Category Archives: the dollar

ECB QE via FX: Plan B

My post last month was a proposal for the European monetary authorities to pursue Quantitative Easing, not by buying euro bonds, but by buying dollar bonds.   I also presented this idea in a speech at a conference sponsored by the Dallas Fed, April 4, “Why the ECB Should Buy US Treasuries.”

But what if the ECB is told by the international community, especially the US, that it doesn’t want them to push the euro down against the dollar, that it fears a re-ignition of the currency wars?   And what if the ECB concludes that it can’t buy US treasuries without US agreement?   After all, it was only February of last year that the G-7 Ministers and Governors agreed not to try to influence exchange rates.

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Considering QE, Mario? Buy US Bonds, Not Eurozone Bonds

         The ECB should further ease monetary policy.  Inflation at 0.8% across the eurozone is below the target of “close to 2%.”  Unemployment in most countries is still high and their economies weak.  Under current conditions it is hard for the periphery countries to bring their costs the rest of the way back down to internationally competitive levels as they need to do.  If inflation is below 1% euro-wide, then the periphery countries have to suffer painful deflation. 

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Stan Fischer, the Fed, and Sub-par US Growth

      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.  

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The Latest on the Dollar’s International Currency Status

 

      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

Reserves

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

 

Table 1

 

Source: Bank of International Settlements’ Triennial Central Bank Survey, Sept.2013.

 

Figures 2 and 3: The share of China’s yuan in foreign exchange trading is rising, but still ranks behind many other currencies

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Dispatches from the Currency Wars

The value of the yen has fallen sharply since November, owing to the monetary component of Japan’s efforts to jump-start its economy (“Abenomics”).  Thus the issue of currency wars is expected to feature on the agenda at the G-8′s upcoming summit in Enniskillen, UK, June 17-18.

The phrase “currency wars” is catchy.  But does it have genuine analytical content?   It is another way of saying “competitive devaluation.”  To use the language of IMF Article IV(1) iii, it is what happens when countries are “manipulating exchange rates…to gain an unfair competitive advantage over other members…” To use the language of the 1930s, this manipulation would be a kind of beggar-thy-neighbor policy, with each country seeking to shift net exports toward its own goods at the expense of its neighbors.

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McKinnon’s Claim that RMB-$ Appreciation Would Not Reduce Trade Imbalances

The International Economy magazine (Winter 2013) asks 16 authorities, “Can Changes in Exchange Rate Valuations Affect Trade Imbalances?”   It is referring to the claim in a recent book by Stanford economist Ron McKinnon that pressure on China to let the renminbi appreciate against the dollar is fundamentally misconceived because such a movement in the exchange rate would not reduce China’s trade surplus nor American’s trade deficit.  This is part of an old debate that pre-dates the rise of the China trade problem.  Ron has long claimed that exchange rates don’t determine trade balances because they are “instead” determined by national saving versus investment.   I thought Paul Krugman demolished the argument pretty effectively 25 years ago, with a textbook graph of internal balance versus external balance.   But evidently many still fall for the argument (including some of the experts in the TIE symposium).   So I try again:

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The Rise of the Renminbi as International Currency: Historical Precedents

All of a sudden, the renminbi is being touted as the next big international currency.   Just in the last year or two, the Chinese currency has begun to internationalize along a number of dimensions.   RMB bank desposits are now available in Hong Kong.  A RMB bond market has grown rapidly there as well, with the issuers including major multinationals such as McDonald’s.   Some of China’s international trade is now invoiced in the currency.  Foreign central banks have been able to hold RMB since August 2010, with Malaysia going first. 

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The FOMC is Right to Stay the Course on QE2

 
            The Fed has come in for a surprising amount of criticism since its decision in the fall of 2010 to launch a new round of monetary easing — Quantitative Easing 2.  Ben Bernanke and his colleagues are right not to give in to these attacks.

            Critiques seem to be of four sorts. (Some are mutually exclusive.)

            1)  “QE is weird.”    Quantitative Easing entails the central bank buying a somewhat wider range of securities than the traditional short-term Treasury bills that are the usual focus of the Fed’s open market operations.    This has been a bold strategy, which nobody would have predicted 3 or 4 years ago.   But it has been appropriate to the equally unexpected financial crisis and recession.    Some who find QE alarmingly non-standard may not realize that other central banks do this sort of thing, and that the US authorities themselves did it in the more distant past.    It is amusing to recall that when Ben Bernanke was first appointed Chairman, some reacted “He is a fine economist, but he doesn’t have the market experience of a Wall Street type.”  The irony is that nobody who had spent his or her career on Wall Street would have had the relevant experience to deal with the shocks of the last three years, since none of them were there in the 1930s.  But as an economic historian, Bernanke had just the broader perspective that was needed.   Thank heaven he did.

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A Review of Predictions of the Last Decade

         December 31 is technically the end of the first decade of the 21st century.  It is perhaps an appropriate time to review one’s predictions.    It seems to me that I got some things right over the last decade.  Indulge me while I review the predictions that came true, before turning to those that did not work out as well.

Stock market peak     At the end of the 1990s, I felt that the dizzying ascent of equity prices could not continue into the new decade, that there was “…a bubble component in the stock market”  (Nov. 20, 1999).   This was four months before the bubble burst in 2000.  So far so good.

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