The Demise of Dollar Diplomacy


October 17, 2017

The Demise of Dollar Diplomacy

by Barry Eichengreen*

http://www.project-syndicate.org

Pundits have been saying last rites for the dollar’s global dominance since the 1960s – that is, for more than half a century now. But the pundits may finally be right, because the greenback’s dominance has been sustained by geopolitical alliances that are now fraying badly.

WASHINGTON, DC – Mark Twain never actually said “Reports of my death have been greatly exaggerated.” But the misquote is too delicious to die a natural death of its own. And nowhere is the idea behind it more relevant than in discussions of the dollar’s international role.

Pundits have been saying last rites for the dollar’s global dominance since the 1960s – that is, for more than a half-century now. The point can be shown by occurrences of the phrase “demise of the dollar” in all English-language publications catalogued by Google.

The frequency of such mentions, adjusted for the number of printed pages per year, first jumped in 1969, following the collapse of the London Gold Pool, an arrangement in which eight central banks cooperated to support the dollar’s peg to gold. Use of the phrase soared in the 1970s, following the collapse of the Bretton Woods system, of which the dollar was the linchpin, and in response to the high inflation that accompanied the presidencies of Richard Nixon, Gerald Ford, and Jimmy Carter in the 1970s.

But even that spike was dwarfed by the increase in mentions and corresponding worries about the dollar starting in 2001, reflecting the shock of the terrorist attacks that September, the mushrooming growth of the US trade deficit, and then the global financial crisis of 2008.

Yet through all of this, the dollar’s international role has endured. As my coauthors and I show in a new book, the share of dollars in the foreign-currency reserves held by central banks and governments worldwide hardly budged in the face of these events. The greenback remains the dominant currency traded in foreign-exchange markets. It is still the unit in which petroleum is priced and traded worldwide, Venezuelan leaders’ complaints about the “tyranny of the dollar” notwithstanding.

To the consternation of many currency traders, the value of the dollar fluctuates widely, as its rise, fall, and recovery in the course of the last year have shown. But this does little to erode the attractiveness of the dollar in international markets.

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America First–Then What is Future of the US Dollar in the Trumpian Era?

Central banks still hold US Treasury bonds because the market for them is the single most liquid financial market in the world. And Treasury bonds are secure: the federal government has not fallen into arrears on its debt since the disastrous War of 1812.

In addition, US diplomatic and military links encourage America’s allies to hold dollars. States with their own nuclear weapons hold fewer dollars than countries that depend on the US for their security needs. Being in a military alliance with a reserve-currency-issuing country boosts the share of the partner’s foreign-exchange reserves held in that currency by roughly 30 percentage points. The evidence thus suggests that the share of reserves held in dollars would fall appreciably in the absence of this effect.

This under-appreciated link between geopolitical alliances and international currency choice reflects a combination of factors. Governments have reason to be confident that the reserve-currency country will make servicing debt held by its allies a high priority. In return, those allies, by holding its liabilities, can help to lower the issuer’s borrowing costs.

Here, then, and not in another imbroglio over the federal debt ceiling this coming December, is where the real threat to the dollar’s international dominance lies. As one anonymous US State Department official put it, President Donald Trump “does not seem to care about alliances and therefore does not care about diplomacy.”

South Korea and Japan are thought to hold about 80% of their international reserves in dollars. One can imagine that the financial behavior of these and other countries would change dramatically, with adverse implications for the dollar’s exchange rate and US borrowing costs, were America’s close military alliances with its allies to fray.

Nor is it hard to imagine how this fraying could come about. President Donald Trump has painted himself into a strategic corner: he needs a concession from North Korea on the nuclear-weapons issue in order to save face with his base, not to mention with the global community. And, for all of Trump’s aggressive rhetoric and posturing, the only feasible way to secure such a concession is through negotiation. Ironically, the most plausible outcome of that process is an inspections regime not unlike the one negotiated by Barack Obama’s administration with Iran.

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Visualizing the Size of the U.S. National Debt

How big is the U.S. National Debt?

The best way to understand these large numbers? We believe it is to represent them visually, by plotting the data with comparable numbers that are easier to grasp.

