Banking, Trade, and the Making of a Dominant Currency∗

We explore the interplay between trade invoicing pa‹erns and the pricing of safe assets in di‚erent currencies. Our theory highlights the following points: 1) a currency’s role as a unit of account for invoicing decisions is complementary to its role as a safe store of value; 2) this complementarity can lead to the emergence of a single dominant currency in trade invoicing and global banking, even when multiple large candidate countries share similar economic fundamentals; 3) €rms in emerging-market countries endogenously take on currency mismatches by borrowing in the dominant currency; 4) the expected return on dominantcurrency safe assets is lower than that on similarly safe assets denominated in other currencies, thereby bestowing an “exorbitant privilege” on the dominant currency. ‘e theory thus provides a uni€ed explanation for why a dominant currency is so heavily used in both trade invoicing and in global €nance. ∗We are grateful to Chris Anderson and Taehoon Kim for outstanding research assistance, and to Stefan Avdjiev, Leonardo Gambacorta, and Swapan-Kumar Pradhan of the Bank for International Se‹lements for helping us to be‹er understand the construction of the BIS banking data. ‘anks also to Andres Drenik and seminar participants at various institutions for helpful comments. Gopinath acknowledges that this material is based upon work supported by the NSF under Grant Number #1628874. Any opinions, €ndings, and conclusions or recommendations expressed in this material are those of the author(s) and do not necessarily reƒect the views of the NSF. All remaining errors are our own.