The international role of the dollar is up for grabs, or at least for discussion. The discussion does not focus specifically on the value of currencies, but on their functionality and dominance in different transactions.
One role for an international currency is its role in trade invoicing. This matters since the use of different currencies in the invoicing of exports and imports plays a central role in how shocks are transmitted across countries and how one designs optimal monetary policy (Corsetti and Pesenti 2005).
If exporters sets prices in their own currencies – the so-called “producer currency pricing” strategy – exchange-rate movements are transmitted to consumer prices. Exchange rate movements then facilitate efficient movements in the relative price of domestic and imported goods, leaving monetary policy free to focus on domestic shocks. This is not the case if exporters set prices in the currency of their customers – the so-called “local currency pricing” strategy. In this case, the relative price of domestic and imported goods is unaltered by exchange rate fluctuations and monetary policy must strike a balance between reacting to domestic and foreign shocks. Indeed, the large use of the dollar in invoicing trade flows, including flows that do not include the US, offers an additional channel through which US monetary conditions are transmitted internationally (Goldberg and Tille 2009a).
What determines the choice of invoicing currency?
Several studies have studied the determinants of invoicing in international trade (Bacchetta and van Wincoop 2005, Devereux, Engel, and Storgaard 2004, Gopinath, Itskhoki, and Rigobon 2009). Two broad categories of determinants emerge. The first reflects industry-specific characteristics, such as the degree to which goods are substitutable. When goods are close substitutes, an exporter wants to limit the ex post fluctuations of her product’s price relative to the prices of competing goods. This leads to a “coalescing” effect as the exporters opts for an invoicing currency that is similar to her competitors (Goldberg and Tille 2008). The second category of drivers reflects the need to hedge against macroeconomic shocks. This favours the use of currencies for which monetary policy is relatively stable, or currencies that offer a hedge by appreciating at times when the exporter faces higher production costs.
The existing literature suffers from two limitations, however. First, empirical analyses consider aggregate datasets and overlook potentially substantial heterogeneity in invoicing practices in different industries. Second, the models used consider a unilateral invoicing choice where the exporter chooses the invoicing currency taking account of the customer’s downward sloping demand. But survey evidence from Friberg and Wilander (2008) shows that invoicing is set through bargaining between exporters and importers.
Invoicing at the transaction level
In a new study, we address both limitations (Goldberg and Tille 2009b). We use a highly disaggregated dataset covering all Canadian imports from February 2002 to February 2009 (44.5 millions observations). For each import transaction we know the date, the country of origin, the currency of settlement, industry code (up to HS10), and the value of the transaction. This data provide a window into the forces driving the choice of invoicing currencies by exporters around the world. Ultimately, analysis of such data also sheds light on the types of forces that can change the international roles of the dollar, euros, and other currencies.
Our data allow us to analyse import transactions both in terms of counts, with an equal weight on each transaction, and in terms of value. Table 1 below shows the average use of the various currencies throughout our sample (the invoice currency shares show little variations through time) for exports to Canada from the US and from all other countries around the world. In terms of transaction counts, the US dollar plays a dominant role, particularly in US exports. For exporters from the rest of the world, by count 72% of exports are invoiced in dollars and the remaining 28% of transactions are split between the Canadian dollar, the euro, and other currencies. While the US dollar still dominates the invoicing in terms of transaction value, its share is reduced for both categories of exporters. The Canadian dollar then accounts for about 20% of transactions.
Table 1. Currency use in Canadian import transactions
|Canadian dollars||US dollars||Euros||Other|
|US exporters||By count||3.2%||96.3%||0.3%||0.2%|
|Non-US exporters||By count||4.5%||72.3%||14.1%||9.2%|
The differences between invoicing shares based on transaction counts and transaction values reflect the fact that the Canadian dollar is used more extensively for larger transactions. This pattern is observed across all industries, with a larger share of the Canadian dollar in the top 5th percentile of transactions in a given industry compared to the bottom 95th percentile. This connection between transaction size and invoicing is a novel pattern not previously shown in the literature.
