I wrapped up a post earlier today about the global role of the dollar by saying:
“When The Economist says: “Unlike other aspects of American hegemony, the dollar has grown more important as the world has globalised, not less”, it is pointing to a truly deep tension. As American hegemony disintegrates, the dollar, ultimately founded on the US state, is taking on an ever more central role in the global economy.”
Corey Robin immediately fastened on this and asked the “so what” question. What does this tension imply?
As far as the Trump administration is concerned it is too early to tell, but what people are thinking and talking about are three types of conflict that might emerge:
- There is a conflict between the global role of the dollar and Trump’s crude ambition to shift the balance of America’s trade balance. A currency that serves as a reserve currency will tend to be “overvalued” and will tend to generate a trade deficit. One way to think about this is to say that the foreign purchases of American currency and financial assets drive up the exchange rate to levels that make manufactured goods uncompetitive. In effect American-issued IOUs are an export. As “safe assets” they are a unique global commodity. And if you export those on the scale that the world demands them from America, then it makes it hard to export other things. Think of AAA rated American securities as a kind of “green gold”, a financial services equivalent to oil. If you are an oil exporter it is very hard to have a trade surplus in cars at the same time. So there is a chronic and irresolvable conflict. This is what the Economist was alluding to in its article when it said that America wanted to shake off its burden of hegemony. This is what the Trumpites believe Germany did by submerging the Deutschmark, the European reserve currency that was, in the “undervalued” Euro. And there is, in fact, some historical warrant for that. Germany in the late 1970s made a conscious decision to avoid the DM becoming a reserve currency. If an “overvalued” dollar is combined with the promised fiscal boost, the combination is likely to exacerbate the trade deficit not close it.
- The second type of conflict is over America’s role and specifically the role of the Fed in global financial regulation. Since US banks are major competitors in global banking and have become more prominent (at least relative to the Europeans) since the 2008 crisis, banking regulation, to be meaningful, has to be pursued at the global level i.e. through the Basel Committee. Since the majority of the rest of the world’s global finance is done in dollars, the Fed has a deep interest in seeing macroprudential regulation extended to the key nodes in the entire global system. Within weeks of the inauguration the Trumpites in Congress have announced that they want a complete halt to any Fed involvement in global banking regulation. They demand that there be a halt until Trump can appoint officials who have the interests of America at heart. The language in this letter from McHenry of the Financial Services Cttee to Yelle at the Fed will enter the archive as truly symptomatic of America’s “National Revolution of 2016/2017”. McHenry-letter-to-Yellen Blocking US engagement in global banking regulation is perverse for many reasons, but perhaps most egregious is the fact that the banks that have been pushing back hardest against Basel IV are not the Americans, who have recovered relatively well since 2009, but the Europeans. It is an open secret that the Europeans stalled any further negotiation of Basel IV in December 2016 precisely in the hope that a Trump administration would block any further progress. Then the highly sensitive issue of risk-weighted balance sheets could be dropped off the agenda as the European banks fervently hope it will be. The net result will be a free for all and a more dangerous global system. The departure of Tarullo from the Fed is generally taken as a worrying sign since he was a pretty aggressive advocate of macroprudential regulation. https://www.ft.com/content/40267cf6-efc6-11e6-ba01-119a44939bb6
- The really fundamental issue is the role of the Fed’s monetary policy and its impact on the rest of the global economy. This manifested itself first around the expansive phase of QE2 in 2010 when dollars flushed out into the Emerging Markets and there was talk of currency wars. Then, in the taper tantrum of 2013 Fed tightening put the reverse pressure on the “Fragile Five” EM economies e.g South Africa, Brazil, Turkey. The upshot is that the impact of Fed policy is so huge that other countries must demand some voice in Fed decision making. Rajan of India was most vociferous in this respect in 2013 and 2014. The Fed is clearly cognizant of the impact its policies have. But it cannot concede such considerations publicly. Its mandate is strictly for the US economy. And the prospect is that the nationalist mood in Washington makes that functional interconnectedness even harder to thematize. The basic functional imperatives of global stability become unspeakable.
- The institutional manifestation of this interconnectedness are a set of instruments that the Fed has managed to keep off the public agenda almost entirely. It concerns the system of swap lines which now backstops a large part of the global banking system. This system that allows the Fed to provide dollars to needy central banks in exchange for their national currencies, was thrown together between 2007 and 2008. Through the swap lines, the Fed provided $ 10 trillion in liquidity for the European central banks and Korea. Almost $ 8 trillion in liquidity was taken by the ECB alone. Since November 2013 this system has been made permanent on an unlimited basis. So, in an emergency in which the stability of the offshore dollar system is threatened, the Fed has out sourced the production of dollars. Most recently they were activated as a precautionary measure in the aftermath of Brexit. The Fed isn’t breaking any laws. It will offer a cogent rationale for this system in terms of the potential blowback on the American banking system, if there were to be a global fire sale of $ trillions of assets. But the Fed would far, far, far rather that the entire topic was never discussed, especially not by an aggressive Congressional committee. NY Fed staff I’ve interviewed say that it felt as though they had a “guardian angel” looking out for them on the Hill in 2008. The swap lines could all too easily be turned into a red rag by no-nothing nationalists. Take away: When the first Trumpite mentions “swap lines” you know there is real trouble ahead.