2013 Globalization and Monetary Policy Institute Annual Report
Methodology: Measuring the External Value of the Dollar
By Adrienne Mack and Mark Wynne
We construct our financially weighted exchange rate indexes using the methodology of Lane and Shambaugh (2010) but with a slightly different country group. To facilitate comparisons with the Trade Weighted Value of the Dollar (TWVD) index constructed by the staff of the Board of Governors, we include only countries that are in the TWVD. Countries whose currencies are included are the euro area, Canada, Japan, Mexico, China, United Kingdom, Taiwan, Korea, Singapore, Hong Kong, Malaysia, Brazil, Switzerland, Thailand, Philippines, Australia, Indonesia, India, Israel, Saudi Arabia, Russia, Sweden, Argentina, Venezuela, Chile and Colombia.
The TWVD weights movements in bilateral exchange rates by the importance of the bilateral trade relationship with the United States. The financially weighted exchange rates weight movements in bilateral exchange rates by the importance of the respective currencies in U.S. foreign asset, liability, total investment or net liability positions. Certain currencies loom larger in international financial relationships than others: Some countries are unable to issue significant amounts of debt denominated in their own currencies, whereas the United States is able to issue sovereign debt exclusively in its own currency. Each index evaluates exchange rate movements from an international investment perspective. The percent change in bilateral exchange rates is weighted by the currency composition of international assets and liabilities.
First the currency composition of the U.S. external asset position is computed separately for five categories of foreign assets: foreign direct investment (FDI), portfolio equity, portfolio debt, other debt and foreign reserves. The aggregate currency composition is a weighted average of the individual categories, where each category is weighted by its share of total assets.
FDI Assets (Tab A1)
FDI assets represent U.S. direct investment located in foreign countries. All investment transactions are assumed to be denominated in the foreign country’s currency. The stock of U.S. direct investment in each country is used to determine the currency composition for FDI assets. The data are obtained from the regular estimates of the U.S. international investment position produced by the Bureau of Economic Analysis (BEA), which include estimates of U.S. foreign direct investment overseas at current cost on an annual basis starting in 1976.
Portfolio Equity Assets (Tab A2)
Portfolio equity assets are U.S. holdings of foreign equity securities and are also assumed to be denominated in the foreign issuer’s currency. The geographic location of U.S. holdings determines the currency composition for the portfolio equity asset category. U.S. holdings of foreign equity securities for each countryare obtained from the Treasury International Capital (TIC) System survey data published by the U.S. Treasury. The U.S. Treasury reports data annually starting in 2003. Prior reports are less frequent: Data are available for 1994, 1997 and 2001. In years for which U.S. Treasury data are not available, we use data from Bertaut and Tryon (2007), which extrapolates the TIC survey data using data on monthly cross-border transactions.
Portfolio Debt Assets (Tabs A3.a, TIC data, A3.b, A3)
Portfolio debt assets represent U.S. holdings of foreign debt securities. Not all debt is issued in the issuing country’s domestic currency. The majority of portfolio debt assets held by U.S. investors are denominated in U.S. dollars. Holdings of foreign-currency denominated debt by U.S. investors are concentrated in the major global currencies. Thus, the geographic location of U.S. holdings does not correctly reflect the currency composition.
The TIC survey reports U.S. holdings of long-term foreign debt securities by country and by currency. (Tab A3.a.) The report gives the value of debt held in U.S. dollars, euros, yen, pounds and the country’s own currency. (Tab TIC data) However, data availability is limited. The initial report covered holdings as of 2001. Following the second report in 2003, data are available annually. To estimate the currency composition of debt assets when TIC survey data are not available, holdings data are adjusted to reflect investor preferences. Holdings data are obtained from Bertaut and Tryon (2007). 2002 holdings are adjusted using the 2003 currency composition for each country. (Tab A3.b) The 2001 currency compositions are used for all years prior to 2001. For example, suppose that for country A, the currency composition in 2001 is 20 percent U.S. dollars, 20 percent euros, 20 percent pounds, 20 percent yen and 20 percent country A currency. Then for the years prior to 2001, out of the reported holdings for country A, only 20 percent would be assigned to country A’s currency, and the remaining holdings would be reallocated accordingly.
Euro-area adjustments: Prior to 2001, U.S. holdings of portfolio debt for Belgium and Luxembourg are reported as a single number. Therefore, the 2001 currency composition of the two countries must be recalculated before it can be applied to the combined holdings data. Debt denominated in euros issued by non-euro-area members is reallocated to Germany.
Other Debt Assets (Tabs A4.a., A4.b, A4.c, A4.d., A4)
Other debt assets are primarily U.S. banks’ claims on foreigners. Like portfolio debt, most other debt is denominated in U.S. dollars, with the foreign currency-denominated component concentrated in the major global currencies. The amount of foreign currency claims on each country is reported by the U.S. Treasury (starting in 2003) and the BEA (prior to 2003). (Tab A4.a) Information on the denomination of foreign currency is not available on a cross-country basis, but assumptions can be made using the Bank for International Settlements (BIS) locational banking database.
The ratio of domestic to foreign currency liabilities of individual reporting banks is used to assign amounts of country-specific foreign currency. (Tab A4.b) U.S. banks’ claims are reported by the foreign country as liabilities to the U.S. Furthermore, U.S. claims on the country that are A denominated in country A’s domestic currency are reported by country A as liabilities in domestic currency. If a large portion of a foreign country’s liabilities are denominated in its domestic currency, it is reasonable to assume the foreign currency component of U.S. claims will also contain a larger portion of that country’s currency.
