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The U.S. economy has downshifted rather abruptly in the last few months, promptingnew discussion within the Federal Reserve about delaying its first interest-rate increase. Yet the growth deceleration should not come as a surprise, because the Fed has already tightened. Read the rest of this entry »
American strategic economic leadership, to an unappreciated extent, rests on the central role the dollar plays in the global financial system, as the latest Capital Account column argues.
Who can challenge that leadership? Neither the yen nor the deutsche mark nor its successor, the euro, has dethroned the dollar. The only contender on the horizon is China’s yuan and most experts think that’s at least decades away. Not only is the yuan not yet freely convertible, there is not yet a deep liquid market of yuan assets for foreigners to buy. Read the rest of this entry »
The U.S. owes its economic leverage to the dollar’s role in the global financial system. The yuan isn’t a serious rival—yet
China’s success at signing up so many countries as founders of the new Asian Infrastructure Investment Bank, despite American concerns, has fueled a popular narrative of waning U.S. economic influence.
In the big picture, this is a sideshow.
The real contest for global economic sway doesn’t hinge on the infrastructure bank, the International Monetary Fund or even international trade. It focuses instead on the financial world, where China is seeking to turn its currency, the yuan, into a rival to the dollar, by far the world’s most important currency.
The U.S. accounts for just 23% of world economic output, but 43% of all cross-border financial transactions are denominated in dollars, as are 63% of known global central-bank reserves. Not every country needs the IMF or trades with the U.S., yet every country needs access to the global financial system, and that system largely transacts in dollars.
This has several obvious domestic advantages: for one, the U.S. government and its companies can borrow cheaply in their own currency. It also gives the U.S. extraordinary strategic leverage, which it has used to devastating effect.
In 2005, the U.S. accused a small Macau-based bank of aiding North Korea’s money laundering, drug trafficking and nuclear proliferation. Fearful of losing access to the U.S. financial system, other banks stopped doing business with it, cutting off North Korea’s access to the proceeds of its illicit business.
In 2012, after the U.S. threatened to blacklist any bank that helped Iran’s central bank sell the country’s oil, Iran’s oil exports promptly plummeted. Federal and state law-enforcement officials have ordered global banks to pay billions of dollars in penalties for facilitating money laundering for terrorists and drug traffickers and helping countries such as Iran and Cuba evade sanctions. Since the alternative is losing license to operate in the U.S., they comply.
During the financial crisis it was the Federal Reserve, not the IMF, that acted as the world’s lender of last resort, printing and lending trillions of dollars to cash-strapped foreign banks.
A reserve currency doesn’t get that status by decree; it must be earned. Over time private and public investors have developed the confidence and habit of storing their wealth in American bank deposits or Treasury bonds, invoicing imports and exports in dollars, issuing and trading stocks and bonds in New York, and settling disputes in American courts.
It wasn’t always so. While the U.S. economy surpassed Britain’s in size by the late 1800s, international use of the dollar lagged far behind use of the pound sterling because U.S. financial markets were so underdeveloped. American banks typically couldn’t do business across state lines much less international borders, and New York lacked London’s deep, liquid market for trade acceptances—IOUs to finance merchandise trade. With the creation of the Fed in 1913, though, banks would open foreign branches, and the Fed fostered a market for trade acceptances in New York. By the late 1920s the dollar had surpassed sterling as a reserve currency, notes economic historian Barry Eichengreen.
Thus, a country needs at least two things to issue the dominant reserve currency: a big economy and a deep, sophisticated and open financial market. China has the first, but not the second. It’s trying to change that.
The yuan can now be traded in 14 places outside China. It is used to pay for nearly 25% of China’s merchandise trade. And foreign investors can own up to $1 billion of Chinese stocks and bonds. China is now lobbying for the inclusion of the yuan in the basket of currencies that comprise the IMF’s own currency, the “special drawing right,” or SDR.
The yuan remains a long way from being a genuine reserve currency. Since the SDR is only used within the IMF, the yuan’s inclusion is largely symbolic. As Eswar Prasad of Cornell University notes, China has made more progress opening up to foreign investors than providing those investors with something to own.
Central banks that want to hold dollars can choose from trillions of dollars of easily traded, safe Treasury bonds. Nothing comparable exists in euros or yen, much less yuan, and it’s not clear China wants that to change. The more yuan foreigners hold, the less control China has over its exchange rate and its financial system. Much of the rise in yuan holdings outside China in recent years was a bet on the currency strengthening, bets that will be called off if China weakens the currency to bolster flagging exports.
