Dol­lar Sen­sa­tion­al­ism

Business a.m. - - EDITORIAL - BARRY EICHENGREE­N Eichengree­n is Pro­fes­sor of Eco­nom­ics at the Univer­sity of Cal­i­for­nia, Berke­ley. His lat­est book is The Pop­ulist Temp­ta­tion: Eco­nomic Griev­ance and Po­lit­i­cal Re­ac­tion in the Mod­ern Era. Copy­right: Project Syn­di­cate, 2020. www.project-sy

BERKE­LEY – The dol­lar is in freefall! The global green­back is doomed! scream re­cent head­lines. Ac­tu­ally, such sen­sa­tional head­lines are “too sen­sa­tional,” to echo that noted au­thor­ity on cur­ren­cies, Miss Prism, in Os­car Wilde’s “The Im­por­tance of Be­ing Ernest.”

The dol­lar’s fall in July to a two-year low against the euro was the im­me­di­ate im­pe­tus for these sto­ries. In fact, the dol­lar’s re­cent slide is one in a se­ries of read­ily ex­pli­ca­ble fluc­tu­a­tions. When the COVID-19 pan­demic went global in March, the dol­lar strength­ened on the back of safe-haven flows into US Trea­suries, as it does at the start of ev­ery cri­sis. By May, the Fed­eral Re­serve, act­ing as global lender of last re­sort, had ac­com­mo­dated this mad scram­ble for dol­lars by pour­ing buck­ets of liq­uid­ity into fi­nan­cial mar­kets, and the green­back gave back its early gains.

The dol­lar’s sub­se­quent de­pre­ci­a­tion re­flects the chang­ing prospects of the US and Euro­pean economies. With the spread of COVID-19, the US out­look is de­te­ri­o­rat­ing, so in­vestors ex­pect the Fed to keep in­ter­est rates low for longer. In the eu­ro­zone, the virus is un­der bet­ter con­trol, and data from pur­chas­ing man­agers’ sur­veys are sur­pris­ing on the up­side.

This im­prov­ing out­look doesn’t mean that the Euro­pean Cen­tral Bank will start raising its pol­icy rate to­mor­row. But it does in­cline in­vestors to be­lieve that it will start nor­mal­iz­ing in­ter­est rates ear­lier.

This re­la­tion­ship – you tell me the out­look for in­ter­est rates, and I can tell you the change in the ex­change rate – has a name, of course. As Miss Prism will re­mind you, it’s called “in­ter­est par­ity.” This the­ory doesn’t work per­fectly. But no the­ory of what de­ter­mines the ex­change rate does. When seek­ing to un­der­stand events, we shouldn’t make the per­fect the en­emy of the good.

Seek­ing to ex­plain euro bullish­ness, some ob­servers, point in­stead to agree­ment by Euro­pean lead­ers to is­sue €750 bil­lion ($884 bil­lion) of Euro­pean Union bonds. This is bullish­ness with­out the “ish­ness.” Seven hun­dred fifty bil­lion eu­ros is less than 5% of the stock of US gov­ern­ment debt held by the pub­lic. It’s a drop in the bucket, in other words. And a drop does not a liq­uid mar­ket in safe as­sets make.

Even if this re­ally is Europe’s “Hamil­to­nian mo­ment,” ramp­ing up EU is­suance by a fac­tor of 20 will take decades. That’s how long Europe will need to cre­ate a bench­mark as­set with the liq­uid­ity of US Trea­suries. And for­eign-ex­change mar­kets trade on to­day’s news, not on some­thing that may or may not hap­pen decades from now.

In­deed, the most strik­ing take­away from re­cent ex­pe­ri­ence is the dol­lar’s re­siliency. Nor­mally, in­vestors hold a cur­rency when the is­suer’s poli­cies are sound and sta­ble. US pol­icy has been risky and er­ratic, de­spite hav­ing a “sta­ble ge­nius” at the helm.

Banks and firms hold a cur­rency when it is use­ful for in­voic­ing and set­tling trade with the is­su­ing coun­try. But Pres­i­dent Don­ald Trump’s ad­min­is­tra­tion has done more than any in liv­ing mem­ory to dis­rupt US trade. Gov­ern­ments, for their part, hold and use the cur­ren­cies of their al­liance part­ners. And, un­der Trump, the United States to­day is no longer the re­li­able al­liance part­ner it once was.

Given all this, it would ap­pear that the stars are aligned for banks, firms, and re­serve man­agers to back away from the dol­lar. But the cur­rency’s in­ter­na­tional role has not di­min­ished sig­nif­i­cantly. It has de­clined only along se­lect di­men­sions – its share in cen­tral banks’ for­eign-ex­change re­serves, for ex­am­ple – and even there only marginally.

The ex­pla­na­tion for this sta­sis, as Mar­garet Thatcher fa­mously put it, is “TINA”: there is no al­ter­na­tive. The euro is not an al­ter­na­tive. The stock of safe euro as­sets re­mains seg­mented along na­tional lines, and Alexan­der Hamil­ton is not com­ing to the res­cue any­time soon.

Nor is the ren­minbi a vi­able al­ter­na­tive. Given height­ened ten­sions with China, no West­ern gov­ern­ment will en­cour­age its res­i­dents to de­pend on the Peo­ple’s Bank of China for liq­uid­ity, any more than they will en­cour­age them to de­pend on Huawei for 5G.

With the Fed­eral Re­serve able and will­ing to act as lender of last re­sort to the world, the sta­tus quo is tol­er­a­ble. One per­son­nel change at the Fed will not al­ter how for­eign of­fi­cials view this sit­u­a­tion. But one per­son­nel change could au­gur another, at which point other coun­tries will think twice. At that point, they will re­al­ize they have no other op­tion to which to turn.

The only so­lu­tion to this co­nun­drum is more re­sources for the In­ter­na­tional Mon­e­tary Fund, so that it can sup­ply coun­tries, in a cri­sis, with the dol­lars that a fu­ture Fed fails to pro­vide. This of course is the so­lu­tion that John May­nard Keynes of­fered al­ready in 1944, al­beit by another name. The 80th an­niver­sary of Keynes’s “ban­cor” pro­posal is im­mi­nent. What bet­ter way to mark the oc­ca­sion than by im­ple­ment­ing it?

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