The Bank of Korea said the wider the dollar is used internationally, the greater the domestic spillover from U.S.-origin financial shocks. It warned that the recently spreading dollar stablecoins could further strengthen the dollar's influence, calling for caution.
In a BOK Issue Note released on the 15th, Dollar hegemony and the global spillover of U.S.-origin shocks, the Bank of Korea analyzed how U.S. financial shocks are amplified through the dollar's international functions. The report was written by Son Min-gyu, head of the financial modeling team at the BOK's Economic Modeling Division.
According to the study, the dollar plays a central role in international finance and trade settlement—such as foreign reserve assets, foreign currency borrowing, and export-import settlement—in many countries including Korea. In particular, because the dollar serves as a safe asset and a working-capital currency, when an economic shock occurs in the United States, it affects Korea's real economy.
For example, when a financial-risk shock occurs, the value of the dollar as a safe asset rises, and the local prices of our products transacted in dollars also increase, worsening the trade balance. This contrasts with the traditional hypothesis that a rise in the won-dollar exchange rate boosts the price competitiveness of exports and leads to an improved trade balance. Monetary tightening from U.S. interest rate hikes similarly triggers dollar strength and affects Korea's real economy.
The researchers argued that if the dollar's hegemony were weaker than it is now, the spillover from U.S. financial shocks would be smaller. Using a DSGE model to analyze a scenario where the dollar was not used as an international finance and trade settlement medium, they found that the decline in domestic output following U.S. rate hikes would shrink by about 30%.
They also found that if Korea's exports were settled in won instead of dollars, a rise in the won-dollar exchange rate would translate into stronger export price competitiveness and, in the short term, higher exports. The drop in domestic output was also reduced by about one quarter.
The researchers expected that concluding currency swaps with countries within Asia or future inclusion in the World Government Bond Index (WGBI) could partially mitigate the spillover from U.S. financial shocks.
However, they noted that if demand for dollar stablecoins spreads, the dollar's international status could change, warranting preparation. Stablecoins are cryptocurrencies designed to be pegged 1-to-1 to legal tender such as the U.S. dollar or the euro.
The researchers said, "If dollar stablecoins come into wide use for export-import settlement, the impact of dollar value fluctuations on global trade could expand," but added, "However, if excessive Government Bonds issuance is tolerated and confidence in U.S. Treasurys deteriorates, or if coin-run risks grow, it could instead negatively affect the dollar's status."