I visited Korea earlier this summer and gave a talk on effects of U.S. Tapering on Emerging Markets. (This was also the subject of comments at an Istanbul conference sponsored by the NBER and the Central Bank of Turkey in June.)
An interview on the effects of policy at the Fed and other advanced-country central banks on East Asian EMs now appears in KRX magazine (in Korean), August. Here is the English version:
Special Interview with Jeffrey A. Frankel <KRX MAGAZINE> August
Q: On 10 June 2014, Federal Reserve Bank of Boston President Eric Rosengren said in a speech that the Fed’s “new” monetary policy tools, including forward guidance and large-scale asset purchases, were “essential” in ensuring the economic recovery in the United States. What do you think about the ‘ongoing’ U.S’s ‘Tapering’ policy? And what is your idea about appropriate “new” monetary policy?
U.S. federal courts have ruled that Argentina is prohibited from making payments to fulfill 2005 and 2010 agreements with its creditors to restructure its debt, so long as it is not also paying a few creditors that have all along been holdouts from those agreements. The judgment is likely to stick, because the judge (Thomas Griesa, in New York) told American banks on June 27 that it would be illegal for them to transfer Argentina’s payments to the 92 per cent of creditors who agreed to be restructured and because the US Supreme Court in June declined to review the lower court rulings.
A long-awaited reform of the International Monetary Fund has now been carelessly blocked by the US Congress. This decision is just the latest in a series of self-inflicted blows since the turn of the century that have needlessly undermined the claim of the United States to global leadership.
The IMF reform would have been an important step in updating the allocations of quotas among member countries. From the negative congressional reaction, one might infer that the US was being asked either to contribute more money or to give up some voting power. (Quotas allocations in the IMF determine both monetary contributions of the member states and their voting power.) But one would then be wrong. The agreement among the IMF members had been to allocate greater shares to China, India, Brazil and other Emerging Market countries, coming largely at the expense of European countries. The United States was neither to pay a higher budget share nor to lose its voting weight, which has always given it a unique veto power in the institution.
Now that Janet Yellen is to be Chair of the US Federal Reserve Board, attention has turned to the candidate to succeed her as Vice Chair. Stanley Fischer would be the perfect choice. He has an ideal combination of all the desirable qualities, unique in the literal sense that nobody else has them. During his academic career, Fischer was one of the most accomplished scholars of monetary economics. Subsequently he served as Chief Economist of the World Bank, number two at the International Monetary Fund, and most recently Governor of the central bank of Israel. He was a star performer in each of these positions. I thought in 2000 he should have been made Managing Director of the IMF.
Most people know that the general trend in the dollar’s role as an international currency has been slowly downward since 1976. International use of the dollar as a currency in which to hold foreign exchange reserves, to denominate financial transactions, to invoice trade, and to serve as a vehicle for foreign exchange transactions is below where it was during the heyday of the Bretton Woods era (1945-1971). But few are aware of what the most recent numbers show. It is not hard to think of explanations for the downward trend. Since the time of the Vietnam War, US budget deficits, money creation, and current account deficits have often been high. Presumably as a result, the dollar has lost value in terms of other major currencies or in terms of purchasing power over goods. Meanwhile, the US share of global output has declined. Most recently, the disturbing willingness of some American congressmen in October to pursue a strategy that would have the Treasury default on legal obligations has led some observers to ask the natural question whether the dollar’s international currency status is now imperiled.Moreover some EM currencies are joining the list of international currencies for the first time. Indeed, some analysts have suggested that the Chinese yuan may rival the dollar as the leading international currency by the end of the decade! (Eichengreen, 2011; and Subramanian, 2011a, 2011b.) The trend in the dollar as an international currency has not been uniformly downward, however. Interestingly, the periods when the public is most concerned about the issue do not coincide well with the periods when the dollar’s share is in fact falling. By the criteria of international use as a reserve currency among central banks and as vehicle currency in foreign exchange markets, the most rapid declines took place during the intervals 1978-1991 and 2001-2010. (The yen and deutschemark were the rising currencies during the first period, and the euro during the second.) In between these two intervals, during the years 1992-2000, there was a clear reversal of the trend, notwithstanding a popular orgy of dollar declinism around the middle of that decade. Central banks held only an estimated 46% of their foreign exchange reserves in the form of dollars in 1992, but had returned to almost 70% by 2000. Subsequently, the long-term downward trend resumed. According to one estimate, the share in reserves declined from about 70% in 2001 to barely 60% in 2010 (Menzie Chinn). During the same decade, the dollar’s share in the foreign exchange market also declined: The currency constituted one side or the other in 90% of foreign exchange trading in 2001, but only 85% in 2010. The most recent statistics unexpectedly suggest that the dollar’s standing has again taken apause from its long-term decline. The International Monetary Fund reports that its share in foreign exchange reserves stopped declining in 2010 and has been flat since then. If anything, the share is up very slightly thus far in 2013 (COFER, IMF, Sept. 30, 2013). Similarly, the Bank for International Settlements reported in its recent triennial surveythat the dollar’s share in the world’s foreign exchange markets rose from 85% in 2010 to 87% in 2013 (preliminary global results). That the dollar has been holding up so well comes as a surprise, in light of dysfunctional US fiscal policy. Or maybe we should no longer be surprised. After all, when the global financial crisis erupted out of the American sub-prime mortgage mess in 2008, the reaction of global investors was to flee into the United States, not out. They clearly still regard the US Treasury bill market as