most immune to its unwanted effects? Consider a city-state like Singapore, Hong Kong, or Dubai:

• Already imports nearly all its food and energy.

• Doesn’t have the land or labor base for manufacturing at scale.

• Thrives by positioning itself as a service and capital hub, not a factory.

So if you assign global reserve currency status to such a place, it doesn’t suffer from industrial hollowing—it starts off hollow. There’s nothing to hollow out. You’ve zeroed the cost side of the tradeoff.

But does that necessarily mean only city-states could issue reserve currencies without incuring harm? Might there be other ways to divert or shield the harm on domestic manufacturing?

A particularly illuminating proposal is the Swiss Franc Sovereign Wealth Fund proposal by the the Swiss polymath Didier Sornette.

In 2015, amidst the height of the European debt crisis, the Swiss Franc found itself to be a favourite amongst investors as a safe haven currency. The competitiveness of Swiss products, lead to a persistent trade surplus. Coupled with the Swiss’ unwillingness to put their savings in risky foreign ventures, this lead to an excess of the balance of the capital account that adds to the excess of the balance of trades. So yes, the Swiss found themselves in the highly unusual situation where they faced both a trade surplus and net capital inflows! To be clear, a double surplus is fantastic. It means the poor are exporting and the rich are seeing their assets inflating, but it’s like two electrons occupying the same state - its abhorred by the laws of economics, so rebalances will naturally commence until its eliminated. And the way the universe balances itself is the appreciation of the Swiss Franc. Currency appreciation will suppress Swiss manufacturing competitiveness, but maintain positive capital account inflow. In other words, the anomaly of the double surplus is resolved in favour of capital inflows, to the detriment of the balance of trade. To put it even more crudely, the poor are thrown under the bus.

Sornette argues that this need not be the course.

He argues that the Swiss Confederacy should print (or “mine”, in his words) Swiss Francs, sell them for euros and foreign currencies (thereby satisfying inflexible foreign demand for francs, and suppressing the franc’s value), put those euros and foreign currencies in a Swiss Sovereign Fund, and invest them in foreign assets. Returns on those investments can then be circulated back to Switzerland to better Swiss lives by means of investment, infrastructure, innovation, pensions, and other goodies.

In my reading, that is saying that the Swiss Franc has acquired reserve-currency-like status, and what Sornette’s saying is that there’s a way to game this and win:

1. Currency appreciation pressure (due to capital inflows, safe haven status, trade surplus) →

2. Swiss National Bank intervenes: prints CHF and buys foreign currencies/assets to weaken the franc (supplying francs to foreign powers)→

3. Foreign currency reserves accumulate at SNB →

4. Instead of passively holding reserves, transfer funds into a Swiss sovereign wealth fund →

5. Global investment strategy (diversified portfolio of equities, infrastructure, innovation, etc.) →

6. Returns from global investments flow back to Switzerland (without causing franc appreciation) →

7. Support Swiss economy long-term (via reinvestment, innovation, pensions, stabilization, etc.)

It’s not clear to me that America cannot at some point in the future, when manufacturing is more or less restablished, most probably with heavy AI integration, that the Sornette Plan cannot be implemented.