I'm in Shanghai to discuss how the G-20 has been doing as the world's "premier economic forum." As fate would have it, the G-20 actually opened its collective mouth in response to the market convulsions of this week:
The Group of 20 leading economies pledged a “strong and co-ordinated” effort to stabilise the global economy in an attempt to calm tumbling equities markets spooked by fears of recession in the eurozone and a gloomy economic outlook in the US.
Bowing to pressure from investors to take action, finance ministers from the G20 economies said in a communiqué issued late on Thursday that they would stop the European debt crisis from deluging banks and financial markets, and take the necessary steps to bolster the eurozone’s rescue fund and assist banks to boost capital reserves in line with new global regulations. The statement followed a day in which the equity markets suffered some of the biggest falls since the collapse of Lehman Brothers in 2008, as investors rushed to safety in a widespread sell-off.
“We commit to take all necessary actions to preserve the stability of banking systems and financial markets as required,” the group said in a statement. “We will ensure that banks are adequately capitalised and have sufficient access to funding to deal with current risks and that they fully implement Basel III along the agreed timelines.”
The G-20's near-total muteness in the face of European sovereign debt convulsions had begun to raise some eyebrows -- particularly as it was the G-7 economies rather than the G-20 that pledged to provide dollar liquidity to European financial institutions.
Unfortunately, if you read the actual communique, you discover... well.... let's describe the statement as very optimistic about what the G-20 countries have done to promote both growth and fiscal rectitude.
One of the takeaways from my conversations so far in Shanghai has been a sense of disappointment about what the next G-20 summit in Cannes will accomplish. The Financial Times' Chris Giles provides some background on the demise of the France's grand ambitious for that summit:
In mid-February, G20 finance ministers gathered in Paris for what turned out to be a harbinger of the challenges that have beset the French G20 presidency ever since. The meeting was supposed to be routine, with finance ministers agreeing a set of indicators that might be used to assess whether their economies and policies fostered balanced global economic growth.
Far from France undermining the meeting with excessive ambitions, countries struggled to agree even the most basic steps to a more stable world economy.
A country’s current account surplus or deficit is the accepted measure of balance in its relations with other countries, but the Chinese arrived in Paris in intransigent mood. Their negotiators refused to let the G20 use the current account as an indicator of balance. After an all-night session, the absurd compromise China accepted was that countries were allowed to assess every component part of a country’s current account, but the term “current account” was banned.
That ended the French presidency’s lofty plans. From then on, limited goals became the order of the day, a shift that has been reinforced as the year has progressed.
I'd quibble a bit with Giles -- any meeting that details indicative guidelines on macroeconomic imbalances is not gonna be a routine meeting. [Um...could you translate that last sentence out of bureaucratese, please?--ed.] Sorry, to rephrase -- any meeting in which the G-20 points out that China's trade surplus is part of the problem in the global economy is not going to be a smooth meeting.
Your humble blogger is near the capital of
Waterworld Pennsylvania at the moment and all conferenced out. Regular blogging will resume after some sleep.
In the meanwhile, however, please check out FP's latest Deep Dive on the future of currencies. I have a contribution on the dollar's future as the world's reserve currency. It's depressing to note that the thing I like best about it is it's title -- which, of course, someone else at FP created.
For the past two years, staunch monetarists and economic conservatives have warned about the evils of massive deficit spending and quantitative easing. They have argued that such policy measures are inevitably inflationary and will debase the currency and raise nominal interest rates. By and large, supporters of Keynesian policies have responded by loudly pointing to the data on core U.S. inflation and the dollar's performance as falsifying the conservative argument. And, by and large, they have a point. If inflationary concerns really were prominent, the dollar should have depreciated in value an awful lot, and nominal interest rates should have soared. Neither of these things have happened. Point for Keynesians.
Right now, however, markets are providing a pretty powerful data point for Tea Party supporters who argue that hitting the debt ceiling is not the end of the world. Last week Moody's issued the following warning:
Moody's Investors Service said today that if there is no progress on increasing the statutory debt limit in coming weeks, it expects to place the US government's rating under review for possible downgrade, due to the very small but rising risk of a short-lived default. If the debt limit is raised and default avoided, the Aaa rating will be maintained. However, the rating outlook will depend on the outcome of negotiations on deficit reduction. A credible agreement on substantial deficit reduction would support a continued stable outlook; lack of such an agreement could prompt Moody's to change its outlook to negative on the Aaa rating.
Although Moody's fully expected political wrangling prior to an increase in the statutory debt limit, the degree of entrenchment into conflicting positions has exceeded expectations. The heightened polarization over the debt limit has increased the odds of a short-lived default. If this situation remains unchanged in coming weeks, Moody's will place the rating under review.
Make fun of the ratings agencies all you like, but this was front-page news last week. One would think that markets would be pricing in the possibility of institutional investors diversifying away from dollar-denominated debt, a collapse in the dollar, skyrocketing interest rates, a drastic reduction in nominal GDP, dogs and cats living together, and so forth. Or, as Tim Geithner put it, "catastrophic economic and market consequences."
And yet.... last week, the yield on 10 year Treasuries fell below three percent. Maybe markets are underestimating the likelihood that a debt ceiling deal won't happen, maybe they are underestimating the damage caused by hitting the debt ceiling, or maybe they think the Chinese will continue to buy dollar-denominated debt no matter what happens on the debt ceiling (though read this). Or... maybe the Tea Party activists have a point.