The role of the various drivers of invoicing can be formally analysed through a multinomial logit analysis, with the dependent variables being dummy variables which show whether a transaction is invoiced in the producer’s currency, the customer’s currency (the Canadian dollar), or a third vehicle currency. We distinguish between imports from the US, which account for a little more than half of all Canadian imports and are primarily invoiced in US dollars, and imports from other countries. We find support for both the industry characteristics and macroeconomic hedging considerations. Exporters in industries where goods are close substitutes make little use of their own currency (unless they are from the US), instead choosing US or Canadian dollars. Exporters from a country with a volatile exchange rate also do not use their own currency much. Exchange rate regimes also matter, with exporters from countries with a US dollar peg making more use of that currency.
Exporters from a country with a dominant share of Canadian imports in the industry in question make more use of their own currency, as they face little competition from exporters in other countries. The analysis confirms the impact of transaction size, with more use of the Canadian dollar in transactions that fall in the top 5th percentile of imports in the industry in question. Interestingly, the impact of transaction size is stronger for imports from a country that has a dominant market share in the industry.
Invoicing as a bargaining outcome
The assumption of unilateral invoicing by the exporter in the literature can be relaxed by allowing for a bargaining between exporters and importers. In addition to its empirical appeal, this setting generates a link between size and bargaining, although we do not claim that it is the only approach that can deliver this linkage.
Intuitively, the invoicing choice under the unilateral decision reflects the exporter’s preferences. The importer would prefer a larger invoicing share for her currency in order to reduce her exposure to exchange rate fluctuations. A bargaining outcome then calls for more use of the importer’s currency. This is especially the case when the importer is large. If the exporter fails to reach an agreement with a large customer, the exporter is left with more limited income than would be the case if demand were less concentrated. Larger customers are then able to extract better terms, leading to more use of the importer’s currency for large transactions.
The link between transaction size and invoicing is stronger when the exporter has a stronger direct bargaining power. Intuitively, an importer who gets a substantial say in setting invoicing will be relatively happy with the outcome, regardless of her size. By contrast, a customer with little say in the determination of invoicing will be left with a left favourable allocation, unless she can rely on being a large customer to induce the exporter to be more accommodating. Size is then a bargaining tool at the disposal of the importer, with importer size appearing as most valuable when the importer has little voice otherwise in negotiations with the exporter.
The availability of highly detailed datasets allows for a finer assessment of what drives the use of various currencies in international trade. For instance, the concentration of retailing towards large chains reinforces the bargaining power of importers vis-à-vis exporters and can lead to a reduction in the aggregate pass-through of exchange rate to consumer prices. Other key drivers of the international role of the dollar include the behaviour of exchange rates; countries with currencies closely tied to the US dollar exhibit a greater tendency to invoice in dollars, while countries with more volatile exchange rates tend to use some vehicle currency or the destination-market currency.
Bacchetta, Philippe, and Eric van Wincoop (2005), “A Theory of the Currency Denomination of International Trade.” Journal of International Economics 67(2), pp. 295-319.
Corsetti, Giancarlo, and Paolo Pesenti (2005), “International dimensions of optimal monetary policy.” Journal of Monetary Economics 52, pp. 281-305.
Devereux, Michael, Charles Engel, and Peter Storgaard (2004), “Endogenous Exchange Rate Pass-Through when Nominal Prices are set in Advance.” Journal of International Economics 63(2), pp. 263-291.
Friberg, Richard, and Fredrik Wilander, (2008), “The currency denomination of exports -- A questionnaire study.” Journal of International Economics 75(1), pp. 54-69.
Goldberg, Linda, and Cédric Tille (2008), “Vehicle currency use in international trade.” Journal of International Economics 76, pp. 177-192.
Goldberg, Linda, and Cédric Tille (2009a), “Macroeconomic Interdependence and the International Role of the Dollar.” Journal of Monetary Economics 56, pp. 990-1003.
Goldberg, Linda, and Cédric Tille (2009b), “Micro, Macro, and Strategic Forces in International Trade Invoicing”, CEPR Discussion Paper 7534.
Gopinath, Gita, Oleg Itskhoki and Roberto Rigobon (2009), “Currency Choice and Exchange Rate Pass-through", American Economic Review, forthcoming.