The aggregate composition of reporting banks’ foreign currency assets is used to allocate the remaining foreign currency claims. The BIS reports aggregate foreign currency holdings in six groups: U.S. dollars, euros, yen, pounds, Swiss francs and other currencies. Only data on euros, yen, pounds and Swiss francs are used to compute shares. (Tab A4.c)
The currency composition is determined from claims payable in foreign currency. The category weight is determined using total claims, which includes both foreign and domestic currency. The amount of total claims on each country is reported by the U.S. Treasury (starting in 2003) and the BEA (prior to 2003).
Reserve Assets (Tab A5)
Foreign currency reserve assets are denominated exclusively in euros (German marks prior to 1999) and Japanese yen. The composition of the two currencies is reported weekly by the U.S. Treasury starting in 1999. Prior to 1999, data are obtained from quarterly reports on the Treasury and Federal Reserve Foreign Exchange Operations. The year-end reports are used to represent the annual composition.
As with U.S. assets, the currency composition is computed separately for each of four individual liability categories. The aggregate currency composition is a weighted average of the individual categories, where each category is weighted by its share of total liabilities.
FDI Liabilities (Tab L1)
FDI liabilities represent foreign direct investment located in the U.S., so they are assumed to be denominated entirely in U.S. dollars. All data are from the BEA’s estimates of the U.S. international investment position, which reports FDI in the U.S. by country of origin. Since the investment is in the U.S. and is assumed to be denominated entirely in U.S. dollars, the currency composition is irrelevant.
Portfolio Equity Liabilities (Tab L2)
Portfolio equity liabilities represent foreign holdings of U.S. securities issued in the U.S. equity market, and are also assumed to be denominated entirely in U.S. dollars. The data are from the U.S. Treasury’s TIC survey, augmented with estimates from Bertaut and Tryon (2007). Since these liabilities are assumed to be denominated in U.S. dollars, the currency composition is not an issue. But the totals are needed to compute the category weights.
Portfolio Debt Liabilities (Tabs L3.a, BIS data, L3)
Portfolio debt liabilities represent foreign holdings of U.S. debt securities. There are three types of debt securities issued: U.S. Treasuries, government agency bonds and corporate bonds. U.S. Treasury bonds are denominated entirely in U.S. dollars, and government agency bonds are almost exclusively issued in U.S. dollars. Therefore, corporate bonds are the primary source of foreign-currency-issued debt.
The currency composition is calculated using issuance data from the BIS international securities database, which reports the amount of long-term debt by currency of issue. The category weight is determined using the amount of foreign holdings of U.S. securities. Data are obtained from the U.S. Treasury and Bertaut and Tryon (2007).
Other (Bank) Liabilities (Tabs L4.a, L4.b, L4.c, L4.d, L4)
The currency composition of other debt liabilities is computed following the same procedure as for the other debt assets.
Data on U.S. banks’ liabilities to each country payable in foreign currency are obtained from the U.S. Treasury (starting in 2003) and the BEA (prior to 2003). These are adjusted using the BIS locational banking database. The portion of foreign currency assigned to each country is determined using the proportion of domestic to foreign currency assets of individual reporting banks. The remaining foreign currency is allocated using aggregate foreign currency holdings of euros, yen, pounds and Swiss francs.
The category weight is determined using total (domestic and foreign currency) liabilities for each country. This is obtained from the U.S. Treasury (starting in 2003) and the BEA (prior to 2003).
The asset and liability indexes use currency shares to weight the annual percent change in bilateral exchange rates. All exchange rates are reported in terms of U.S. dollars per unit of foreign currency, so a decline in an exchange rate corresponds to an appreciation of the dollar (fewer dollars are needed to purchase a unit of foreign currency).
A rapid foreign currency appreciation will cause the exchange rate to fall toward zero rather than approach infinity. This is consistent with that investment becoming worthless.
All data are annual and start in 1994. Since currency weights are based on end-of-period values, year t values are used to weight the change in year t+1: 1994 currency weights are used with 1995 growth rates. Each index is set to 100 in 1994 and then extended using the weighted growth rates.
- The different country sample maintains a similar currency composition. Assets are more concentrated in the foreign direct investment and portfolio equity categories, but this has minimal effect on the overall index.
- We also follow the same procedure for the inclusion of euro-area countries. Prior to 1999, the 11 original member countries are computed separately. After 1999, the country weights are combined, and the euro area is reported as a whole. As countries join the euro area, they are included in the sum. Source on methodology change for the TWVD index when Greece joined the euro: www.federalreserve.gov/pubs/bulletin/2005/winter05_index.pdf. A current list of countries: www.federalreserve.gov/releases/H10/Weights/.
- All references to tabs are to sheets in the accompanying Excel workbook, “Mack–Wynne Spreadsheets for 2013 Institute Annual Report.”
- TIC annual surveys can be found at www.treasury.gov/resource-center/data-chart-center/tic/Pages/fpis.aspx#usclaims. No data are available for Saudi Arabia.
- See www.federalreserve.gov/pubs/ifdp/2007/910/.
- Currency composition of long-term debt is assumed to represent all portfolio debt. No data are available for Saudi Arabia.
- Lane and Shambaugh (2010) use the 2003 currency composition for all years.
- This is also true in the equity data, but currency composition is not an issue there.
- U.S. holdings for nonreporting countries represent less than 1 percent of total holdings.
- See www.treasury.gov/resource-center/data-chart-center/IR-Position/Pages/default.aspx.
- See www.newyorkfed.org/newsevents/news/markets_archive.html.
- The totals must be computed using bilateral data due to country sample.
Bertaut, Carol C., and Ralph W. Tryon (2007), “Monthly Estimates of U.S. Cross-Border Securities Positions,” International Finance Discussion Paper no. 910 (Washington, D.C.: Federal Reserve Board, November).
Lane, Philip R., and Jay C. Shambaugh (2010), “Financial Exchange Rates and International Currency Exposures,” American Economic Review 100 (1): 518–40.