So, my question to readers, investors, and experts on the global political economy -- why aren't markets freaking out more about the rising probability of hitting the debt ceiling?
I'm at the point in my life when there are only three occasions that prompt the watching of cable news:
1) An election night;
2) A real-time breaking news event in which video has a comparative advantage over the web;
3) Being on the treadmill on a slow sports day with nothing good on basic cable.
So yesterday was no. 3, and I caught a report on Fox News about "pre-summit brinkmanship" on the part Hu Jintao. The headline was accurate: "China's President Hu Jintao: Dollar-Based System 'Thing of the Past.'" And I should stress that Fox News was hardly the only news outlet to jump on this turn of phrase.
That said, some perspective might be in order. The statement came from a
series of answers that
a committee of propaganda writers with the
stylistic panache of Andrei Gromyko Hu provided to the Wall
Street Journal and Washington
Let's reprint the question and answer in full, shall we?
Q: What do you think will be the US dollar's future role in the world? How do you see the issue of making the RMB an international currency? Some think that RMB appreciation may curb China's inflation, what's your view on that?
HU: The current international currency system is the product of the past. As a major reserve currency, the US dollar is used in considerable amount of global trade in commodities as well as in most of the investment and financial transactions. The monetary policy of the United States has a major impact on global liquidity and capital flows and therefore, the liquidity of the US dollar should be kept at a reasonable and stable level.
It takes a long time for a country's currency to be widely accepted in the world. China has made important contribution to the world economy in terms of total economic output and trade, and the RMB has played a role in the world economic development. But making the RMB an international currency will be a fairly long process. The on-going pilot programs for RMB settlement of cross-border trade and investment transactions are a concrete step that China has taken to respond to the international financial crisis, with the purpose of promoting trade and investment facilitation. They fit in well with market demand as evidenced by the rapidly expanding scale of these transactions.
China has adopted a package plan to curb inflation, including interest rate adjustment. We have adopted a managed floating exchange rate regime based on market supply and demand with reference to a basket of currencies. Changes in exchange rate are a result of multiple factors, including the balance of international payment and market supply and demand. In this sense, inflation can hardly be the main factor in determining the exchange rate policy (emphases added).
Meh. First of all, Hu isn't saying anything here that hasn't been said by other Chinese officials since early 2009.
Second of all, Hu didn't say that the RMB was going to be supplanting the dollar anytime soon. In fact, he pretty much said the opposite of that. China wants a multiple-reserve currency regime, and they're moving veeeerrrrrry slowly to bring their currency into the conversation. And minus the RMB, as I've said before, there ain't much in the way of viable alternatives right now.
If you read the rest of the answers, there's a lot of
"stiffly worded answers" mixed in with "a positive note on
bilateral ties," as Richard MacGregor of the Financial Times notes.
What I don't see is any brinkmanship.
Substantively, however, what about the future? Will a multiple currency reserve system work? It's a vision shared by Barry Eichengreen, Nicolas Sarkozy, and.... well, I'm not sure who else. I have my doubts, but I can't quite convey them in a single blog post.
What do you think?
You know, as insults go, this one is pretty bush league:
China's credit-rating agency on Tuesday downgraded its rating for U.S. sovereign debt and warned of further cuts, in a pointed move ahead of this week's Group of 20 major economies meeting.
Dagong Global Credit Rating Co. Ltd., the only wholly Chinese-owned rating agency, cut its rating on U.S. debt to A from AA, citing the Federal Reserve's move last week to initiate another round of asset buying, worth $600 billion. It also placed the U.S. sovereign credit rating on negative watch.
"The new round of quantitative easing monetary policy adopted by the Federal Reserve has brought about an obvious trend of depreciation of the U.S. dollar and the continuation and deepening of credit crisis in the U.S.," Dagong said.
"Such a move entirely encroaches on the interests of the creditors, indicating the decline of the U.S. government's intention of debt repayment," the agency said.
Sounds very, very serious, until we get to this part of the story:
The downgrade of the U.S. rating by Dagong comes just over a month after the U.S. Securities and Exchange Commission denied the firm's application to officially rate bonds in the U.S.
At that time, Dagong called the SEC's move discriminatory and said it was considering legal action.
The SEC said in denying the application that "it does not appear possible at this time for Dagong to comply with the record keeping, production and examination requirements of the federal securities laws."
Indeed, even the New York Times' now-thrice-weekly story about rising Sino-American tensions observes:
In the rest of the world, the United States is still the strongest of credit risks, and the Chinese downgrade is not expected to have much real impact....
[T]hose critics, mostly countries that fear that recent American policy will devalue the dollar and undercut their competitiveness, do not appear poised to offer an alternative to an economic order that has been led by the United States since the end of World War II, or to the role the dollar has played for decades as the de facto world gold standard.
The Chinese, who have protested that the Federal Reserve is trying to unilaterally manipulate the dollar for the purpose of creating jobs at home, have been accused of doing exactly that for years - the root of many of the world's economic tensions today, in the eyes of Mr. Obama and his economic aides.
Look, clearly China is suffering from... an insult gap. Americans have been leading the world in trash-talking for decades now. China is trying hard to catch up, but I think the authorities in Beijing need some assistance in their game of catch-up.
