Barry Eichengreen has a white paper out at the DWS Global Financial Institute. I thought it would be somewhat of an epilogue, or just some minor reflections on his book "Exorbitant Privilege". And in some ways, it is. By the way, you can't not have read the book - it's just a fascinating read infused with historical perspective, reality checks and substantive solutions.
A few facts beforehand, lifted from the paper:
1) 85% of all foreign exchange trades worldwide are "dollar-trades".
2) The dollar accounts for 60% of the reported foreign exchange reserves of central banks and governments around the world.
3) The dollar also accounts for 45% of all international debt securities.
There aren't just two sides to this debate (What are we debating?). It's a multi-faceted and multi-polar issue with no visible solutions. Is there a problem? No, but there might be. Are there solutions? Yes, but there are problems with the solutions. It's not as easy as it seems.
One would think that in the long run (in which we're all dead), this would make sense. The US economy is relatively nowhere near the behemoth it was post World War II. Naturally, this relative decline in output (to the world) would lessen the global 'need' and 'convenience' of the dollar. In fact, today most estimates put the US economy as accounting for about a quarter of the global economy and a lesser fraction of global trade.
Eichengreen mentions two other points of note that could lead one to question the role of the dollar and the first is far more obvious than the second. He says that the depth and liquidity of the US financial markets are simply no longer a hallmark of the US alone. I think this is debatable because while true, it still doesn't change the fact that there is simply no comparable alternative to the US financial market especially in terms of liquidity. But more on this later.
Furthermore, the first-mover advantage, the incumbency factor or changing the status quo (whatever you call it), is less of a hindrance now than it ever has been. This refers to the convenience of the dollar - that everyone uses it - so everyone will continue to use it. The ease of transaction is immense but newer technology, systems and frameworks could lead to a scenario where multiple operating systems could exist.
Lastly, a less intrinsic factor and something that has gained rapid traction recently, is the US fiscal situation. This brings the Triffin dilemma into play - that just as the expanding global economy needs a growing supply of dollars, we mustn't forget that the liquidity of the 'international reserve asset', i.e: the US treasury bill, is backed by the full faith of the United States government. Cue fiscal impasse.
If the world economy is expanding faster than the US economy, logically the capacity of the US government to keep providing safe assets will, at some point, be "overwhelmed by the scale" of this expansion. The key point here, is that the full faith of the government simply refers to its "power to tax". This thought gathers even more steam when the polarity of the American political situation comes into light.
The bottom line is that one could envision multiple scenarios but these are the ones that stand out:
a) The US gets it fiscal house in order and the exorbitant privilege continues though gradually losing its monopoly and sharing international space with the euro (yes, it will survive! or wait...no it won't!) and the renminbi. This perhaps, is the essence of the book - that inevitably, China and Europe will catch up through their financial markets' own depth and liquidity.
b) The adverse scenario, which is undoubtedly one which anyone and everyone has replayed in their mind and thought of - is that the US indulges in major fiscal folly and general confidence in the dollar is severely undermined and tested. While this is adverse, it's something that no one could risk writing off. The amount of political drama between the left and the right is at times suffocating, and their paths are theoretically polar. The last thing one would want is a looming fiscal cliff but that's exactly what's around the corner...
Anyways, the paper also has a section on international hostility to the Fed's unconventional and easy monetary policies. In accordance with the trilemma, and in a world of free capital flows, the near-zero interest rate environment in many advanced economies, coupled with higher interest rates in emerging markets forces capital out and into markets that may not be well equipped enough to handle such a 'tsunami of capital'. Unchecked capital flows of course, can rapidly create asset bubbles, stoke inflation fears and put immense pressure on a float. While true, I'm not quite sure what the viable alternative is. If domestic monetary policy is of paramount importance (and naturally it is!), then the Fed obviously cannot sit still or in reverse gear while the domestic economy suffers from no growth and severe unemployment. Zero sum game indeed!
I don't have any charts but i'll try and create one with events, of the dollar's reaction to the downgrade and the central bank announcements etc. but it's clear that the 'safe-haven' tag has never been questioned as investors have time and time again sought comfort in treasuries. Eichengreen provides three reasons for this:
1) The US financial markets are simply way, way, way more liquid than any other market anywhere, ever. In an uncertain environment, naturally investors crave liquidity the most.
2) There has been no attempt at debt monetization, no attempt to inflate away the debt. Monetization occurs when the treasury issues debt to finance spending, and the central bank purchases it thereby increasing base money. While cash and credit in circulation must have gone up, inflation has not reared its head one bit. But that's because of the liquidity trap and the depressed economy and not because monetizing debt is a "bad thing" necessarily!
3) Lastly, and most funnily as well as obviously, in an environment like the one we live in today, Eichengreen states that "despite its warts", the dollar "is still the least unattractive belle at the ball".
Bill Gross has stated that it's the "least dirty shit in the pile". You get the point. It's the outright lack of viable alternatives.
