RATIONALITY OF HOLDING US DOLLAR ASSETS BASED ON GLOBAL US DOLLAR LIQUIDITY STRUCTURAL TRANSFORMATION: A NEW PERSPECTIVE ON ASSET ALLOCATION

Abstract

ABSTRACT As a crucial share of global liquidity, USD liquidity heightens a prominent negative spillover effect within the international monetary system. Especially, against the turbulent world background after the 2020 pandemic and the Russo-Ukrainian War, it is more observable to intensify the negative spillovers of USD liquidity during bad times. US Treasury securities, which greatly contribute to the USD liquidity externality because of their safety and reliability, have long been preferred by the world’s main economies. Moreover, the yield of US Treasury securities can be an important factor determining the USD liquidity spillover and is a key consideration in evaluations of the international monetary system. Considering the dilemma USD assets holders are faced with, we dig into the spillover effect at the macro-economic level and extend this mechanism into asset allocation effectiveness at the micro-economic level. Our investigation results point to a significantly negative relationship between the effect and risk level of USD assets on the one hand and the scale of USD foreign exchange reserves on the other. This implies that the world’s main economies face more challenges regards to international liquidity management, lacking a feasible plan for replacing USD assets. We contend that reform and diversification are needed in the current USD standard monetary system to strengthen the effect of global liquidity. Keywords negative externality of USD liquidity, US Treasury securities, asset allocation, monetary system reform, turbulence