I hereby call on all readers to offer, in the comments, ways that Chinese authorities can really sharpen their rhetorical jabs at the United States. In the spirit of kicking off the conversation, here are a few suggestions:
"Chinese Halitosis Institute Downgrades American Fresh Breath Index to BB: 'Seriously, What's The Deal With All The BBQ,' Asks Agency Head"
"Chinese Election Monitors Accuse Obama Administration of Rampant Ballot Fraud During Midterm Elections: 'It's No Myanmar, I'll Say That' According to Chief Monitor"
"Chinese Dietary Institute says American Food Leaves Them Hungry After Only 12 Hours"
Go to it.
At APSA today I attended a panel on what political scientists can offer to political journalists. Mark Schmitt, Marc Ambinder, Matt Yglesias, Mark Blumenthal, and Ezra Klein all offered interesting advice. Two messages that came through loud and clear:
1) Be willing to advertise one's research wares; and
Mr. Gorbachev, tear down these paywalls Make the research accessible to people without a JSTOR account.
So, in that spirit, let me announce that I have an article in the latest issue of International Relations of the Asia-Pacific entitled "Will Currency Follow The Flag?" It's on the future of the U.S. dollar as the world's reserve currency. The abstract:
The 2008 financial crisis and its aftermath have triggered uncertainty about the future of the dollar as the world's reserve currency. China and other countries in the Asia-Pacific region have voiced support for a new global monetary regime. There are both economic and geopolitical motivations at the root of these challenges. Going forward, what will the future hold for the international monetary system? Crudely put, will currency follow the flag?
This article addresses this question by considering the economic opportunity and geopolitical willingness of actors in the Pacific Rim to shift away from the current international monetary system – with a special emphasis on China as the most powerful actor in the region. While the dollar has shifted from being a top currency to a negotiated one, neither the opportunity nor the willingness to shift away from the dollar is particularly strong. The current window of opportunity for actors in the region to coordinate a shift in the monetary system is small and constrained. The geopolitical willingness to subordinate monetary politics to security concerns is muted.
The entire article is free for anyone to download and read. So read the whole thing, political journalists!!
One of the purposes of this blog is to
profess my deep, profound admiration for Salma Hayek take somewhat arcane concepts from the world of social science and make them more accessible to the general interest reader. For example, there's been a lot of talk in recent years about the end of the dollar's status as the world's reserve currency. I keep saying it's not going to happen. To undertstand why, let me put it this way: the U.S. dollar is the Facebook of hard currencies.
Social networking technologies, like reserve currencies, have a peculiar quality -- they are more useful when more people use them. A social networking site is only worth something if everyone's friends and contacts are on the site. It doesn't matter if there's another site that's superior, unless everyone is willing to simultaneously switch over.
This gives the owner of the dominant social networking site an exorbitant privilege. It can change the rules of the game in its favor with minimal risk of mass defections. Indeed, it looks like Facebook is doing exactly that in an effort to increase its profit sources.
A lot of us can’t just decide to “leave” without having somewhere to go. That’s because Facebook has become not just an extension of our offline networks, but to some extent, a space in which our virtual identities live – our most important semi-imagined community. The decision to leave such sites is usually agonizing and isolating, because we are deeply committed to what Facebook has to offer, even as many of us abhor on principle what Facebook is becoming....
Plenty of us would choose such an exile from the dictatorship of Facebook were there a welcoming neighbor nearby to which we could escape with our friends and families. The latter is crucial: since the “space” of social networking sites is constituted both by the platform and by one’s social network, we need a way to convince people in our Facebook networks to join us in exodus. That requires a social networking utility as cool and functional as Facebook, with none of its privacy-violating nonsense. Not just any country, but a country where we and our friends would actually want to go.
There's an additional requirement -- everyone would need to agree that the new country is clearly cooler than Facebookland. These are pretty imposing barriers to exit.
Now, lest one despair too much, Facebook, like the U.S. Treasury Department or the Federal Reserve, does not have unlimited power -- there is a limit pricing effect. Too much abuse of the privilege will lead to increased search for alternatives, and give competitors an enhanced incentive to encroach on Facebook's turf. Indeed, in this way, Facebook's status is more fragile than the dollar -- because while there are viable alternatives to Facebook, the only plausible rival to the dollar right now is doing a lovely job of imploding right now.
There is one warning, however -- Facebook's hegemony will seem impregnable right up to the moment it collapses. Because the attraciveness of these sites depends on the number of other users, there's always the possibility that an inflection point is reached in which everyone migrates from Facebook to Orkut or something else. And when that does happen, the fall of Facebook will be fast and hard.
And yes, this applies to the dollar as well.
In his New York Times column today, Paul Krugman writes about the problem of macroeconomic imbalances between China and the United States. Which is fine, except he wrote the exact same column last month. Just like last month's column, this one makes some good points and fails to mention some important dynamics. Beyond the inclusion of a useful footnote, however, there's nothing new here.
As part of an ongoing public service to busy readers of Foreignpolicy.com, the hard-working staff here at the blog is ready to help you bypass the chore of having to read the same Krugman column time and again with this handy-dandy crib sheet. My guess is that the next six months' worth of Krugman columns will boil down to the following assertions:
Now, let me stress that I agree with 1, 3, and 6 at this point, and I'm agnostic on 4 and 5, so it's not like Krugman is wrong in what he's saying. It's just that he's saying the same damn thing over and over again.