Today’s data visualization plots the U.S. National Debt against everything from the assets managed by the world’s largest money managers, to the annual value of gold production.

1. The U.S. national debt is larger than the 500 largest public companies in America.
The S&P 500 is a stock market index that tracks the value of the 500 largest U.S. companies by market capitalization. It includes giant companies like Apple, Exxon Mobil, Microsoft, Alphabet, Facebook, Johnson & Johnson, and many others. In summer of 2016, the value of all of these 500 companies together added to $19.1 trillion – just short of the debt total.

2. The U.S. national debt is larger than all assets managed by the world’s top seven money managers.
The world’s largest money managers – companies like Blackrock, Vanguard, or Fidelity – manage trillions of investor assets in stocks, bonds, mutual funds, ETFs, and more. However, if we take the top seven of these companies and add all of their assets under management (AUM) together, it adds up to only $18.9 trillion.

3. The U.S. national debt is 25x larger than all global oil exports in 2015.
Yes, countries such as Saudi Arabia, Kuwait, and Russia make a killing off of selling their oil around the world. However, the numbers behind these exports are paltry in comparison to the debt. For example, you’d need the Saudis to donate the next 146 years of revenue from their oil exports to fully pay down the debt.

4. The U.S. national debt is 155x larger than all gold mined globally in a year.
Gold has symbolized money and wealth for a long time – but even the world’s annual production of roughly 3,000 tonnes (96 million oz) of the yellow metal barely puts a dent in the debt total. At market prices today, you’d need to somehow mine 155 years worth of gold at today’s rate to equal the debt.

5. In fact, the national debt is larger than all of the world’s physical currency, gold, silver, and bitcoin combined.

That’s right, if you rounded up every single dollar, euro, yen, pound, yuan, and any other global physical currency note or coin in existence, it only amounts to a measly $5 trillion. Adding the world’s physical gold ($7.7 trillion), silver ($20 billion), and cryptocurrencies ($11 billion) on top of that, you get to a total of $12.73 trillion. That’s equal to about 65% of the U.S. national debt.

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To get there, Trump’s administration will have to offer something in return. The most obvious bargaining chip that could be offered to make the North Korean regime feel more secure is a reduction in US troop levels on the Korean Peninsula and in Asia in general, With that, the US security guarantee for Asia will weaken, in turn providing China an opportunity to step into the geopolitical breach.

And where China leads geopolitically, its currency, the renminbi, is likely to follow.

*Barry Eichengreen is Professor of Economics at the University of California, Berkeley, and a former senior policy adviser at the International Monetary Fund. His latest book is Hall of Mirrors:The Great Depression, the Great Recession, and the Uses – and Misuses – of History.

The Guardian view on the IMF’s message: Yes, tax the super-rich


October 13, 2017

The Guardian view on the IMF’s message: Yes, tax the super-rich

https://www.theguardian.com/commentisfree/2017/oct/12/the-guardian-view-on-the-imfs-message-yes-tax-the-super-rich

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The International Monetary Fund has been on quite a journey from the days when it was seen as the provisional wing of the Washington consensus, an ideology that promoted the false idea that growth was turbo-charged by scrapping welfare policies and pursuing privatisations.

These days the IMF is less likely to harp on about the joys of liberalised capital flows than it is to warn of the dangers of ever-greater inequality. The Fund’s latest – and welcome – foray into the realms of progressive economics came this week when it used its half-yearly fiscal monitor – normally a dry-as-dust publication – to make the case for higher taxes on the super-rich. Make no mistake, this is a significant moment.

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What a striking contrast–Reagan -Thatcher and May-Trump

For almost 40 years, since the arrival of Margaret Thatcher in Downing Street and Ronald Reagan in the White House, the economic orthodoxy on taxation has been that higher taxes for the 1% are self-defeating. Soaking the rich, it was said, would punish initiative and lead to lower levels of innovation, less investment, weaker growth and, therefore, reduced revenue for the state. As last week’s Conservative party conference showed, this line of argument is still popular. Minister after minister took to the stage to warn that Jeremy Corbyn’s tax plans would lead to a 1970s-style brain drain.