Still, the U.S. would be wise not to take the challenge lightly. If the U.S. overuses its sway over the financial system in pursuit of narrow foreign-policy goals, it could encourage private investors and countries to seek alternatives—eroding its leverage.
“Once the yuan becomes an alternative to the dollar, rules of the game begin to change,” says Juan Zarate, who helped implement financial sanctions while serving in George W. Bush’s Treasury department.
The yuan is still many years away from being that alternative. But if China takes the right steps, the change in fortunes could be swift. Just ask the British.
Write to Greg Ip at email@example.com
Corrections & Amplifications
The U.S. accounts for 23% of world economic output. An earlier version of this column incorrectly cited the total as 18%.
The Fed mollifies its hawks but now its doves are fretting
Nov 8th 2014 | From the print edition
IN HIS nine years as president of one of the Federal Reserve’s twelve regional branches, in Dallas, Richard Fisher has voted against the Fed’s monetary policy eight times, always in favour of a tighter stance. Not one to let his vote speak for itself, Mr Fisher has compared the Fed’s bond purchases to bourbon served to an alcoholic, “dry inflationary tinder” and water pouring over the “the gunwales of the ship of our economy.”
So few were as happy as Mr Fisher when the Fed last month decided to bring its third round of bond buying (known as “quantitative easing”) to a halt. He and his fellow hawk, Charles Plosser, president of the Philadelphia Fed, registered their approval by not dissenting. Rather, the locus of opposition shifted to the doves, in the form of Narayana Kocherlakota, the president of the Minneapolis Fed, who wanted more bond buying and a stronger commitment to getting inflation higher. Read the rest of this entry »
Modest, though not radical, budget goals are within the Republicans’ reach
OF THE many reasons Congress is scorned, fiscal policy tops the list. Since Republicans took control of the House of Representatives in 2010 bitter battles with Senate Democrats and Barack Obama produced a near-default on the national debt, a white-knuckle fiscal cliff and a 16-day government shutdown. Now that Republicans also control the Senate, they have a chance to improve on that record.
Their first test comes quickly. Most of the federal government is operating on a temporary “continuing resolution” until December 11th. Without an extension, the government will shut down again. Given the beating their image took last time, Republican leaders are unlikely to want a repeat. They are more likely to seek a deal with Democrats, who control the Senate until the end of the year, to extend it at least until April, when Congress is supposed to pass a budget resolution.
That resolution lays out broad guidelines for how much the government may spend and tax. Congress hasn’t passed one since 2010, largely because the Republican House and Democratic Senate have been ideologically too far apart. Once Republicans control both chambers, they can use the resolution to instruct key committees to rewrite the laws governing taxes and entitlements such as Obamacare and Medicare (health care for the elderly) through a process called reconciliation. Provided those changes reduce the budget deficit, a reconciliation bill could not be filibustered by the Democratic minority in the Senate because it only needs 51 votes, not the usual 60; though Mr Obama can still veto it. Read the rest of this entry »
Voters in Kansas will pass judgment on a bold experiment in tax cutting
Public investments in infrastructure do the most good at times like the present
THOSE trying to fly to or from Chicago in the past week learned first-hand the shortcomings of America’s public infrastructure. A suicidal employee set fire to a nearby air-traffic-control centre, resulting in the cancellation of thousands of flights, the third such interruption this year. The chaos is aggravated by a system dating from the 1950s that relies on radar. Unpredictable funding has delayed its planned replacement with a system that uses satellites.
Public infrastructure is one of the few forms of government spending that both liberals and conservatives support. Ports, power lines and schools are essential to the smooth running of the economy. But as America’s outdated air-traffic-control system shows, public investment is at the mercy of the fiscal weather. Cash-strapped governments are loth to pile on debt or raise taxes even for something as popular as a new road. After a burst of stimulus spending in the immediate wake of the recession, public investment has fallen back in the rich world (see charts).
This is profoundly short-sighted. That is the message of a new study by the International Monetary Fund, released as part of its half-yearly “World Economic Outlook”. It found that in rich countries at least, infrastructure spending can significantly boost growth through higher demand in the short run and through higher supply in the long run. This comes with caveats: the results depend on how the investment is financed, how efficiently it is carried out and what the prevailing economic conditions are. As it happens, the present conditions are perfect.