Following up on my dollar post from earlier this week, I see that Paul Krugman is talking a related issue in his New York Times column today -- the refusal of the renminbi to depreciate against the dollar:
Many economists, myself included, believe that China’s asset-buying spree helped inflate the housing bubble, setting the stage for the global financial crisis. But China’s insistence on keeping the yuan/dollar rate fixed, even when the dollar declines, may be doing even more harm now.
Although there has been a lot of doomsaying about the falling dollar, that decline is actually both natural and desirable. America needs a weaker dollar to help reduce its trade deficit, and it’s getting that weaker dollar as nervous investors, who flocked into the presumed safety of U.S. debt at the peak of the crisis, have started putting their money to work elsewhere.
But China has been keeping its currency pegged to the dollar — which means that a country with a huge trade surplus and a rapidly recovering economy, a country whose currency should be rising in value, is in effect engineering a large devaluation instead.
Krugman then goes on to excoriate the U.S. Treasury department for not upbraiding the Chinese more on this.
Fair enough, but the thing is, the United States is not the country that's hurt the most by this tactic. It's the rest of the world -- particularly Europe and the Pacific Rim -- that are getting royally screwed by China's policy. These countries are seeing their currencies appreciating against both the dollar and the renminbi, which means their products are less competitive in the U.S. market compared to domestic production and Chinese exports.
This leads to the title of this post. Krugman presumes that the U.S. has the strongest incentive to talk to China about this issue. If one thinks of the U.S. acting as the hegemon, that's possibly true. As a matter of direct economic interest, however, why haven't the Europeans and East Asians been screaming bloody murder about this? China's policies are forcing them to take actions they don't want to take -- so why aren't they complaining more loudly about this?
Over at Politico, Eamon Javers notes an odd trend in the Drudge Report:
On Tuesday, Matt Drudge ran a headline about the weakening U.S. dollar on his website, Drudgereport.com. In and of itself, that would be unremarkable, except that it was the 18th time Drudge had posted a link to a story about the weak dollar this month.
And October was only 20 days old.
Clearly, Matt Drudge has developed a fascination with the declining U.S. dollar.
“He’s fixated on it,” said Tom Rosenstiel, director of the Pew Research Center’s Project for Excellence in Journalism. “There’s no question that Drudge can alter what people are paying attention to.”
Market watchers say it’s unlikely that Drudge is actually moving the currency markets with his relentless attention.
“I don’t think that anyone who seriously trades currencies reads The Drudge Report before making important buy or sell decisions,” said Chris Roush, a professor of business journalism at the University of North Carolina at Chapel Hill. (emphasis added... because that's a priceless quote)
Drudge isn't the only one obsessed about the dollar. Last week, James Pethokoukis blogged the following for Reuters:
The aftershocks of the global financial crisis may now be propelling the dollar back to the political forefront. The greenback’s continuing slide makes it a handy metric that neatly encapsulates America’s current economic troubles and possible long-term decline. House Republicans for instance, have been using the weaker dollar as a weapon in their attacks on the Bernanke-led Federal Reserve.
For more evidence of the dollar’s return to political salience, look no further than the Facebook page of Sarah Palin. The 2008 GOP vice presidential nominee — and possible 2012 presidential candidate — has shown a knack for identifying hot-button political issues, such as the purported “death panels” she claims to have found in Democratic healthcare reform plans. In a recent Facebook posting, Palin expressed deep concern over the dollar’s “continued viability as an international reserve currency” in light of huge U.S. budget deficits.
She might be onto something here, politically and economically. A recent Rasmussen poll, for instance, found that 88 percent of Americans say the dollar should remain the dominant global currency. Now, the average voter may not fully understand the subtleties of international finance nor appreciate exactly how a dominant dollar has benefited the U.S economy. But they sure think a weaker dollar is a sign of a weaker America.
The dollar's slide in value has been predictable, as the need for a financial safe haven has abated. By and large, a depreciating dollar helps the U.S. trade balance (though it would help much more if the Chinese renminbi got in on the appreciation).
Even the Chinese, who have spoken like they want an alternative to the dollar as a reserve currency, are in point of fact not doing much to alter the status quo. Why? To paraphrase Winston Churchill, the dollar is a lousy, rotten reserve currency - until one contemplates the alternatives.
Because all of the alternatives have serious problems. The euro, the only truly viable substitute for the dollar, is not located in the region responsible for the largest surge of growth. It would be unlikely for the ASEAN +3 countries to agree to switch from the dollar to a new currency over which regional actors have no influence (the Europeans wouldn't be thrilled either, as it would lead to an even greater appreciation of the currency). Oh, and the European Union has no consolidated sovereign debt market. The euro is worth watching, but it's not going to replace the dollar anytime soon.
The other alternatives are even less attractive. Most other national currencies beyond the euro - the yen, pound, Swiss franc, Australian dollar - are based in markets too small to sustain the inflows that would come from reserve currency status. The renminbi remains inconvertible. A return to the gold standard in this day and age would be infeasible - the liquidity constraints and vagaries of supply would be too powerful. There's the using-the-Special-Drawing-Right-as-a-template-for-a-super-sovereign currency idea, but this is an implausible solution. As it currently stands, the SDR is not a currency so much as a unit of account. Even after the recent IMF authorizations, there are less than $400 billion SDR-denominated assets in the world, which is far too small for a proper reserve currency.