The IMF agrees that a return to the income tax levels seen in Britain during the 1970s would have an impact on growth. But that was when the top rate of income tax was 83%, and Mr Corbyn’s plans are far more modest. Indeed, it is a sign of how difficult it has become to have a grown-up debate about tax that Labour’s call for a 50% tax band on those earning more than £123,000 and a 45% rate for those earning more than £80,000 should be seen as confiscatory. The IMF’s analysis does something to redress the balance, making two important points.

First, it says that tax systems should have become more progressive in recent years in order to help offset growing inequality but rather have been becoming less progressive. Second, it finds no evidence for the argument that attempts to make the rich pay more tax would lead to lower growth. There is nothing especially surprising about either of the conclusions: in fact, the real surprise is that it has taken so long for the penny to drop. Growth rates have not picked up as taxes have been cut for the top 1%. On the contrary, they are much weaker than they were in the immediate postwar decades when the rich could expect to pay at least half their incomes – and often substantially more than half – to the taxman. If trickle-down theory worked, there would be a strong correlation between countries with low marginal tax rates for the rich and growth. There is no such correlation and, as the IMF rightly concludes, “there would appear to be scope for increasing the progressivity of income taxation without significantly hurting growth for countries wishing to enhance income redistribution”.

With a nod to the work of the French economist Thomas Piketty, the fiscal monitor also says countries should consider wealth taxes for the rich, to be levied on land and property. The IMF’s findings on tax provide ample and welcome political cover for Mr Corbyn and John McDonnell, the shadow chancellor, as they seek to convince voters that Labour’s tax plans are not just equitable but also economically workable.

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By contrast, the study challenges Donald Trump to rethink tax plans that would give an average tax cut of more than $200,000 a year for someone earning more than $900,000. The response from the US administration was predictable: mind your own business. The IMF is not naive. It knows it is one thing to make the case for higher taxes on the rich but another thing altogether to get governments to implement them, because better-off individuals have more political clout. The IMF has demolished the argument that what is good for the super-rich is good for the rest of us, but don’t expect the top 1% to give up without a fight.

 

Twenty years on: The Asian Financial risis and Asian Monetary Fund (AMF)


September 28, 2017

Twenty years on: The Asian Financial risis and Asian Monetary Fund (AMF) 

David Nellor

http://www.eastasiaforum.org

 

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Proposals for an Asian Monetary Fund (AMF) dominated corridor conversations at the 1997 IMF–World Bank annual meetings in Hong Kong. The Asian financial crisis had erupted a few months earlier and was engulfing the region.

The United States vetoed the idea, framing the proposal as the ‘IMF versus AMF’ where any type of AMF would undermine the IMF’s central role in the global financial system. Twenty years on, the circle has been closed, with the IMF launching a framework for collaborative action with regional arrangements.

 

Arguably, at that early stage of the crisis, the US position was not unreasonable. The mood of Asian finance officials was one of denial. Set against the backdrop of the Asian miracle, it was inconceivable, they thought, that self-inflicted policy distortions — quasi-fixed exchange rates combined with independent monetary policy — as well as compromised financial sector supervision helped drive the crisis. The idea of unconditional financing — not tied to reform — that would avoid reform was, they thought, a defendable proposition.

Still, the push for an AMF did suggest gaps in the global and regional financial architecture. What followed was a struggling ASEAN seeking to catch up, stop gap consultative groups like the Manila Framework Group, and a sequence of ad hoc parallel financing arrangements from the ‘Friends of Thailand’ to Indonesia’s so-called ‘second line of defence’.

The crisis broke on 2 July 1997. By late July, plans led by Japan and in cooperation with the IMF were underway for a regionally based meeting on Thailand. This informal grouping hosted by Japan in Tokyo on 11 August, became the ‘Friends of Thailand’. The concrete outcome of the meeting was a series of financial commitments by seven countries and the multilaterals, with the United States notably absent. The absence of the United States was perhaps shaped by congressional dissatisfaction with the Clinton Administration’s financial support of Mexico, which had been provided directly by the US Treasury without congressional approval during Mexico’s 1994 crisis.

