This week, a frisson passed through Treasury markets when it emerged that China has been selling US government bonds. These sales were not huge — a mere $20.5bn in March — nor were they made with accompanying public threats. But in the current protectionist climate, the news left investors pondering two unnerving questions. Could the current trade war turn into a capital and currency war? And if so, might that undermine the dominance of the US dollar? The answer to the first question is, “one hopes not”. And to the second, “almost certainly no”.
The reasons for this were neatly laid out at a meeting of central bankers earlier this week in Zurich, organised by the IMF and Swiss National Bank. This started with a paper from Barry Eichengreen, the American economist, outlining a split among academics in the US about the way the dollar has in effect anchored the international monetary system (it accounts for about 60 per cent of foreign exchange reserves, foreign currency liabilities and bank deposits). Prof Eichengreen noted that at the University of California, Berkeley, where he teaches, economists tend to assume that dollar dominance will eventually end. Other currencies (or metals) have been dominant in the past — sterling in the 19th century, say.
However, a little-noticed feature of these earlier eras was that dominance almost always occurred within a multipolar global system. The Berkeley economists assume that the world will eventually become multipolar again, particularly as the current status quo does not serve anybody well. Most notably, emerging markets are laden with alarmingly large levels of dollar-denominated debt. And while US leaders like the political status and power associated with the dollar’s dominant role, it has some negative consequences for America’s domestic economy too. It fosters an excessively strong currency and artificially low levels of market interest rates. But “eventually” is the keyword here. Even Prof Eichengreen does not predict that the dollar will lose its dominance in the near future.
Meanwhile, on the other side of the US at Harvard University, a group of economists, including Gita Gopinath (now chief economist at the IMF), have recently developed some powerful empirical arguments for why dollar supremacy is “sticky”. Currently, the dollar is the dominant currency for trade invoices (if you exclude euro-denominated payments inside the eurozone) and that encourages debt issuance in dollars too. Taken together, these factors create an overwhelming dollar tilt that is difficult to shift, particularly since the Chinese currency is not yet liberalised and markets in the eurozone remain disunited.
The case of Russia demonstrates this “stickiness”. At first glance, Moscow seems to be trying to escape the dollar yoke. At the IMF-SNB meeting Elvira Nabiullina, Russia’s central bank governor, revealed that between July 2017 and July 2018 Russia cut the dollar proportion of its foreign exchange reserves from 46.3 per cent to 21.9 per cent, replacing these with euros and some Chinese renminbi. That might seem to make sense given Russia’s trading patterns: commerce with America accounts for a measly 1.5 per cent of Russian gross domestic product, whereas trade with the EU and China is a whopping 24.3 per cent of GDP. But here is the catch: measured overall, 55 per cent of Russia’s trade is still invoiced in dollars, Ms Nabiullina noted. And since Russian companies (sensibly) try to match liabilities and revenues, 54 per cent of Russian debt is dollar-denominated too.
Now, a critic of America might point out that Russia is an extreme case — it is highly dependent on commodity exports, which tend to be priced in dollars. But the global pattern is clear. And what was striking about the IMF/SNB event was that while almost all the central bank governors from emerging market countries fretted about the pain the dollar yoke creates, none predicted it was about to vanish. However, there was also an interesting caveat.
This, the ninth such meeting, was the first to include representatives of fintech companies, who boldly predicted that technologies such as blockchain and cryptocurrencies are poised to overturn global finance. Unsurprisingly, the central bankers were not convinced, but they did not dismiss the fintech claims out of hand. So if you want to see what might eventually challenge dollar supremacy, look to Silicon Valley as much as China. Just don’t expect that change too soon, even amid a trade war.
Source: Financial Times – Gillian Tett