Manifest currency? U.S. dollar’s global dominance not set in stone
Incumbency, it is often said, confers many advantages.
Sitting U.S. presidents certainly have reaped its benefits – in the past 80 years, only three have been unseated.
Most economists believe the same benefits apply to reserve currencies. Yes, the U.S. dollar may one day be supplanted as the leading international currency, the thinking goes, but that day is many decades away.
Then again, maybe not.
A new working paper from the National Bureau of Economic Research that looks more closely at the dollar’s own rise to the top in the 20th century suggests, among other things, that “the advantages of incumbency are not all they are cracked up to be.”
By looking at the currency denomination of foreign public debt issued by 33 countries from 1914 to 1946, the authors – University of California-Berkeley professor Barry Eichengreen and Livia Chitu and Arnaud Mehl of the European Central Bank – find that dollar-denominated bonds were nearly equal to those priced in sterling by the late 1920s. That’s about two decades earlier than the date assumed by previous scholars.
When stripping out Commonwealth countries that had strong commercial and political links with Britain, the dollar overtook sterling in 1929.
Is U.S. economic patriotism hurting?
Any Americans believing that their country is being bought up by the Chinese might want to pay heed to a new report from the Vale Columbia Center on Sustainable International Investment. It says that China is a minimal player in terms of foreign direct investment in the United States and that Washington should in fact be doing a lot more to get it to gear up its buying.
To start with, look at the magic number. In 2010, the last year for which numbers are available, only 0.25 percent of FDI into the Untied States came from China. Switzerland, Britain, Japan, France, Germany, Luxembourg, the Netherlands, Canada were all far bigger. In the U.S. Department of Commerce’s report on the year, China, numbers were so small they were lumped into a category simply called ”others”.
This is not enough, the Vale Columbia report says. Given China’s burgeoning economic role across the globe, America can benefit from a lot:
First, FDI provides an influx of capital into the struggling economy, increasing employment at no cost to the taxpayer. Second, jobs in foreign affiliates are typically better remunerated than similar jobs in domestically owned companies. Third, keeping the US open to foreign investment demonstrates a global example for international openness. Finally, Chinese money refused by the U.S. could alternatively be directed to competitors or even the U.S.’s enemies.
(On the latter point, its worth reading our global economic correspondent Alan Wheatley’s story on China’s influence in Europe)
The Vale Columbia report acknowledges that Chinese FDI is controversial – primarily because a lot of Chinese companies are state-controlled and therefore raise fears that FDI may be more strategic that profit-seeking. There is also the concern about subsidies, piracy and economic espionage.
But the gains from opening the door to Chinese outweigh the risks, the report — entitled Economic Patriotism: Dealing with Chinese direct investment in the United States — says, recommending a series of steps such as dumping reciprocity clauses in FDI bilateral dealings.
“The US should corral as much of this investment as possible to revitalize the domestic economy and strengthen its image as an active supporter of an international investment openness.”
…or not.
China appears to fall into that grey area of desired market, yet geopolitical strategic opponent.
Just how close should we really be with them?
China bear Pettis says world coming around to his view
Few mainstream economists have been quite as downbeat on China as Peking University professor and noted China watcher Michael Pettis. Pettis has long held that the world’s No. 2 economy will grow at a maximum of 3.5 percent a year for the rest of the decade, well below a consensus call that appears to have settled into the 5-7 percent range. “And honestly, I think if I’m wrong, it will be to the downside rather than the upside,” he told Reuters.
Lately, though, Pettis says that many people inside China and in some of the countries whose fortunes are tightly tied to its economy are starting to come around to his point of view. At a recent lunch with visiting European Union officials, Pettis said the mood among the attending Chinese economists, academics, think-tankers and policy advisors was universally gloomy. “I’m used to being the most pessimistic guy in the room, but in this case, they were much worse than I.”
Pettis says that’s because the Chinese understand, far better than the average Western investor or economist, just how tough it’s going to be to rebalance from investment to consumption and shift wealth from the state to Chinese households.
There are many ways China can rebalance, but none is without difficulty. A steady, gradual rise in the exchange rate, interest rates and wages would help enrich households and wean exporters off their generous state subsidies but could also stoke inflation. Moving more swiftly could sink the economy as exporters go out of business and people lose their jobs.