Almost remarkably, this rushed US$17.2 billion collaborative financing arrangement was the regional success story from a sequence of ad hoc efforts to provide funding to mitigate the consequences of the crisis. The support was structured as a series of bilateral arrangements between Thailand and each country. Each drawing under these agreements was triggered in parallel with Thailand’s drawings under the IMF supported program. Commitments were credible as they were both conditional and fulfilled step by step.

By contrast, Indonesia’s more than US$40 billion package — including an US$18 billion ‘second line of defence’ through bilateral support — failed. The enormous scale of the funding, especially at that time, was intended to be a ‘shock and awe’ approach signalling to financial markets that stability was assured.

Some thought the second line would never need to be drawn and perhaps commitments were made with that expectation. But markets saw through this and in short order sufficient questions arose about the willingness of countries to follow through on commitments. This triggered uncertainty at best and arguably made the situation worse.

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The South Korean experience of international support was different. The concentration of external debt through the South Korean banking system enabled the coordination of a relatively effective capital control mechanism, creating a window to develop a market-based debt restructuring in the first half of 1998. Here the US Federal Reserve played a leading role, along with other central banks, supported by the technical contributions of IMF and South Korean officials.

Asia’s leaders were unanimous in supportive statements about the need for a regional crisis response mechanism including funding. Yet there were issues that continue to pose a challenge for the credibility of arrangements, such as the ASEAN+3 Chiang Mai Initiative, today. Lee Kuan Yew, while not opposed to an AMF, cautioned that such an arrangement would need to do more than provide funding that might enable crisis countries to avoid essential reform. He went on, ‘I do not see any Asian group of governments in the AMF strong enough to tell … President Suharto, “You will do this or we will not support you”. If you don’t say that and you support him, that’s money down the drain’.

The Manila Framework Group was established in a November 1997 meeting as the direct result of the failed AMF discussions in Hong Kong. It would serve as a surveillance forum of 14 APEC economies meeting regularly and on an ad hoc basis through to the end of 2004. It played an important role by, for example, triggering a June 1998 Tokyo meeting with the G7 to respond to destabilising global currency moves. The G20 would also start in the aftermath of the Asian financial crisis.

ASEAN was a participant but not a driver when the crisis broke. Its most concrete response came a few years later when, along with the ASEAN+3 countries, the Chiang Mai Initiative was launched in 2000. It was a modest first step especially as operational modalities remained to be defined for at least a decade and only in 2016 was there a ‘dry run’ to test the Chiang Mai Initiative’s capacity to respond to crisis.

Indonesia’s hastily developed Deferred Drawdown Option, with multilateral and bilateral support during the Global Financial Crisis, was another ad hoc instrument showing that gaps in the regional financial architecture persisted well into the 2000s.

Twenty years on, the IMF has spelled out plans for how to make the global financial safety net more effective through collaboration with regional financial arrangements — an outcome that seemed remarkably distant in the midst of the Asian financial crisis.

David Nellor is a Jakarta-based consultant. He was based in Asia for the IMF throughout the Asian financial crisis and participated in discussions on regional arrangements.

 

IMF on Malaysia–Report Card


May 3, 2017

International Monetary Fund on Malaysia–Report Card

by The International Monetary Fund

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Putrajaya–The Administrative Capital of Malaysia

The IMF conducts an Annual Review of member country economic situation. At the conclusion of the consultations the Executive Board considers the findings which are also conveyed to the Government. A Press Release is issued  together with access to the full staff report on the Fund’s website. The Report  is in the nature of a “Report Card”.

The text of the Press Release is reproduced below. The full report can be accessed and downloaded from  ::

http://www.imf.org/en/Publications/CR/Issues/2017/04/28/Malaysia-2017-Article-IV-Consultation-Press-Release-Staff-Report-and-Statement-by-the-44869

On March 15, 2017, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation1 with Malaysia.

Despite a challenging global economic environment, the Malaysian economy performed well over the past few years. Notwithstanding the impact of the global commodity price and financial markets volatility, the economy remained resilient, owing to a diversified production and export base; strong balance sheet positions; a flexible exchange rate; responsive macroeconomic policies; and deep financial markets. While real GDP growth slowed down, Malaysia is still among the fastest growing economies among peers. The challenging global macroeconomic and financial environment puts premium on continued diligence and requires careful calibration of policies going forward.