So, what's really going on here with the dollar obsession? I suspect that with the Dow Jones going back over 10,000, Republicans are looking for some other Very Simple Metric that shows Obama Stinks. The dollar looks like it's going to be declining for a while, so why not that? Never mind that the dollar was even weaker during the George W. Bush era -- they want people to focus on the here and now.
The thing is, I'm not sure this gambit is going to work. People who already think Obama is a socialist will go for it, sure, but that's only rallying the base. I'm not sure how much fence-sitters care about a strong dollar, however. If anything, populist movements tend to favor a debasing of the currency rather than a strengthening of it.
Still, I'm just a political scientist -- I'm sure that, "theories on political behavior are best left to CNN, pollsters, pundits, historians, candidates, political parties, and the voters."
So, have at it, readers! Will the falling dollar be a source of populist outrage if Drudge links to it enough?
For the past week, your humble blogger has not been blogging from home, but rather in the Swiss city of Basel (for those speaking German), also called Basle (for those speaking French), teaching a summer course on the global political economy.
[Ahem, weren't you doing this in Barcelona a few weeks ago?--ed. Um... well... yes. I know, I know, my life really sucks right now.]
My students this time are a bit more homogenous -- 85% Swiss, with a few Germans and the stray Russian thrown in. A few minor notes:
1. Maybe it's because they're Swiss, but the whole "Americans are manipulating the world" meme isn't as powerful here as it was in Barcelona. I've been asked the occasional question about the military-industrial complex causing the Iraq War, and one student asked me about whether central bankers timed certain moves to bail out rich bankers during the Great Depression. Those were outliers, however.
2. Man, if you think the bank bailouts are unpopular in the United States, try the Swiss reaction to the Swiss federal government's bailout of UBS. It's to the Voldamortian point where they asked me not to say "UBS" because it's so embarrassing. We have compromised -- I can now say "UBS," but must then spit three times over my right shoulder to ward off evil spirits.
3. McDonald's is the most ubiquitous U.S. multinational in Europe, but I must say I'm impressed at the expanding reach of Starbucks. They now have coffeehouses in 15 European countries. This is pretty surprising to me, because it's not like they have a shortage of good coffee on this continent. It's not cheap, either -- a tall latte goes for about $6.50 here.
Rather, I would chalk it up to two other reasons. First, the cafes themselves are quite friendly and open -- chalk a victory for Virginia Postrel here. Second, local cafes don't have anything that approximates the frappuccino. [Aha!! The secret American plan to fatten up Europeans is working!!--ed. Shhhh.......]
UPDATE: A source based in Geneva e-mails an additional explanation for the European success of Starbucks:
My strong sense of Starbuck's success here is that they have wifi and cheesecake. Forget the coffee - the foreigners love it because it's familiar, and young Swiss who've traveled, because it's fun. But everyone I know goes there mainly because of the easy and free connection plus seats that work if you have a laptop. I often meet people there - Lausanne or Geneva - for informal business meetings.
The Financial Times' Peter Garnham reports that China is getting serious about internationalizing the use of the renminbi:
China has kick-started a major plan to internationalise the renminbi and the process is likely to be faster than many expect, according to HSBC....
“China is beginning an ambitious scheme to raise the role of the renminbi in international trade and finance and to reduce reliance on the US dollar,” said Qu Hongbin, China chief economist at HSBC.
“This will likely be a multi-year and gradual process. Yet, we believe the pace is likely to be faster than many expect.”
HSBC said the internationalisation of the renminbi was long overdue, given China’s rising economic power relative to the limited use of the renminbi overseas.
If you read the whole story, you discover that the FT's evidence for this assertion rests entirely on assertions by HSBC officials. Which leads one to wonder whether maybe, just maybe, the FT should have checked to see whether HSBC has any financial stake in globalizing the use of the renminbi. Crazy talk, I know...
Loyal readers are surely aware that this is not the first time the Financial Times has hyperventilated over Chinese moves that don't necessarily amount to all that.
Now before anyone accuses me of going all Brad DeLong on the FT, I think a lot of their China coverage (particularly by Jamil Anderlini and Geoff Dyer) has been very informative. That said, this kind of thinly sourced story does lead one to wonder just how much of the coverage of China's financial moves is hype from financial players with a vested interest in feeding the China bubble.
Readers -- am I underreacting to this?
My latest Newsweek column is online. It looks at China's recent moves to challenge the dollar's status as the world's reserve currency and what to make of them.
The closing paragraphs:
If these moves do not amount to much, then why all the hubbub? To be blunt, America is out of practice at dealing with an independent source of national power. For two decades the United States has been the undisputed global hegemon. For the 40 years before that, America was the leader of the free world. As a result, American thinkers and policymakers have become accustomed to having all policy decisions of consequence go through Washington. Our current generation of leaders and thinkers are simply unprepared for the idea of other countries taking the lead in matters of the global economic order.