Mass privatization, Pettis said, would help revitalize the economy but would likely face stiff political resistance.
How about having the state take over private sector debt, keeping companies humming along and people employed? Pettis points to Japan, which followed that route in the 1990s and today faces a crushing public debt burden at 200 percent of GDP.
When people ask me if China will have a hard landing or a soft landing, I find that whole discussion useless. What I think we’ll have is a long, bumpy landing. If growth rates slow too much, they will step on the credit accelerator. But then they’ll get the wrong kind of growth and they’ll apply constraints to slow it down again. So my guess is we’ll get this very jagged growth, with the peaks lower each time and the troughs lower each time. I don’t expect it to be a straight line.
Euro zone hopes for funds from the Fund
Focus for the euro zone is firmly on Washington with G20 policymakers gathering ahead of the IMF spring meeting. The Fund is seeking an extra $400 billion-plus in crisis-fighting funds which, tallied with the $500 billion euro zone rescue fund about to be established, adds up to a meaningful firewall for the markets to ponder before they consider pushing Spain and Italy to the edge.
But as many sage minds are saying – U.S. Treasury Secretary Timothy Geithner among them – a firewall does not solve the root problems of the euro zone debt crisis. As our very own Alan Wheatley puts it, “It is not obvious why a stronger firewall should encourage anyone to enter a burning house”. Nonetheless, Reuters polling yesterday ascribed only a 25% and 13% chance respectively to Spain and Italy needing an international bailout.
If the IMF falls short, given the jittery mood in financial markets, that could be cue for a further sell-off. The IMF has pledges of $320 billion so far. The Chinese and British have yet to show their hands and the BRICS led by Brazil are demanding more power at the Fund before handing over extra cash. German Finance Minister Wolfgang Schaeuble told us earlier in the week that conflating those two issues was not acceptable so there is potential for a rift. The U.S. and Canada have already said they will provide no more funding. Finance ministers and central bankers from the Group of 20 advanced and emerging economies had dinner on Thursday night, ahead of a longer session on Friday.
Concerns about Spain in particular are well justified but it is not yet close to the precipice. The banks are at the heart of the country’s problems and data this week showed they are carrying the biggest burden of bad loans since 1994. They will almost certainly need more capital at some point. On the other hand, the central bank pointed out yesterday that thanks to the ECB’s three-year money offer, Spain’s banks have their funding needs covered for this year, and maybe next too. Add to that the fact that Spain has shifted half its government debt issuance for 2012 in the first third of the year and it is clear it has some time to turn around market sentiment, which soured sharply when Madrid reneged on an agreed deficit target back in March.
In the end, having lost confidence, Spain will have to do something to regain it. A strong agreement with its regions on where to cut spending might help. Ministers have met regional chiefs this week and a deal could be announced today. There is a weekly cabinet meeting today which could spell out health and education cuts, which are supposed to amount to 10 billion euros.
If the markets are onside, everything is easier. Italy showed this week that deficit targets can be loosened slightly without prompting an investor strike if they believe the direction of travel is sustainable. Spanish officials admit the communication surrounding the changed deficit target was “sub-optimal”.
Foreign investors still buying American
Overseas investors have yet to sour towards U.S. assets despite high government debt levels, according the latest figures on capital flows.
Including short-dated assets such as bills, foreigners snapped up $107.7 billion in U.S. securities in February, following a downwardly revised $3.1 billion inflow for January. At the same time, the United States attracted a net long-term capital inflow of just $10.1 billion in February after drawing an upwardly revised $102.4 billion in the first month of 2012.
The data showed China boosted purchases of U.S. government debt for a second month in February, but also some waning of demand for longer-dated securities.
Still, recurring fears that foreign investors might be scared off by high levels of U.S. debt have thus far proven overdone. Writes Millan Mulraine at TD Securities:
Overall, the massive foreign flow into U.S. assets in March suggests that US securities continue to enjoy healthy global appetite in time of fear (Treasuries) and times of hope (equities). The reallocation from Treasuries to shorter-term securities in February is broadly consistent with the risk-on tone that prevailed during the month, reversing the trend of the past few months, when concerns in Europe resulted in the flight to quality.