the safe haven and the dollar as the top international currency. The explanation must be the one that is so often noted: the absence of good alternatives. In particular, the euro has its own all-to-obvious problems. Indeed the euro’s share of reserve holdings and its share of foreign exchange transactions have both fallen by several percentage points over the last three years (reserves from 28% of allocated reserves in 2009 and 26% in 2010, to 24% in the most recent 2013 figures; forex trading from 39% of transactions in 2010 to 33% in 2013). What about the vaunted yuan? According to the IMF statistics, it hasn’t yet broken into the ranks of the top seven currencies in terms of central bank reserve holdings. The top six are the US dollar and euro, followed by the yen and pound (the latter quietly reclaimed the number three position in 2006 and has been running neck-and-neck with the yen recently), and the Canadian dollar and Australian dollar (also running neck-and-neck). According to the BIS statistics, China’s currency has finally broken into the top ten in forex trading; but its share is only 2.2% of transactions. This is behind the Mexican peso at 2.5%, and still farther behind the Canadian dollar, Australian dollar and Swiss franc. (See Table 1 and Figures 2 & 3). Since 2.2% is much less than China’s share of world trade, it would be more accurate to say that the renminbi is becoming a normal currency than to say that it is becoming an international currency, let alone the top international currency.Despite recent moves by the Chinese government, the yuan still has a long way to go. Of the three kinds of attributes that a currency needs to become widely used internationally the yuan has two – size of the home economy and the ability to hold its value – but still lacks the third: deep, liquid, open financial markets. What might account for the recent stabilization of the dollar’s status? What do the last three years have in common with the preceding period of temporary reversal, 1992-2000? Both intervals saw striking improvements in the US budget deficit, both structural and overall. The federal deficit is now less than half what it was in 2009 or 2010; and the record deficits of the 1980s were converted into record surpluses by the end of the 1990s. Perhaps the fiscal observation is a coincidence. It would be foolish to read too much into two historical data points. It would be even more foolish to believe, just because American politicians have failed to dislodge the US dollar from its number one status over the last forty years, that they could not accomplish the job with another few decades of effort. Pound sterling had the top spot in the nineteenth century, only to be surpassed by the dollar in the first half of the twentieth century. It is not an eternal law of nature that the US currency shall always be number one. The day may come when the dollar too succumbs in its turn. But that day is not this day.
Figure 1: The share of the dollar in central banks’ foreign exchange reserves stopped its downward trend in 2010-2013
source: Menzie Chinn (2013), based on IMF’s COFER.
Table 1: The share of the dollar in global foreign exchange trading reversed its downward trend in 2010-2013
After the currency crises of 1994-2001, and especially the East Asia crises of 1997-98, a lot of research investigated what countries could do to protect themselves against a future repeat. More importantly, policy makers in emerging markets took some serious measures. Some countries abandoned exchange rate targets and began to float. Many accumulated high levels of foreign exchange reserves. Many moved away from dollar-denominated debt, toward other kinds of capital inflow that would be less vulnerable to currency mismatch, such as domestic currency debt or Foreign Direct Investment. Some instituted Collective Action Clauses in their debt contracts to facilitate otherwise-messy restructuring of debt in the event of a severe negative shock. A few raised reserve requirements or otherwise tightened prudential banking regulations (clearly not enough, in retrospect). And so on.
It is time for the Managing Director of the International Monetary Fund to come from an emerging market country. But that has been said often before. Whining about the injustice of the 65-year duopoly under which the IMF MD comes from Europe and the World Bank President comes from the US won’t change anything. Only if emerging market countries were to unify quickly behind a single strong candidate would they have a shot at the post. They are evidently too fragmented even to make an effort to come together in this way. Thus the job will probably go to a European yet again.
By now just about everybody agrees that the European bailout of Greece has failed: The debt will have to be restructured. As has been evident for well over a year, it is not possible to think of a plausible combination of Greek budget balance, sovereign risk premium, and economic growth rates that imply anything other than an explosive path for the future ratio of debt to GDP.
There is plenty of blame to go around. But three big mistakes can be attributed to the European leadership. This includes the European Central Bank – surprisingly, in that the ECB has otherwise been the most competent and successful of Europe-wide institutions.
Korea may have an opportunity to exercise historic leadership, when it chairs the G-20 meeting in Seoul, November 11-12. This will be the first time that a non-G-7 country has hosted the G-20 since the larger, more inclusive, group supplanted the smaller rich-country group in April of last year as the premier steering committee for the world economy. With large emerging market and developing countries playing such expanded economic roles, the G-7 had lost legitimacy. It was high time to make the membership more representative. But there is also a danger that the G-20 will now prove too unwieldy, in which case decision-making might then revert to the smaller group.
With aftershocks of the recent global financial earthquake still being felt in some parts of the world, it would be useful to have a set of Early Warning Indicators to tell us what countries are most vulnerable. Nobody should be surprised that it is hard to forecast crises with high reliability; low-risk opportunities for profits are never easy to find. Thus it is especially hard to predict the timing of a crisis. Some economists, however, are skeptical that Early Warning Indicators (EWIs) have any useful predictive ability at all. A common assessment is that EWIs have failed, in the sense that in each historical round of emerging market crises (1982, 1994-2001, 2008) those particular variables that appeared statistically significant in that round did not perform well in the subsequent round. This is not the right conclusion.