Of course this leads us to a discussion on the alternatives which is, I suppose the crux of the paper. What comes next? Essentially, what is the fate of the euro and what exactly is the status of the internationalization of the renminbi? And thus, what is the fate of the dollar?
More on that later, maybe.
A few facts beforehand, lifted from the paper:
1) 85% of all foreign exchange trades worldwide are "dollar-trades".
2) The dollar accounts for 60% of the reported foreign exchange reserves of central banks and governments around the world.
3) The dollar also accounts for 45% of all international debt securities.
There aren't just two sides to this debate (What are we debating?). It's a multi-faceted and multi-polar issue with no visible solutions. Is there a problem? No, but there might be. Are there solutions? Yes, but there are problems with the solutions. It's not as easy as it seems.
One would think that in the long run (in which we're all dead), this would make sense. The US economy is relatively nowhere near the behemoth it was post World War II. Naturally, this relative decline in output (to the world) would lessen the global 'need' and 'convenience' of the dollar. In fact, today most estimates put the US economy as accounting for about a quarter of the global economy and a lesser fraction of global trade.
Eichengreen mentions two other points of note that could lead one to question the role of the dollar and the first is far more obvious than the second. He says that the depth and liquidity of the US financial markets are simply no longer a hallmark of the US alone. I think this is debatable because while true, it still doesn't change the fact that there is simply no comparable alternative to the US financial market especially in terms of liquidity. But more on this later.
Furthermore, the first-mover advantage, the incumbency factor or changing the status quo (whatever you call it), is less of a hindrance now than it ever has been. This refers to the convenience of the dollar - that everyone uses it - so everyone will continue to use it. The ease of transaction is immense but newer technology, systems and frameworks could lead to a scenario where multiple operating systems could exist.
Lastly, a less intrinsic factor and something that has gained rapid traction recently, is the US fiscal situation. This brings the Triffin dilemma into play - that just as the expanding global economy needs a growing supply of dollars, we mustn't forget that the liquidity of the 'international reserve asset', i.e: the US treasury bill, is backed by the full faith of the United States government. Cue fiscal impasse.
If the world economy is expanding faster than the US economy, logically the capacity of the US government to keep providing safe assets will, at some point, be "overwhelmed by the scale" of this expansion. The key point here, is that the full faith of the government simply refers to its "power to tax". This thought gathers even more steam when the polarity of the American political situation comes into light.
The bottom line is that one could envision multiple scenarios but these are the ones that stand out:
a) The US gets it fiscal house in order and the exorbitant privilege continues though gradually losing its monopoly and sharing international space with the euro (yes, it will survive! or wait...no it won't!) and the renminbi. This perhaps, is the essence of the book - that inevitably, China and Europe will catch up through their financial markets' own depth and liquidity.
b) The adverse scenario, which is undoubtedly one which anyone and everyone has replayed in their mind and thought of - is that the US indulges in major fiscal folly and general confidence in the dollar is severely undermined and tested. While this is adverse, it's something that no one could risk writing off. The amount of political drama between the left and the right is at times suffocating, and their paths are theoretically polar. The last thing one would want is a looming fiscal cliff but that's exactly what's around the corner...
Anyways, the paper also has a section on international hostility to the Fed's unconventional and easy monetary policies. In accordance with the trilemma, and in a world of free capital flows, the near-zero interest rate environment in many advanced economies, coupled with higher interest rates in emerging markets forces capital out and into markets that may not be well equipped enough to handle such a 'tsunami of capital'. Unchecked capital flows of course, can rapidly create asset bubbles, stoke inflation fears and put immense pressure on a float. While true, I'm not quite sure what the viable alternative is. If domestic monetary policy is of paramount importance (and naturally it is!), then the Fed obviously cannot sit still or in reverse gear while the domestic economy suffers from no growth and severe unemployment. Zero sum game indeed!
I don't have any charts but i'll try and create one with events, of the dollar's reaction to the downgrade and the central bank announcements etc. but it's clear that the 'safe-haven' tag has never been questioned as investors have time and time again sought comfort in treasuries. Eichengreen provides three reasons for this:
1) The US financial markets are simply way, way, way more liquid than any other market anywhere, ever. In an uncertain environment, naturally investors crave liquidity the most.
2) There has been no attempt at debt monetization, no attempt to inflate away the debt. Monetization occurs when the treasury issues debt to finance spending, and the central bank purchases it thereby increasing base money. While cash and credit in circulation must have gone up, inflation has not reared its head one bit. But that's because of the liquidity trap and the depressed economy and not because monetizing debt is a "bad thing" necessarily!
3) Lastly, and most funnily as well as obviously, in an environment like the one we live in today, Eichengreen states that "despite its warts", the dollar "is still the least unattractive belle at the ball".
Bill Gross has stated that it's the "least dirty shit in the pile". You get the point. It's the outright lack of viable alternatives.
Of course this leads us to a discussion on the alternatives which is, I suppose the crux of the paper. What comes next? Essentially, what is the fate of the euro and what exactly is the status of the internationalization of the renminbi? And thus, what is the fate of the dollar?
More on that later, maybe.
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