Most of China's recent actions do not constitute a real threat to the United States; indeed, to the extent that China helps to boost the economies of the Pacific Rim, they are contributing a public good. Obama—and Hunstman—need to make the mental adjustment to a rising China, welcoming many of China's policy initiatives while pushing back at those that threaten American core interests. If they can make this cognitive leap, then Sino-American relations can proceed on the basis of shared interests rather than mutual fears.
The New York Times runs two op-eds today on the future of the dollar's status as the world's reserve currency, particularly with regard to China.
Victor Zhikai Gao's essay doesn't actually say a whole lot on the matter, except for this excerpt:
Beijing recently called for a greater role in international trade for the special drawing rights currency of the International Monetary Fund. But China is also fully aware that the United States can veto an I.M.F. decision. China’s call was more meant to sound an alarm to the United States.
Many Chinese people increasingly fear the rapid erosion of the American dollar. The United States may want to consider offering inflation-protection measures for China’s existing investments in America, and offer additional security or collateral for its continued investments. America should also provide its largest creditor with greater transparency and information.
As Brad Setser points out, it's a bit rich for the Chinese to fret about U.S. inflation, since if the renminbi started appreciating, many of the macro imbalances currently plaguing the international monetary system might be lessened. Of course, talking about "currency appreciation" puts the onus on Beijing, while talking about inflation conveniently puts the onus on the United States.
The other op-ed is by Nouriel Roubini -- a.k.a., Dr. Doom. It's a good primer on the benefits that accrue to the United States from having the dollar as the world's reserve currency. That said, this part confused me:
We have reaped significant financial benefits from having the dollar as the reserve currency. In particular, the strong market for the dollar allows Americans to borrow at better rates. We have thus been able to finance larger deficits for longer and at lower interest rates, as foreign demand has kept Treasury yields low. We have been able to issue debt in our own currency rather than a foreign one, thus shifting the losses of a fall in the value of the dollar to our creditors. Having commodities priced in dollars has also meant that a fall in the dollar’s value doesn’t lead to a rise in the price of imports (emphasis added).
The other parts of that paragraph make sense, but that last sentence mystifies me. Wasn't part of the reason that oil and other commodity prices spiked last year was the declining value of the dollar?
In general, both op-eds urge the U.S. to get its financial house in order. I certainly don't disagree with that recommendation. Still, it's a bit disingenuous to suggest that the U.S. is the only country at fault for the current overhang of dollar reserves. Beijing needs to take a good hard look in the mirror on this issue.
One of the great ironies about the Sino-American financial relationship is that most Americans believe that China has been screwing the U.S. over through their massive accumulation of dollars, while most Chinese believe that America has been screwing China over through.... their massive accumulation of dollars.
Well, what if the accumulation is not so massive? Yesterday's New York Times story by Keith Bradsher suggested that China was buying far fewer dollars than it used to, and therefore we can all breathe easier about China using its dollar holdings as a form of foreign policy leverage:
Chinese reserves fell a record $32.6 billion in January and $1.4 billion more in February before rising $41.7 billion in March, according to figures released by the People’s Bank over the weekend. A resumption of growth in China’s reserves in March suggests, however, that confidence in that country may be reviving, and capital flight could be slowing.
The main effect of slower bond purchases may be a weakening of Beijing’s influence in Washington as the Treasury becomes less reliant on purchases by the Chinese central bank.
Asked about the balance of financial power between China and the United States, one of the Chinese government’s top monetary economists, Yu Yongding, replied that “I think it’s mainly in favor of the United States.”
He cited a saying attributed to John Maynard Keynes: “If you owe your bank manager a thousand pounds, you are at his mercy. If you owe him a million pounds, he is at your mercy.”
I don't disagree with Yu, but I do disagree with Bradsher. It's necessary to separate China's willingness to use its reserves as a lever from the expectation that such a lever will net it significant concessions.
As long as China is heavily dependent on the U.S. market as a source of economic growth, it is fundamentally constrained in using its reserves in a strategic manner. Regardless of its feelings towards the United States, Beijing will not take actions that shoot itself in the economic foot.
If, however, China manages to decouple its economy somewhat from the U.S. market, then the calculus of compellence changes. Such a decoupling would contribute to the unwinding of the macroeconomic imbalances caused by the Bretton Woods II arrangements. It would also reduce whatever constraints economic interdependence has placed on China's financial statecraft.
This is the paradox -- the more leverage China has, the more reluctant it will be to use it. The more willing China is to use its reserves in a strategic manner, the less likely such statecraft will yield anything in the way of meaningful concessions.
[This sounds.... familiar.--ed. Oh, shut up.]
Apparently the foreign exchange markets got taken for a ride earlier today in response to Tim Geithner's chat at the Council on Foreign Relations. This makes me wonder if anyone working in forex markets actually listened to the words that came out of Geithner's mouth.
Here's Kathy Lien at FX360 explaining what Geithner said that caused markets to go into a tizzy:
In a blink of an eye, the U.S. dollar has collapsed against the Euro, Japanese Yen and other major currencies. The trigger was comments from Tim Geithner who said that the U.S. is "quite open" to China's suggestion of moving towards a Special Drawing Right (SDR) linked currency system. If the world adopts the SDR, which was created by the IMF as an international reserve asset, it would mean that countries around the world would need to hold less U.S. dollars. (emphasis added)
Except that this is not what Geithner actually said. To be more specific, he did say "quite open," but that's not all he said in his first response. This is from the CFR transcript:
[A]s I understand his proposal, it's a proposal designed to increase the use of the IMF's special drawing rights. And we're actually quite open to that suggestion. But you should think of it as rather evolutionary, building on the current architectures, than -- rather than -- rather than moving us to global monetary union.