Even the downtrend in Treasuries may have been short-lived, said George Goncalves at Nomura, as evidence by the recent drop in benchmark 10-year yields to around 2 percent:
Biggest indicator of the week: China GDP
It wasn’t very long ago that economic numbers out of Asia would barely register a blip on Wall Street’s radar screen. That’s not the case anymore. Commerzbank touts Chinese gross domestic product figures due out on Friday as the most important gauge of global economic health following last week’s disappointing U.S. employment report.
Writes economist Jörg Krämer in a research note:
China’s economy has continued to slow into 2012 largely on the back of deliberate policy measures. We expect growth of 8% year-on-year in Q1, down from 8.9% in the final quarter of 2011 (consensus 8.3%), which is consistent with our call for full-year growth of 7.5% in 2012.
Fixed investment in particular has slowed recently, to its weakest year-on-year rate since 2002 and will be the primary driver of the slowdown in GDP growth. Net exports also deteriorated in the quarter, with China recording a very large trade deficit of US$31bn in February.
A report on Tuesday offered some reason for optimism. China returned to an export-led trade surplus of $5.35 billion in March, suggesting a rebound in the global economy may be lifting overseas orders just in time to compensate for a slowdown in domestic demand.
Euro zone perspective – nowhere near out of the woods
After the Easter break, a bit of perspective — to paraphrase the immortal Spinal Tap, maybe too much perspective.
Over the past two weeks, Spanish and Italian borrowing costs have continued to rise – in the former’s case they have now relinquished more than half their fall since December and are heading back into the danger zone. Stocks have also appeared to have given up on their first quarter rally, presumably testament to the realization that the ECB and other top central banks are unlikely to be writing any more blank cheques for banks to reinvest.
Late last year, it was Italy that seemed to have the power to drag Spain into the debt crisis mire. Now, it’s the other way round and after the ECB anaesthesia wears off, it’s clear the euro zone patient is still sickly.
The European Commission will cast an eye over Spanish budget plans at some point this week. Spanish risk premiums have leapt since Prime Minister Mariano Rajoy defied Europe in early March by unilaterally easing Madrid’s 2012 deficit target. The silver lining for Madrid is that it has taken advantage of the benign market conditions early in the year to clear almost half its 2012 debt issuance needs and Rajoy is pushing through sweeping labour reforms and savage spending cuts. The trouble is that policy mix is likely to drive Spain further into recession – a recipe for debt to rise not fall.
Approaching elections in Greece and France throw further uncertainty into the mix. The former could weaken austerity resolve and the latter may elect a socialist president intent on rewriting the bloc’s new fiscal rules.
After weak U.S. jobs data on Friday, even a surprise Chinese trade surplus in March – suggesting it’s fabled soft landing is on track – has failed to lift equities. European stocks have dropped more than one percent in early post-holiday trade and safe haven German Bunds have jumped at the open with yields at their lowest level since September. For the first time this year, the markets have reverted to a glass half empty rather than half full bent.
The U.S. data overhang continues to be the strongest driver for now but a wobbly Spanish bond auction last week is also fresh in investors’ memories, given a big Italian debt sale looms on Thursday.
from Breakingviews:
China’s trade deficit is sign of things to come
By Wei Gu and Edward Hadas The authors are Reuters Breakingviews columnists. The opinions expressed are their own.
China will have to get used to monthly trade deficits. Special factors contributed to the $4.2 billion negative number for the first two months of 2012, but something fundamental is changing. A smaller portion of China’s imports are of goods which will be processed for export, and a higher portion is going straight into domestic consumption.
A 13 percent volume increase in soybean imports may be partly due to precautionary purchase after drought losses in South America. And the 50 percent year-on-year increase in copper imports is suspicious. Copper can be used a wheeze to circumvent tight monetary policy. Importers get a letter of credit for commodity imports, sell the commodity quickly and keep the credit until maturity.
But some of the shift is durable. The increased wealth of Chinese households leads to more imports for consumption. Agricultural imports by value quintupled between 2000 and 2010. Automobile imports jumped 33 percent to 184,000 vehicles during the first months of 2012, year on year.
That development makes a big change in the Chinese economic model. Up to now, China’s huge trade machine – about 40 percent of GDP, three times the U.S. or European ratios – has been overwhelmingly dedicated to processing: import something, add a little bit value through cheap labour, export. But as China gets richer, labour gets more expensive and the country becomes more self-sufficient. A higher proportion of trade will come from sectors where China is either especially weak or strong.