Risks to the outlook are tilted to the downside, originating from both external and domestic sources. External risks include structurally weak growth in advanced and emerging market economies and retreat from cross-border integration. Although the Malaysian economy has adjusted well to lower global oil prices, sustained low commodity prices would add to the challenge of achieving medium-term fiscal targets. Heightened global financial stress and associated capital flows could affect the economy.

Domestic risks are primarily related to public sector and household debt, along with pockets of vulnerabilities in the corporate sector. Federal debt and contingent liabilities are relatively high, limiting policy space to respond to shocks. Although the household debt-to-GDP ratio is likely to decline, household debt also remains high, with debt servicing capacity growing only moderately.

Real GDP growth rate is expected to increase moderately to 4.5 percent year-on-year (y/y) in 2017 from 4.2 percent in 2016. Domestic demand, led by private consumption, continue to be the main driver of growth, while a drag from net exports, similar to 2016, will remain.

Consumer price inflation is projected to rise and average 2.7 percent y/y in 2017 on the back of higher global oil prices and the rationalization of subsidies on cooking oil. The current account surplus would be largely unchanged as impacts from an improved global outlook and higher commodity prices would be offset by the strength of imports on the back of a resilient domestic demand.

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Bank Negara Malaysia—in full control of the Pulse of the Malaysian Economy

Executive Directors commended the resilience of the Malaysian economy, which reflects sound macroeconomic policy responses in the face of significant headwinds and risks. While Malaysia’s economic growth is expected to continue in 2017, weaker-than-expected growth in key advanced and emerging economies or a global retreat from cross-border integration could weigh on the domestic economy. Against this background, Directors urged vigilance and continued efforts to strengthen policy buffers and boost long-term economic growth.

Directors agreed that the authorities’ medium-term fiscal policy is well anchored on achieving a near-balanced federal budget by 2020. The planned consolidation will help alleviate risks from elevated government debt levels and contingent liabilities and build fiscal space for future expansionary policy, as needed.

Directors recommended that the pace of consolidation reflect economic conditions and that any counter-cyclical fiscal policy measures be well-targeted and temporary. They noted that improvements to the fiscal framework, such as elaborating medium term projections and preparing and publishing an annual fiscal risks statement, would help anchor medium-term fiscal adjustment and mitigate risks.

Directors agreed that the current monetary policy stance is appropriate. Going forward, Bank Negara Malaysia (BNM) should continue to carefully calibrate monetary policy to support growth while being mindful of financial conditions.

Directors emphasized that global financial market conditions could affect the monetary policy space and should be carefully monitored.

Directors noted that the banking sector is sound overall and that financial sector risks appear contained. Nonetheless, they cautioned that potential pockets of vulnerability should be closely monitored. They noted that household debt remains relatively high, while in the corporate sector, there are emerging vulnerabilities in some sectors. Directors suggested that macroprudential measures be adjusted if needed.

Directors underscored the central role of macroeconomic policy and exchange rate flexibility in helping the economy adjust to external shocks. In this regard, they welcomed the authorities’ commitment to keeping the exchange rate as the key shock absorber. They recommended that reserves be accumulated as opportunities arise and deployed in the event of disorderly market conditions. Noting the authorities’ aim to improve the functioning of the onshore forward foreign exchange market, Directors urged the BNM to monitor the effects of the recent measures introduced in this regard, recognizing their benefits and costs.

They emphasized that close consultation and communication by BNM (Bank Negara Malaysia–Central Bank) with market participants will be essential in further developing the foreign exchange market and bolstering resilience.

Directors underscored that steadfast implementation of the authorities’ ambitious structural reform agenda is key to boosting long-term economic potential. They supported the emphasis on increasing female labor force participation, improving the quality of education, lowering skills mismatch, boosting productivity growth, encouraging research and innovation, and upholding high standards of governance.

At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country’s authorities. An explanation of any qualifiers used in summings up can be found here: http://www.imf.org/external/np/sec/misc/qualifiers.htm.