Trade Invoicing, Bank Funding, and Central Bank Reserve Holdings

In recent work (Gopinath and Stein 2017), we explore how a currency like the dollar can become entrenched as a dominant global currency, focusing on the two-way feedback between trade invoicing and banking structure. The basic idea is that when a larger share of a country’s imports are invoiced in dollars, its citizens have a greater demand for dollar-denominated safe claims. This in turn leads the local banking sector to become more dollarized, in the sense of funding itself more with dollar-denominated liabilities. Here we extend the framework of that paper to consider the implications for central-bank reserve holdings. We show that when a country’s banks are more heavily dollar funded, this induces the central bank—in its role as lender of last resort—to hold a larger stockpile of dollar reserves. We also provide some suggestive evidence which is consistent with this hypothesis.