There are signs of that transition. Exports of labour-intensive clothing and shoes fell by more than 2 percent, year-on-year. Higher-end exports are faring better, but the 8.8 percent year-on-year growth rate in of electronics and machinery still marks a deceleration from the 11.5 percent growth seen in the last three months of 2011.
It’s fairly easy to keep trade in surplus when almost all exports are basically imports-plus-labour. But as the import economy takes on its own momentum and becomes more separated from the export trade, occasional monthly deficit will be harder to avoid. The trade deficit is sign of things to come.
China renminbi as reserve currency: yuan a bet?
China’s importance to the global economy makes it difficult to believe the role of the yuan in foreign exchange will not continue to expand. Will that dominance advance sufficiently to make the Chinese renminbi one of the world’s reserve currencies? A new study from the Brookings Institution suggests that in the long run, the ascendance of the yuan to reserve-currency standing is likely. It notes that of the six largest economies in the world, China is the only one whose currency does not have reserve status. But the road to getting there will be long and tortuous, the study warns, and there will be plenty of potholes.
Getting there will require overcoming two main challenges, according to Eswar Prasad and Lei Ye, who authored the report:
Sequencing of capital account opening with other policies, such as exchange rate flexibility and financial market development, to improve the cost/benefit trade-off.
Financial market development – strengthening the banking system; developing deep and liquid government and corporate bond markets, as well as foreign exchange spot and derivative markets.
That’s another way of saying that China’s exchange rate policy, which many in the United States argue has been to keep the yuan artificially low in order to boost exports, is actively standing in the way of a bigger role for the yuan in international trade.
How will this gradual – sometimes glacial – process of adjustment unfold? Prasad envisions the following steps:
The government’s medium-term objective, which we believe will be achieved in the next five years, is an open capital account but with numerous “soft” controls. This will allow the currency to play an increasingly significant role in global trade and finance, but in a manner that allows the government to retain some control over capital flows.
The renminbi will be included in the basket of currencies that make up the International Monetary Fund’s Special Drawing Rights basket within the next five years.
Although China’s rapid growth will help promote the international use of its currency, its low level of financial market development is a major constraint on the likelihood of the renminbi attaining reserve currency status.
The renminbi will become a reserve currency within the next decade, eroding but not displacing the dollar’s dominance.
But given China’s robust growth rates in recent years, why would it want to change the way it does things? Prasad offers some reasons:
China’s priority is to have her international trade and investments denominated in RMB so that the RMB could be “floated” freely in the foreign exchange market, if the US allegation of “currency manipulation” spun out of control. When China’s international trade and investments are denominated in RMB, she would no longer have such a great need for a stable US$-CNY exchange rate.
Since China does not intend to be a current account deficit country, reserve currency status is of no great priority for her. Countries that want to have the RMB as part of their foreign reseves would have to do so according to Chinese terms.
from Global Investing:
January in the rearview mirror
As January 2012 drifts into the rearview mirror as a bumper month for world markets, one way to capture the year so far is in pictures - thanks to Scott Barber and our graphics team.
The driving force behind the market surge was clearly the latest liquidity/monetary stimuli from the world's central banks.
The ECB's near half trillion euros of 3-year loans has stabilised Europe's ailing banks by flooding them with cheap cash for much lower quality collateral. In the process, it's also opened up critical funding windows for the banks and allowed some reinvestment of the ECB loans into cash-strapped euro zone goverments. That in turn has seen most euro government borrowing rates fall. It's also allowed other corporates to come to the capital markets and JP Morgan estimates that euro zone corporate bond sales in January totalled 46 billion euros, the same last year and split equally between financials and non-financials..
But to the extent that the ECB move was aimed primarily at preventing a seizure of the banks, then one measure of success can be seen in the degree to which it steepened government yield curves in Spain and Italy. A positive yield curve, which measures the gap between short-term and long-term interest rates, is effectively commercial banks' ATM -- they make money by simply borrowing short-term and lending long. This chart then shows some normality returning to the benchmark interest structure.
It seems unlikely any other nation of the world would want to have it’s currency and people abused as much as the dollar is, in our current status as reserve currency. Name one country that could withstand that kind of abuse, and survive, or benefit? None.