Trump­ing the global mon­e­tary sys­tem

China Daily (Hong Kong) - - VIEWS -

It is dif­fi­cult to know ex­actly what US pres­i­dent-elect Don­ald Trump will do when he takes of­fice in Jan­uary. But thanks to his vow to pur­sue tax cuts and in­crease in­fra­struc­ture spend­ing, fi­nan­cial mar­kets ex­pect faster growth in the United States — a per­cep­tion that is boost­ing the dol­lar’s ex­change rate against most cur­ren­cies, in­clud­ing the ren­minbi, and trig­ger­ing cap­i­tal flight from emerg­ing economies.

Notwith­stand­ing Trump’s vow to im­pose tar­iffs of up to 45 per­cent on Chi­nese goods, a resur­gent dol­lar will hurt the US’ trade com­pet­i­tive­ness, as ac­cord­ing to the In­ter­na­tional Mon­e­tary Fund, the dol­lar was al­ready about 10-20 per­cent over­val­ued in June.

And while trade is sup­posed to be the pri­mary driver of ex­change rates, cap­i­tal flows have grown to the point that their role in guid­ing ex­change rates is now much larger. In this con­text, mar­ket op­ti­mism about US growth could lead to ever-larger im­bal­ances and pos­si­bly dis­rupt the in­ter­na­tional mon­e­tary sys­tem.

Be­sides, from 1997 to 2007, the US net in­vest­ment deficit widened by only $0.3 tril­lion, while the net in­vest­ment sur­pluses of China, Ja­pan and Ger­many rose by $1.2 tril­lion, $1.1 tril­lion, and $0.8 tril­lion. The ma­jor in­vest­ment-deficit play­ers were the eu­ro­zone mi­nus Ger­many, with a deficit of $2.4 tril­lion dur­ing that decade, and the UK, with a deficit of $0.5 tril­lion.

Over the next seven years, un­til 2014, the US’ net in­vest­ment po­si­tion de­clined by $5.7 tril­lion, lead­ing to a li­a­bil­ity of 40.2 per­cent of GDP. Ger­many’s net in­vest­ment sur­plus in­creased by $0.8 tril­lion, Ja­pan’s rose by $1.2 tril­lion, and China’s was up by $0.7 tril­lion. The rest of the world’s net in­vest­ment po­si­tion strength­ened by $3 tril­lion dur­ing this pe­riod, ow­ing mainly to the com­mod­ity boom, which faded as China’s economy slowed.

The rapid growth in the US’ gross li­a­bil­i­ties to the rest of the world is ap­par­ent in the US Trea­sury data on for­eign hold­ings of US se­cu­ri­ties, which rose from $9.8 tril­lion in 2007 to $17.1 tril­lion in June 2015, of which $10.5 tril­lion was debt and $6.6 tril­lion eq­uity. For­eign hold­ings of US se­cu­ri­ties were equiv­a­lent to 95 per­cent of the coun­try’s GDP in June 2015.

Against this back­ground, poli­cies that will strengthen the dol­lar con­sid­er­ably could prove highly prob­lem­atic. As the dol­lar strength­ens, the value of US hold­ings of for­eign as­sets will de­cline in dol­lar terms, while the coun­try’s li­a­bil­i­ties will con­tinue to grow, ow­ing to sus­tained fis­cal and cur­rent ac­count deficits (now around 3-4 per­cent of GDP an­nu­ally). The re­sult will be fur­ther de­te­ri­o­ra­tion of the US’ net in­vest­ment po­si­tion, which the IMF has pro­jected will reach mi­nus 63 per­cent of GDP by 2021.

The truth is that it is un­likely that the dol­lar-in­duced im­bal­ances will be sus­tain­able. The other re­serve-cur­rency coun­tries will prob­a­bly con­tinue to al­low their cur­ren­cies to de­pre­ci­ate, in or­der to re­flate their economies, and emerg­ing economies will prob­a­bly con­tinue to use ex­change rates to cope with cap­i­tal-flow volatil­ity. If this con­tin­ues, the strain on the in­ter­na­tional mon­e­tary sys­tem will only in­ten­sify.

There is some­thing that can be done to ease the pres­sure. Dur­ing the global eco­nomic cri­sis, the Fed eased global liq­uid­ity shocks by un­der­tak­ing cur­rency swaps with other ma­jor cen­tral banks. It could un­der­take sim­i­lar swaps to­day, but with coun­tries fac­ing large cap­i­tal out­flows, thereby slow­ing the dol­lar’s ap­pre­ci­a­tion. The ques­tion is whether the US un­der Trump would be will­ing to de­velop cur­rency-swap ar­range­ments and other co­or­di­na­tion mech­a­nisms for emerg­ing economies such as Rus­sia and China.

At a time of far-reach­ing eco­nomic and geopo­lit­i­cal risks, in­vestors view the US dol­lar as a safe haven. But, in time, they may find that a new Plaza Ac­cord — the 1985 agree­ment to de­value the dol­lar and push the Ja­panese yen and the Deutsche mark sharply up­ward — will be­come nec­es­sary. Trump bought the Plaza Ho­tel three years later, but sold it in 1995. So, this time, it might be called the “Trump Tower Ac­cord”.

An­drew Sheng is dis­tin­guished fel­low of the Asia Global In­sti­tute at the Uni­ver­sity of Hong Kong and a mem­ber of the UNEP Ad­vi­sory Coun­cil on Sus­tain­able Fi­nance, and Xiao Geng, pres­i­dent of the Hong Kong In­sti­tu­tion for In­ter­na­tional Fi­nance, is a pro­fes­sor at the Uni­ver­sity of Hong Kong. Project Syndicate

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