When former Bank of England Governor Mark Carney spoke at the Jackson Hole Symposium in 2019, he made a surprising argument against the further dollarization of the global economy. He rejected the consensus that all countries can achieve price stability and minimize volatility by adopting flexible targeting of inflation and floating exchange rates as “unsustainable.” Globalization has “steadily increased the impact of international developments on all of our economies,” he said, and “the price of dominant currencies” in dollars is undermining the ability of any central banker to do their job in managing politics. national monetary policy and inflation in an open economy.
Dollar trade, once limited to oil and other commodities, now extends to all goods and services traded outside and sometimes even within national borders. Over 80% of cross-border billings are in dollars. Cross-border dollar borrowing far exceeds borrowing in other currencies and continues to grow faster. Dollars and dollar-denominated assets decline as global currency reserves, but remain dominant at 59% in 2021. Meanwhile, the US economy’s share of global gross domestic product is shrinking as other economies grow. Are growing. Carney called the situation a “destabilizing asymmetry”.
This “destabilizing asymmetry” has arisen because multiple actors and institutions in the public and private sectors have chosen over the decades to perpetuate and increase dollarization. Governments have legislated for the national currency to be pegged to the dollar in order to ensure greater national monetary stability and the capacity of capital markets. Central banks have chosen to hold dollars and dollar assets as official reserves to promote confidence in national currencies and absorb financial shocks.
Most cross-border government debt and hedges are denominated in dollars. Exporters rationally set their prices in dollars to be competitive in dollarized world markets. Banks everywhere borrow in dollars and lend in dollars because that is what their customers who price imports and exports in dollars or who trade in global assets and derivatives are asking for.
Businesses, especially in developing countries, often finance themselves with dollar debt because interest rates are generally lower and more stable than national currency rates, and the dollar debt market is large. deeper and more liquid with the capacity of global investors. The rich everywhere are using dollar-denominated tax havens and many small savers are hoarding dollar liquidity around the world.
The dollar remains the anchor against which all other currencies are quoted and valued, whether or not the anchor lags on a seabed of growing US budget deficits, trade deficits, civil unrest and political dysfunction. Assets denominated in dollars remain tradable globally, if not preferred. The dollar remains “the cleanest dirty shirt in the basket,” as Barry Eichengreen, professor of economics and political science at the University of California, likes to say.
Carney was right to draw attention to the “unsettling asymmetry” of dollar dominance. This raises important questions. How can central bankers measure or meet the needs of domestic economies when the domestic economy does business in dollars and prefers dollarized assets? How can central bankers influence inflation or deflation from the pass-through of dollar import and export prices or exchange rate volatility? How can they stabilize a shock when market stress can communicate across borders from New York in microseconds, and dollar funding to domestic banks and corporations is disappearing just as quickly? How can they strengthen their depth and capacity in local markets when 150 national markets globally price against US Treasuries in New York? How can they let a national bank or broker fail if the bulk of its assets are resolved under New York insolvency law for the primary benefit of US creditors and counterparties, leaving too little for collection national creditors?
Carney called for more international coordination, better oversight of cross-border spillovers to guide policymakers and a “proper global financial safety net”. This all makes sense, although little progress has been made, despite another global economic crisis in 2020. The Financial Stability Board confirmed in the summer of 2020 that there is no consensus for a global financial safety net , although he advocated for a payments roadmap that lacks any mention of dollar liquidity issues for economies most vulnerable to dominant currency prices and funding shocks.
Where Carney went wrong in 2019 was in his call to replace the dollar with a “synthetic hegemonic currency” for international settlements. The United States may one day regret the weighted formula of the special drawing right basket. The renminbi may one day replace the dollar as the main SDR currency based on faster export growth and three financial variables under a new SDR weighting formula agreed in 2015. However, it there is still a long way to go. The renminbi joined the basket in 2016 and is only used for 1.4% of global cross-border payments.
The United States is unlikely to agree to a basket formula where the dollar can lose primacy or the United States authorities cede control. The fate of Facebook’s Libra basket digital currency is instructive. Under pressure from the US authorities, Facebook renamed its digital currency to Diem, moved the association’s headquarters from Switzerland to California and, instead of being backed by a basket of currencies from the Organization for Cooperation and Development economic, will be launched as a stable dollar coin. Diem will join other 1: 1 stablecoins with a current market cap of over $ 118 billion. The “destabilizing asymmetry” could worsen as “digital dollarization” accelerates in global online commerce, making it even more difficult for central bankers to do their jobs.
In December 2020, Stefan Ingves, Governor of the Swedish Riksbank, delivered a speech that highlighted the mismatch between the national monetary toolkit and the challenge of serving “a small open economy integrated and strongly correlated with a financialized global economy” . He observed that Swedish banks, businesses and even individuals can choose to borrow, transact and invest in other currencies if the Riksbank adopts unpopular policies. Ingves did not claim to have the answers, but invited innovation “to develop new tools and do new types of analysis … If the world changes, we must change with it”.
The mandates of single-currency central banks, business models, policies and toolkits of the 20th century seem dangerously outdated in the 21st century multi-currency, multi-polar, digital, financialized and prone to global crises. Every open economy is now a multicurrency economy requiring central banks to have multicurrency data and financial stability tools to do their jobs now and in the next crisis.
Central banks and other policymakers must work together to better defend national economies against the dollar exchange rate or funding volatility and market dysfunction shocks. Like the climate crisis, dollarization was born out of decades of state and private sector actions and can only be mitigated through collaboration and experimentation with new tools for monitoring and managing global risks.
The Pacemaker animations accompanying this commentary use data from table BIS C3 for debt securities issued by banks and other financial institutions. They show that the UK, a larger OECD economy with a permanent dollar swap line, has less funding volatility than Sweden, a smaller open economy that must apply for a dollar swap line. emergency for stress after a shock has already caused damage. They also show that the local debt market in Sweden has less capacity to support banks and absorb shocks. Regardless of swap lines, the Riksbank and the Bank of England should be wary of the risk of debt refinancing and currency mismatches that could strain financing and debt servicing if US rates rise for counter US inflation.
Kathleen Tyson is Executive Director of Pacemaker.Global, a financial technology company that provides central banks with financial stability analysis and solutions.