When Jay Powell, US Federal Reserve chairman, gave a news conference this week, investors were on red alert about what he might say about the dollar. No wonder.
When Jay Powell, US Federal Reserve chairman, gave a news conference this week, investors were on red alert about what he might say about the dollar. No wonder.
As recent crises in Turkey and Argentina have shown, a rising greenback — and higher US interest rates — puts emerging market borrowers in a vice, making it crucial to know whether the Fed is seeking a stronger dollar.
In the event, Mr Powell was non-committal. But as investors ponder the dollar’s price, there is a second issue they should watch: the role of the American currency in the financial system. Something rather unexpected is occurring on this front.
In the past week, Donald Trump has declared (yet again) that he wants to shake up the postwar global order. Speaking at the UN, the US president stressed that America is adopting a more unilateralist stance. And even before Mr Trump was elected, a number of countries had started quietly trying to change the global financial order, by pledging to reduce the postwar pattern of dollar dominance.
Jean-Claude Juncker, European Commission president, this month provided one demonstration of this, when he used a speech to rail against dollar pre-eminence, and call for more euro influence. “It is absurd that Europe pays for 80 per cent of its energy import bill in US dollars when only roughly 2 per cent of our energy imports come from the US . . . [or] that European companies buy European planes in dollars instead of euros,” he fumed.
China has pledged to make its currency more widely used, to match its swelling economic power; some officials mutter that the renminbi will eventually eclipse the dollar as a reserve currency. And emerging market countries have been trying to boost local currency bond markets to cut their dollar ties.
But this has not worked: in recent years dollar pre-eminence has actually risen, not fallen. As Ruchir Sharma, an economist at Morgan Stanley, puts it, “the dominance of the dollar is now at record levels” — never mind Mr Trump’s isolationist stance.
According to a recent European Central Bank report, the euro is almost as widely used as the dollar as a payments currency. But that is the only area of (near) parity: the dollar still accounts for 62 per cent of global debt, 56 per cent of international loans, nearly 44 per cent of foreign exchange turnover and nearly 63 per cent of foreign exchange reserves.
The corresponding numbers for the euro are in the low 20s, except for its share of turnover which is 15.7 per cent.
Look also at emerging markets. Local currency bonds have flourished. But, in the past decade, dollar borrowing by emerging markets has more than doubled, and accounts for the vast majority of debt there. That is true even in China: its companies have expanded dollar borrowing at a heady pace this decade.
Although the renminbi’s share of global currency reserves rose to 2.8 per cent in the earlier part of this decade, it slipped back to 2 per cent after China reintroduced capital controls in 2015. As economist Carmen Reinhart notes, when China makes loans to low-income African or Asian countries, these — ironically — tend to be in dollars.
Don’t hold your breath waiting for this to change. One reason why dollar usage is at a record high is that the global power of American financial companies has swelled since the financial crisis (which is another irony of the modern world).
A second is the relative strength of the US economy. But a third issue is that none of America’s competitors offers the liquidity and credibility currently associated with dollar markets: China’s financial reforms are (at best) half completed, Japan is inwardly focused, and the eurozone faces structural challenges.
Of course, the US’s credibility could crash if it suffers its own sovereign debt crisis. This is a real and rising threat in the medium term, given Mr Trump’s budget-busting tax cut and spending bills. Some people on Wall Street are so concerned about this that they tell me they are developing dollar alternatives, as a hedge for clients. But these focus on digital hedges, using blockchain or gold — not euros, yen or renminbi.
Call this pattern, if you like, America’s exorbitant privilege; or, more accurately, it might be labelled as the non-American world’s terrible curse. Either way, it means that, whatever Mr Trump does — or does not — say next on the global stage, Mr Powell wields extraordinary power over global markets. Let us hope he wields it more predictably and cautiously than his president.
