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.
Resolving Shirakawa’s conundrum
The governor of the Bank of Japan, Masaaki Shirakawa, says he is confounded by the still very low level of Japanese government bond yields given the country’s elevated debt to GDP ratio of over 200 percent. Speaking on an IMF panel over the weekend, he offered a rather unintuitive explanation for the phenomenon:
It seems difficult to explain the case of Japan in light of conventional wisdom. One frequently offered explanation is that the ample domestic savings in Japan have absorbed the issuance of JGBs and the share of JGBs held by foreign investors is very small. But a more fundamental explanation is that the stability in the current bond yields reflects market participants’ expectations that fiscal soundness will be restored through structural reforms imposed in the economic and fiscal areas.
Most economists think Japanese yields are low because of continued expectations for deflation and weak economic growth. But for Shirakawa, it seems, it is public confidence in future fiscal restraint that is keeping bond yields low. Except he then contradicts this point by saying weak confidence in future fiscal reforms is also simultaneously undermining consumer spending:
At the moment, such expectations are not firmly backed by concrete reform plans. The public therefore restrains spending on concerns over future fiscal developments. This constitutes one factor behind sluggish economic growth and mild deflation. If this is indeed the case, the experience of Japan indicates a possibility that a cumulative increase in government debt combined with weak economic growth expectations might generate deflationary pressures.
Not so, argues Ugo Panizza, head of debt and finance analysis at the United Nations Conference on Trade and Development. He and co-author Andrea Presbitero find no causal link between high debt levels and weak economic growth.
Christopher Sims, a Nobel-winning economist and Princeton professor also on the panel with Shirakawa, had a much simpler explanation for why Japanese yields are low while Europe’s face steady upward pressure even though both economies are struggling with soft growth:
IMF crisis funds: Why nobody really cares
With reporting from Steven C. Johnson and Nick Olivari
A lot of time and money is spent on high-profile multilateral gatherings like this weekend’s International Monetary Fund meeting in Washington. The central story this time is the Fund’s effort to raise more funds (no pun intended), which appears to have been successful as G20 nations committed more than $430 billion in new funds.
French Finance Minister François Baroin, speaking to reporters at a press briefing on the sidelines of the IMF meeting, greeted the news with optimism:
Clearly, the reinforcement of the IMF with more than $400 billion in new resources and its effects on confidence will contribute to financial stability in the euro zone.
Except that for investors, the main worry is the continued ability of Spain and Italy to keep funding their debts as borrowing costs rise. The IMF’s new so-called firewall is of little consequence to that immediate chain of events, although it does provide some marginal reassurance.
Robert Tipp, chief investment strategist at Prudential Fixed Income, says:
Election fever hits the markets
We’re not talking about the U.S. presidential vote, though that does cast another layer of uncertainty over the outlook. Rather, investors are focused on even shorter-horizon events, as evidenced by this jam-packed electoral worry list from Marc Chandler, currency strategist at Brown Brothers Harriman:
This weekend’s first round of the French presidential election kicks of the quarter that will include:
* Greek national elections, where polls warn that the current coalition government may not be returned, increasing the uncertainty.
* Italian municipal elections which will be, at least in part, a referendum on Monti, who has seen his support wane since the labor reform was unveiled.
* Two German state elections, which may see the FDP further marginalized, making a grand coalition next year more likely.
* Irish referendum on the fiscal compact. Due to qualified majority procedures, an Irish rejection would not prevent the adoption of the fiscal compact, but would jeopardize Irish access to the ESM, should it be needed.
* After the second round of the French presidential election in early May, there is the parliamentary election in June.
Europe’s triple threat: bad banks, big debts, slow growth
The financial turmoil still dogging Europe is most often described as a debt crisis. But sovereign debt is only part of the problem, according to new research from Jay Shambaugh, economist at Georgetown’s McDonough School of Business. The other two prongs of what he describes as three coexisting crises are the region’s troubled banks and the prospect of an imminent recession.
These problems are mutually reinforcing, and require a more forceful policy response than the authorities have delivered to date. In particular, Shambaugh advocates using tax policy to lower labor costs, fiscal stimulus from those economies strong enough to afford it, and more aggressive action from the European Central Bank:
It is possible that coordinated shifts in payroll and consumption taxes could aid the painful process of internal devaluation. The EFSF could be used to capitalize banks and to help break the sovereign / bank link. Fiscal support in core countries could help spur growth. Finally, the ECB could provide liquidity to sovereigns and increase nominal GDP growth as well as allow slightly faster inflation to facilitate deleveraging and relative price adjustments across regions.
All these steps, especially if taken together in an attempt to treat the three crises holistically could substantially improve outcomes. At the same time, institutional reforms to create a true financial union and a common risk free asset could help both solve the current problems and reduce the connections of these crises in the future. Of course, politics, ideology, or additional economic shocks could all hinder improvement. The euro area is highly vulnerable and without deft policy may continue in crisis for a considerable amount of time.
Return of the currency wars
Maybe it never went away at all. But if the war was dormant, Brazilian President Dilma Rousseff certainly launched what appeared to be an opening salvo for a new round of battles – rhetorical ones for now.