Geithner is asked about China (not my question) and the IMF's new proposals for expanded lending. He responds by praising Zhou Xiaochuan, China's central bank governor, but claims that he hasn't read his proposal in detail. Geithner makes it clear that he is quite open to expanding the IMF's Special Drawing Rights for less developed countries. Still, he wants it to evolve and be integrated within the current international monetary system -- as opposed to the de novo creation of a new global currency.
I've read the report (Tim, it's not that long, take a look!) and Zhou is not proposing anything so radical so soon, so this is a bit of a red herring. Still, Geithner's statement here carries the same kind of firm pushback that Obama gave yesterday about any move ending the dollar as the global reserve currency.
SDRs are intended for least developed countries, so expanding that program would not profoundly affect the distribution of currency reserves among the world's principal players.
And yet, after Geithner reaffirms this point later in the talk, Lien interprets it as follows:
A few minutes after saying the U.S. is open to an SDR linked currency, Geithner clarified his comments by saying that there is "no change in dollar as world's reserve currency and likely to remain so for long time." In our alert, we said that the dollar would rebound if he attempts to clarify his comments. These contradictory statements are clearly the act of an amateur Treasury Secretary that has been thrust onto the public forum and is struggling with the need to be very particular in his choice of words.
Okaaaaaay..... except there was no contradiction between his statements, and anyone who's been following this stuff for the past week should have understood Geithner's point the first time.
Question to readers: shouldn't the forex markets have interpreted these statements better than your humble blogger? What does this say about the wisdom of crowds?
UPDATE: The Financial Times' Krishna Guha, Tom Braithwaite and Peter Garnham provide more precise reporting on this point:
The dollar fell 1.3 per cent against the euro as headlines saying “Geithner open to SDR currency” flashed across traders’ screens. With the currency falling, Mr Geithner’s interviewer – Roger Altman, a deputy Treasury secretary in the Clinton administration – gave Mr Geithner the chance to clarify.
The Treasury secretary said: “I think the dollar remains the world’s dominant reserve currency.” The dollar subsequently recovered much of its losses.
One fuzzy headline, and you get majoy gyrations in the forex markets.
James Carville once said, "I want to come back as the bond market. You can intimidate everybody." I want to be reincarnated as a headline editor.
Susan Strange, the godmother of international political economy, wrote a book that is suddenly very relevant to thinking about today's international monetary system. In Sterling and British Policy, Strange talked about different types of international currency. Top currencies, for example, are forms of international money where the economic incentive to hold them is pretty overwhelming. Negotiated currencies, on the other hand, are forms of international money where there the economic incentive is more muted, but political imperatives lead to an agreement on a particular form of currency as the reserve to hold.
Why am I bringing this up? Remember, like 48 hours ago, when I said that this news item warranted watching?
Well, this Financial Times story by Jamil Anderlini drops the other shoe:
China’s central bank on Monday proposed replacing the US dollar as the international reserve currency with a new global system controlled by the International Monetary Fund.
In an essay posted on the People’s Bank of China’s website, Zhou Xiaochuan, the central bank’s governor, said the goal would be to create a reserve currency “that is disconnected from individual nations and is able to remain stable in the long run, thus removing the inherent deficiencies caused by using credit-based national currencies”.
Analysts said the proposal was an indication of Beijing’s fears that actions being taken to save the domestic US economy would have a negative impact on China.
“This is a clear sign that China, as the largest holder of US dollar financial assets, is concerned about the potential inflationary risk of the US Federal Reserve printing money,” said Qu Hongbin, chief China economist for HSBC....
China has little choice but to hold the bulk of its $2,000bn of foreign exchange reserves in US dollars, and this is unlikely to change in the near future.
Here's a link to the actual paper, which is not long.
That last paragraph is important -- what China is proposing is not going to happen anytime soon. Indeed, looking at the actual proposal, I'm not convinced that Beijing's idea is even doable (a show of hands -- who's comfortable with the IMF as the world's central bank? Anyone?).
With China and Russia both proposing some sort of change in the international monetary system, we're about to some veeery interesting economic negotiations. There are other important players -- the EU, UK, Japan, Brazil, the Gulf economies, etc. And their incentives to switch away from the dollar are more cross-cutting. For example, while the EU would probably love to switch to a system that keeps the euro from appreciating too much, I suspect they will be loathe to reallocate the IMF voting quotas that China would demand in any switch to a new system. Both Japan and the Gulf economies have security considerations that make them less eager to change.
If this does happen, however, the United States will suffer a serious loss of standing and, oh yes, a much harder budget constraint. And whatever happens, it would be difficult to call the dollar a top currency anymore. I think we have clearly crossed some threshhold where the dollar is now a negotiated currency -- and some of the negotiating partners are pretty hostile to U.S. hegemony.
China should seek guarantees that its $682 billion holdings of U.S. government debt won’t be eroded by “reckless policies,” said Yu Yongding, a former adviser to the central bank.
