Hardly at all, then at once—the tectonic plates of the global monetary system are shifting.
Mark Carney, the outgoing Bank of England governor, yesterday shocked the traditionally staid annual August gathering of central bankers in Wyoming’s Rocky Mountains by aiming a direct attack at US monetary hegemony.
Increasing global tensions
In a speech to the 2019 Jackson Hole symposium, Carney blamed the dominant role of the US dollar for rising international tensions.
“The growing asymmetry at the heart of the international monetary and financial system is putting the global economy under increasing strain,” Carney said.
As if echoing the point, on the day Carney delivered his speech the two main protagonists in the new global arms race lashed out at each other.
China imposed new tariffs on imports from the US and the US president responded in kind, using Twitter to announce new counter-measures and order US firms to stop doing business with China.
China’s new tariffs, set to affect about $75bn of US goods, will take effect in two stages on 1 September and 15 December.
In response, the US will raise its tariffs on $250bn of Chinese imports on 1 October. Planned tariffs on $300bn of other Chinese goods will also rise by 5 percent, said Trump.
Asymmetry in the dollar’s role
Put simply, the US currency punches above its weight, given the country’s role in the world’s economy, said Carney.
The dollar is the currency of choice for global trade deals, said Carney: it is the unit of account in invoices worth five times more than the US’s share in world goods imports, and three times the country’s share in world exports.
And the dollar also dominates the financial markets, Carney said.
“Two-thirds of both global securities issuance and official foreign-exchange reserves are denominated in dollars,” he said.
Because all dollar transactions end up being routed through US-based banks and settled in the accounts of the US central bank, the Federal Reserve, this confers great political power on US institutions like the Department of the Treasury, who can sanction countries or institutions they don’t like.
Structural risks in dollar dominance
The knock-on effects of dollar dominance on other world economies are amplified by the way the world’s financial infrastructure is currently built, said Carney.
“any of our problems is your problem”
“Financial instability in advanced economies causes capital to retrench from emerging market economies to ‘safe havens’, as it did during the 2008 financial crisis and the 2011 euro-area crisis,” said Carney.
“Connally’s dictum ‘our dollar, your problem’ has broadened to ‘any of our problems is your problem.”
Carney’s referral to Connally, US Treasury secretary under President Nixon in 1971, is pointed.
Connally’s blunt dismissal of foreign concerns came in response to complaints that the US was exporting its own domestic inflation to other countries, as the Vietnam war imposed heavy costs on US public finances.
Since 1945, the US currency had been tied to the value of gold under the so-called Bretton Woods accord, while other countries then managed their currencies’ values against the dollar.
In 1971 the US suspended the convertibility of dollars to gold and launched the world into an era of freely floating, unpegged fiat currencies.
If the 1970s saw sharp rises in the prices of commodities and tradeable goods, causing interest rates to soar, this time central bankers are concerned primarily about asset price inflation.
An unwinding of the current asset bubble could cause a damaging liquidity crisis, said Carney, citing mutual funds as a likely future source of instability.
Several fund managers have recently stopped investors withdrawing money from their funds, citing problems selling their holdings.
“$30 trillion of global assets are held in investment funds that are particularly flighty, reflecting their promise of daily liquidity to investors despite investing in potentially illiquid underlying assets,” Carney warned.
The proposed solution—a global basket currency
To address the problems caused by dollar dominance, Carney, who leaves his post in London in January 2020, called for the introduction of a new multipolar currency system, based on a basket of currencies issued by participating countries.
The value of a basket currency, such as the International Monetary Fund’s Special Drawing Rights (SDR), is derived directly from the weights in the basket of several underlying currencies.
A new basket currency system could also help stop interest rates falling further into negative territory, said the Bank of England governor.
This summer, a tidal wave of market-driven rate reductions has pushed the yields on a third of the global bonds into negative territory. A negative-yielding bond taxes the owner, rather than paying him or her interest.
Negative yields threaten a flight of asset from the banking system into cash and assets like gold and bitcoin.
“Multiple reserve currencies would increase the supply of safe assets, alleviating the downward pressures on the global equilibrium interest rate,” Carney said.
Carney left the most dramatic reform call to the last page of his speech.
“this centre won’t hold”
In response to the obvious question of who gets to run the new global basket currency, the Bank of England suggested that it might not be governments.
“It is an open question whether such a new [currency] would be best provided by the public sector,” Carney said.
Facebook, which in June announced a new project for a global currency called ‘Libra’, has attracted a wave of criticism for its effort.
But while pointing out the Libra project’s shortfalls, Carney didn’t rule out something similar succeeding in future.
“Technology has the potential to disrupt the network externalities that prevent the incumbent global reserve currency from being displaced,” said Carney.
Carney finished with an urgent warning.
“Even a passing acquaintance with monetary history suggests that this centre won’t hold,” the Bank of England governor said.
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