Rousseff reached for some cataclysmic language to describe the recent appreciation of the real, which Brazil worries will crimp exports and hurt the domestic economy. The culprit, according to Rousseff, is an irresponsible “monetary tsunami” resulting from the ultra-loose monetary policies of rich nations like the United States.
Alonso Soto and Tiago Pariz offer some background in this Reuters article out of Brasilia:
Brazil has just taken fresh steps to defend itself in what it calls a “global currency war,” extending a tax on foreign loans to slow down a flood of capital that is strengthening its currency.
Analysts said the move was unlikely to have a major impact and the real <BRBY> actually strengthened in midday trade. Brazil’s central bank has also recently increased interventions in the currency market, buying dollars and selling reverse currency swaps to halt the real’s gains.
The real, considered one of the world’s most overvalued currencies, has gained more than 8 percent so far in 2012, making it harder for Brazilian industry to compete at home and abroad. The strong real is a top concern for President Dilma Rousseff, who is taking measures to protect local industries as she strives to ensure economic growth above 4 percent this year.
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.
Will U.S. criticism affect Japan’s FX stance?
Currency analysts are divided over whether U.S. criticism of Japan’s forex policy will change Tokyo’s currency stance. While some say it could raise the hurdle for further Japanese intervention, others think it might not have much impact. Rob Ryan, FX strategist at BNP Paribas in Singapore says the effect will be limited given uncertainty about the Japanese economy’s outlook and current levels of dollar/yen and cross/yen pairs.
“I think if they (Japanese authorities) feel they have to intervene, they will intervene,” Ryan says, adding that a dollar drop down to the “low 76s” might be enough to prompt further action from Japan.
The U.S. Treasury Department said in its semi-annual report on international exchange rate policies issued on Tuesday that the U.S. did not support Japan’s recent bouts of solo FX intervention, adding that they took place when volatility in dollar/yen was relatively low. USD/JPY was currently trading at Y77.98, not too far from a record low of Y75.311 hit on Oct. 31, when Japan conducted massive yen-selling intervention.
Without “bazooka,” Europe still vulnerable
This time it was going to be different. A make-or-break, comprehensive, grand, “bazooka” solution would draw a line under the euro zone debt crisis.
But the plan agreed by all EU states except Britain to pursue stricter budget rules and a stronger fiscal union did little to soothe bond markets. Ten-year Italian yields rose as far as 6.8 percent, prompting the European Central Bank to intervene in the secondary market, and German Bunds rose more than 100 ticks on the day.
Among the short-falls, the capacity of the euro zone’s bailout fund was capped and it was not granted a banking license. For now, this puts more pressure on the European Central Bank to help contain the crisis by stepping up bond-purchases. The bank however has repeatedly resisted a bigger crisis-fighting role and last week dampened expectations that it could ramp up a program which has tried to keep borrowing costs affordable. The legal basis of a new accord to enforce debt and deficit rules also still needs to be worked out.
Analysts at Societe Generale:
The outcome of the EU summit may be good enough to keep the holiday season from being spoiled by nasty market disruptions. But we fear that it is not the bazooka that can carry us to the wall of Q1 supply with much confidence.
The euro zone’s funding needs are estimated at more than 800 billion euros next year, and 215 billion euros for Italy alone.
Charles Diebel, head of market strategy at Lloyds Bank says:
psuedo-lofty journalistic repetitions are also a drag – do you have any real analysis? any econometrics or indicators you can offer the reader?
this level of repetitious cliches, bazookas, ECB-not-doing-this, soothing bond markets is lite news, almost fraudulent
write something original and perceptive
Drop in Fed custody holdings reflects FX interventions
A sharp recent drop in the Fed’s holdings of U.S. Treasuries for foreign central banks probably reflects the effort by many developing economies to stem rapid declines in their currencies, not some frightening move by the likes of China out of U.S. bonds. That’s the argument put forth by Marc Chandler at Brown Brothers Harriman, who notes the pullback of recent weeks appears to have been the most dramatic since the Asian financial crisis of the late 1990s.
His reasoning makes sense: a September spike in the U.S. dollar was accompanied by steep plunges in the exchange rates of many emerging economies. Still, Chandler remains puzzled as to why the selling accelerated to a hefty $21 billion even as the dollar reversed course in the last week:
This is the seventh consecutive weekly decline and over this period, custody holdings have fallen an average of about $12-$12.5 billion a week, making this past week quite large relative to trend. It likely reflects foreign central banks’ selling of Treasuries to intervene to support their currencies rather than a dumping of Treasuries to diversify reserves or as a protest to such low interest rates.
Yet the difficulty with this hypothesis is that during the week through Wednesday, most emerging market currencies have generally risen against the dollar. This generalization holds true for East Asia which is suspected to use the Fed’s custodial services. For some of the run the dollar was appreciating in general, so private sector dollar buying offset the official selling, but now — over past week — it would seem like the central banks and the private sector have been on the same side selling dollars.
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.