The U.S. “should make the Chinese feel confident that the value of the assets at least will not be eroded in a significant way,” Yu, who now heads the World Economics and Politics Institute at the Chinese Academy of Social Sciences, said in response to e-mailed questions yesterday from Beijing.
Well, there's mostly hate going on -- but keep that bolded section in mind the next time someone mentions the prospect of China exercising its creditor power.
China will continue to buy US Treasury bonds even though it knows the dollar will depreciate because such investments remain its “only option” in a perilous world, a senior Chinese banking regulator said on Wednesday....
Luo Ping, a director-general at the China Banking Regulatory Commission, said after a speech in New York on Wednesday that China would continue to buy Treasuries in spite of its misgivings about US finances.
“Except for US Treasuries, what can you hold?” he asked. “Gold? You don’t hold Japanese government bonds or UK bonds. US Treasuries are the safe haven. For everyone, including China, it is the only option.”
Mr Luo, whose English tends toward the colloquial, added: “We hate you guys. Once you start issuing $1 trillion-$2 trillion [$1,000bn-$2,000bn] . . .we know the dollar is going to depreciate, so we hate you guys but there is nothing much we can do.” (emphasis added)
It's been fashionable as of late to predict the end of the dollar's hegemony as a reserve currency. And, to be sure, the U.S. performance in recent years does not recommend the dollar as a great store of value.
World politics is a relarive game, however, so while the dollar might have its problems, what are the alternatives? China might have its fiscal house in order, but the renminbi is not fully convertible. The yen is appreciating, but Japan's economy is too small (and its growth opportunities are not exactly robust).
The only viable alternative is the euro. But as Landon Thomas Jr. story in the New York Times suggests, that currency's odd political status is creating economic fissures within the Eurozone. The key paragraph:
For some of the countries on the periphery of the 16-member euro currency zone — Greece, Ireland, Italy, Portugal and Spain — this debt-fired dream of endless consumption has turned into the rudest of nightmares, raising the risk that a euro country may be forced to declare bankruptcy or abandon the currency.
As the story makes clear, the odds of this happening are still small. Because they are not trivial, however, uncertainty surrounding the euro will remain high. Which means that it is not going to displace the dollar anytime soon.
Economies are like battleships -- they can't make immediate U-turns. As Martin Wolf observed yesterday, the unwinding of serious macroeconomic imbalances has to start now -- but it can't be done immediately and efforts to do so would be very problematic.
So I started hyperventilating a little bit when I read Keith Bradsher's NYT front-pager:
China has bought more than $1 trillion of American debt, but as the global downturn has intensified, Beijing is starting to keep more of its money at home, a move that could have painful effects for American borrowers.
The declining Chinese appetite for United States debt, apparent in a series of hints from Chinese policy makers over the last two weeks, with official statistics due for release in the next few days, comes at an inconvenient time.
If this was true and persisted for a while, then those trillion-dollar budget deficits would become much more expensive to finance -- plus there would be knock-on effects on the balance of trade. In the short term, declining Chinese demand for the dollar would blunt the effects of a fiscal stimulus.
Fortunately, my first impulse whenever I read this kind of article is to go check what Brad Setser thinks. And, his reaction to the Bradsher article is as reassuring as one can be in the curent economic climate: "the available data from US suggests that China has yet to lose its appetite for either dollars or Treasuries, despite all the talk coming out of China." Rather, it appears that the Chinese government, like its sovereign wealth fund, is shifting its composition of dollar assets from riskier to safer holdings.
So China isn't going on a dollar fast -- they're just switching from one fad diet to another.
One of the most extraordinary features of the past month is the extent to which the dollar has remained immune to a once-in-a-lifetime financial crisis. If the US were an emerging market country, its exchange rate would be plummeting and interest rates on government debt would be soaring. Instead, the dollar has actually strengthened modestly, while interest rates on three- month US Treasury Bills have now reached 54-year lows. It is almost as if the more the US messes up, the more the world loves it. But can this extraordinary vote of confidence in the dollar last?Keith Bradsher's latest in the New York Times suggests that the wheel is turning:
Tremors from Wall Street are rattling Asian confidence, leading many investors to question the wisdom of being invested in the United States to the tune of trillions of dollars. Asian investors were starting to show hesitation even before the financial earthquake of the last week. Now, a wariness toward the United States is setting in that is unprecedented in recent memory, reaching from central banks to industrial corporations, from hedge funds to the individuals who lined up here to withdraw money from the American International Group on Wednesday. Asia’s savings have, in essence, bankrolled American spending for decades, and an Asian loss of confidence in American financial institutions and assets would have dire consequences for both the United States government and American taxpayers. The potential for panic is stoked by Asian news organizations, which tend to focus more on business and economics than on politics, which can be touchy here. Their coverage has been obsessive and unrelentingly negative about the bankruptcy of Lehman Brothers, Merrill Lynch’s rush to find a buyer and the turmoil at A.I.G. The nonstop deluge of bad publicity for American investments seems to be seeping into the consciousnesses of the rich and middle class across Asia.It seems like official investors are still cooperating with the United States, so the exorbitant privilege might not go away anytime soon. When the immediacy of the current crisis passes, however, I have to think that this episode is going to linger in the minds of official and private investors for quite some time.
Daniel W. Drezner is professor of international politics at the Fletcher School of Law and Diplomacy at Tufts University.