Who would have thought, even a couple of months ago, that calls for a global currency might be taken seriously as a solution to the current financial crisis?
Yet, the concept is gaining incredible momentum.
The dollar’s hegemony, of course, was first seriously called into question by Vladimir Putin back in January. Further calls by Russia came this month. Meanwhile, China concretely jumped on the bandwagon this week — first with a written proposal by the governor of the People’s Bank of China for a new system based on special drawing rights and then with similar references made by the vice president of the Bank of China Wang Yongli on Thursday.
As Dennis Gartman of the Gartman letter points out, Yongli’s calls came in an article penned for the Financial News. In the piece Yongli says the world actually needs a single global currency that should not be controlled by any single nation, and there should be a global central bank established to issue and manage this currency. And the crazy thing is that Gartman, despite seeing it as an anathema of a concept, is still taking it seriously:
We would normally toss such a notion aside at a moment’s notice for this is utter and complete nonsense. The US would never accede to such a notion… at least not in our lifetime. Both the Left and the Right would and shall find it anathema; however, because the article was posted in The Financial News and because The Financial News is the People’s Bank of China’s “affiliated” newspaper, his comments were likely vetted by the PBoC and by Beijing too, for that matter.
Meanwhile, as Bloomberg reports on Friday, Indonesia, Malaysia and Thailand are also joining the global currency call bandwagon.
Bank of Indonesia Governor Boediono told reporters: “We need a currency that is stable by volume and value so that world trade and investment can be more stable, Trade transactions using one currency that’s dependent on the condition of a single country’s economy is dangerous.”
Bank Negara Malaysia Governor Zeti Akhtar Aziz called it “a viable proposal that should be considered.”
And Bank of Thailand Governor Tarisa Watanagas said it may benefit developing nations to have an alternative to the dollar.
The main criticism of such calls is usually that it would take years to implement anything like a global currency, that the world’s governance is not suitably united to make it feasible and that America itself would never bow easily to seeing its dollar dominance slip away.
Yet some very notable figures seem to disagree. Among them is Nobel prize-winning economist Joseph Stiglitz, who even inferred on Thursday not only was the implementation of a global currency possible, it was possible quickly.
According to Reuters, Stiglitz believes the whole thing could in fact be phased in within a year. He addressed the subject as part of his role heading a UN panel analysing the financial crisis. As Reuters reports:
Stiglitz’s panel has issued a set of recommendations for global financial reforms, including a proposal for a new SDR-based reserve system. In an 18-page report released on Thursday, the panel said such a system “could contribute to global stability, economic strength, and global equity.” The panel said such an SDR system would be “feasible, non-inflationary, and could be easily implemented.” Russia earlier this month proposed creating a new reserve currency, to be issued by international financial institutions. This week, China outlined how SDRs could take over the dollar’s role as the global reserve unit.
Stiglitz said there was a “growing consensus that there are problems with the dollar reserve system.” He added that economists have been discussing the weaknesses of single-currency reserve systems for decades. “One of the problems (with single currency reserves) is that because of the huge level of volatility, countries are accumulating large amounts of reserves,” he said. The use of dollar reserves was also “contributing to the weakness of the global economy,” the former World Bank chief economist said.
Driving much of the momentum for a global currency are probably increased fears about the viability of ongoing investments into US Treasuries by surplus countries like China. QE intervention has led to clear abnormalities appearing along the US Treasury curve. As Reuters columnist John Kemp explained in an article – there is very little appetite for investments at the back-end as investors increasingly price in the risk of inflation following the Fed’s QE efforts.
This also appears to be the case in the UK, where investors are increasingly skirting long-dated conventional gilt issues, unprepared to invest in long-term securities without the provision of a corresponding inflation hedge — meaning long-dated index-linked issues are predominantly of interest .
Back to the US, Kemp concludes:
The U.S. government is trapped. It needs to issue more medium-term securities and lengthen its maturity profile otherwise it will become a prisoner of the refunding market, vulnerable to any shift in sentiment, like the banks before the onset of the crisis. Too much short debt that needs to be constantly rolled forward will complicate monetary policy when the time comes to start reducing the Fed’s balance sheet and start raising interest rates.
Suddenly, all of the above does make sense. This is especially the case when you consider the following statistics on US Treasury investments as gathered by CFR blogger Brad Setser:
China’s purchases of US Treasuries in 2008 (Setser/ Pandey estimate): $245 billion
US money market funds purchases of US Treasuries in 2008, from the flow of funds: just under $400 billion
China’s purchases of Treasuries and Agencies in 2008: $283 billion
US money market funds’ purchase of Treasuries and Agencies in 2008: $942b
As Setser points out, China’s large purchases of Treasuries in 2008 happened not because supply was there to be picked up, but because it was forced to stop buying other – now risky – securities like Freddie/Fannie agency debt. Eventually its reallocation to Treasuries-only investments will be completed, and when that happens its purchasing pace of Treasuries will begin to track its reserve growth.
And, of course, as China’s reserve growth slows, the volume of Treasury purchases will slow – leaving the US vulnerable to a ‘refunding’ crisis – or as Kemp calls it a ‘refunding trap’.
In the meantime, as Setser points out, it is US money market funds that will mostly plug the gap, which leads him to assert:
I am waiting for a round of stories pondering whether money market funds will continue to buy Treasuries and Agencies at their 2008 pace!
To sum up the situation, it is perhaps best to quote the following paragraph from an essay published on People’s Bank of China website on Friday:
In fact, lack of remorse is one key factor leading to the current crisis. Before the crisis, there was a prevalent complacency. Although the US regulatory structure was a complex patchwork of fragmented agencies and jurisdictions, some believed that it worked quite well. Though some made efforts to address issues, most are reluctant to take a serious crack at the problems with an excuse of “(i)f it ain’t broke, don’t fix it.” The cost of waiting for the system to break has turned out to be tremendous. Against this backdrop, we should begin with an attitude of self-criticism while addressing the challenges of financial regulatory reform.
So, is it the case the surplus countries are no longer prepared to tolerate waiting for the system to break?
Related links:
Is a global super-currency on the agenda? – FT Alphaville
Introducing the global central bank solution – FT Alphaville
