The banking crisis and the irreplaceable dollar

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Welcome to Trade Secrets. The big news in global governance was the announcement last night by the US Federal Reserve and five other major central banks to resume daily dollar exchange operations, which they used during the financial crisis and again (with nine central banks at the time) in the early months. pandemic Covid-19. Below, I discuss the indispensability of the US currency in the global financial and trading system. Separately, I will briefly look at US-China trade and offer a little guilt for complacency in the face of the conflict between Washington and Beijing.

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Better fed than dead

A year ago, when the US imposed sanctions on Russia, we had another occasional spasm of speculation about the death of the dollar. Presumably some combination of China, India and the Middle East will start trading oil in some other currency and weaken the international use of the dollar.

I said it would be nonsense, and it was. The US has expanded its use of the dollar as a weapon against Russia, including an unprecedented freeze on central bank assets, without creating a serious rival.

The network effects of the dominance of the US currency remain overwhelming. Traditional measurements and explanations often miss the point or confuse cause with effect.

It’s not really about foreign exchange reserves, governments’ own borrowing, or trade accounts. Reserves matter less because many emerging markets have moved away from fixed exchange rates; EM switched to issuance of sovereign debt in national currency; and trading accounts in dollars save US companies from having to pay for currency hedging, but this is not a decisive advantage.

All this, in fact, is more of a consequence than a cause. It is the network effect of the dollar’s role in global finance—the international payment system and as a funding currency for non-US banks—that ensures its dominance. See this graph (from the Fed’s own report on the phenomenon) Here.

And this is supported by a competent, experienced, active central bank, ready to provide dollar liquidity through its major partners when needed. (To be fair, not all central banks, which is a bit of an annoyance for those outside the vicious circle.) Swap lines are now becoming a standard feature of the crisis: The Fed also extended them into 2020 due to the shock of the Covid pandemic. bank funds dried up.

The Fed takes comfort in the fact that because it lends to other countries’ central banks, they, not the US, are taking the risk of lending to the private sector. There is a long debate going on (returning to the dispute about Triffin’s Dilemma in the 1960s) on the costs associated with issuing the world’s dominant currency. But this liquidity provision is not a significant burden or danger to the US economy or taxpayers.

Many now point out that non-US banks relying on dollar funding are inherently risky because it creates liquidity and maturity mismatches for those banks that borrow and lend in dollars, making them vulnerable to market volatility. The IMF warned about this. a few years ago, like Committee on the Global Financial Systema gang of influential politicians under the auspices of the Bank for International Settlements.

Fair point, but what to do about it? Findings about mitigating these risks focused primarily on improving financial regulation and risk management in banks. No one is making serious efforts to instigate a serious transition to a multipolar monetary system. The arrangement we have is not perfect, but so far the Fed has done enough to prevent the collapse of the global system, and there is no realistic chance of anyone else taking over.

Conscious separation from China

For years, I have been convinced that globalization in its broadest sense is doing a pretty good job of weathering the most recent upheavals, including Covid. Was I too optimistic? Perhaps in some particular way.

I mentioned, among others, the rise in the cost of trade in goods between the US and China as evidence that Washington’s efforts to consciously disengage have not produced much results. Then comes the annoyingly well-informed Chad Bone of the Peterson Institute in Washington, who points out that last year’s bilateral trade record in value terms was rather an artifact of high commodity prices and concerns about food security due to the war in Ukraine than anything else.

Using a more meaningful relative measure, U.S. exports to China are now 23% lower than they would be if they kept pace with global exports to China as a whole over the 2018-2022 period. Sales of cars, Boeing aircraft, semiconductors in the US all collapsed. Former President Donald Trump’s “Phase 1” deal with his counterpart Xi Jinping, in which China promised to buy far more American goods, was largely pointless.

This does not mean that globalization is collapsing. Instead, most of this trade will simply move to other countries. But it highlights that a shock like Covid that supply chain managers might try to work around is not the same as a determined and powerful government that plugs gaps as soon as they appear.

Japan and Korea put an end to claims for damages for forced labor during World War II and improved diplomatic relations, paving the way for closer cooperation in trade and technology policy. Tokyo has lifted export controls on chemicals supplied to the Korean semiconductor industry, and Seoul dropped a WTO lawsuit it filed on the matter.

The South China Morning Post reports that China’s 10th anniversary Belt and Road Initiative will focus on smaller, less risky and more profitable trade-related infrastructure projects rather than the controversial and often costly mega-schemes that have become its hallmark.

Via Scott Lincicom at Cato, a story about Volkswagen’s small, affordable electric car that will not be available to US consumers because it wasn’t made there.

FDI Intelligence investigates whether Lula, re-elected as President of Brazil, is indeed could revive EU-MERCOSUR deal.

Trade Talks Podcast Considers Opportunity revival of the World Trade Organization.

Trade secret edited Jonathan Moles

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