The FT notes, in today’s leader, that the G-7 hasn’t been able to agree on the massive, co-ordinated intervention needed up hold the dollar up against the euro.
The euro, and commodity currencies such as the Australian dollar, are bearing the brunt of the dollar’s fall and the erosion of their trade competitiveness. These are the nations with something to gain from G7 or IMF management of the dollar’s fall, but even if they could agree amongst themselves, it is unlikely they could muster support for the massive, co-ordinated, global intervention that would be needed to hold the dollar up.
The funny thing is that the emerging world has been able to muster support for massive, global intervention needed to hold the dollar up – the IMF estimates that global reserve growth is set to top $1 trillion in 2007, and judging from the first two quarters, that may be an underesimtate.
And even more surprisingly, they have managed to do this without any formal coordination. There is no real analogue today to the G-7 of the 1980s (see HSBC’s Stephen King in yesterday’s Independent). The big emerging economies don’t sit down with the US in the G-20, for example, and agree to intervene to hold the dollar up while the US takes steps to put its financial house in order. But they nonetheless intervene on a far larger scale – both relative to US GDP and their own GDP – than the G-7 ever did in the 1980s.
So how can this system be sustained in the absence of formal coordination? After all, Barry Eichengreen argued back in 2004 than every individual country in the dollar financing cartel had an incentive to cut back on its dollar holdings before others do– and as a result, the Asian central bank cartel financing the US would prove to be unstable.
I would point to two things.
First, so long as China resists allowing its currency to appreciate – a policy that requires that China buy tons of dollars in the foreign exchange market and invest tons of money in the US – any emerging economy that allows its currency to appreciate against the dollar also allows its currency to appreciate against the RMB. That has a real cost. Ask India. Or Thailand. Those emerging Asian economies that have allowed their currency to appreciate now generally run current account deficits, not surpluses – and many are seeing a very rapid rise in their imports from China. As a result, even countries with higher upfront sterilization costs than China are still intervening to resist pressure for their currencies to appreciate. Ask the Reserve Bank of India how many dollars it has bought over the last month. And then ask the Bank of Thailand.
Call it coordination without any formal coordination. Almost every emerging economy is – or has – intervened over the past year to prevent their currencies from appreciating. And they all have done so without demand anything from the US in return, and by and large, without talking to each other either.
Second, high oil prices – and policy inertia in the oil exporting economies.
The oil exporters have a ton of cash with oil trading in the $85-90 range, even if many now need $40 oil – if not a bit more -- to avoid running an external deficit. Taking in $85 a barrel and spending $40 on imports leaves $45b a barrel to invest globally. It is – in that narrow sense -- equivalent to taking in $65 and spending $20.
The oil exporters don’t really have to worry about Chinese competition -- so that can hardly explain their continued willingness to peg to the dollar. So why have they joined the dollar financing carterl?
Inertia probably plays a bigger role than most would suspect. The GCC countries haven’t agreed on what should take the place of their dollar pegs in the run-up to their now-likely-to-be-delayed yet again monetary union. And so long as they peg to the dollar, they have an incentive to hold dollars – at least the bigger countries. Selling risks driving the dollar and thus the GCC currencies down.
To be honest, though, the asset allocation of some Gulf countries investment funds now looks to be adding to the pressures on the dollar. I would be bet a lot of money that a smaller share of today’s oil surplus is held in dollars than was the case in 2004 or 2005. We more of less know this is true for three countries: Russia, Kuwait and Qatar. The portfolio allocation of these countries consequently may be adding to the problems their central banks are now facing with inflation.
And, if is widely suspected, some investment funds have reduced the dollar share of their portfolio, inertia alone consequently is no longer a fully satisfactory answer. Other policies have changed faster than the peg.
I suspect part of the answer is that the some GCC countries – the Emirates for example -- is effectively run by a set of property magnates. Big property investors haven’t exactly been hurt by higher inflation, negative real rates and the resulting surge in demand for property. Especially not when a lot of the increase in inflation comes from higher rents. Higher rents and rising property prices help the property-owning sheiks -- particularly since they also tend to own the major property developers. And the sheiks are the ones calling the shots.
Here though I am probably speculating a bit too freely about the Gulf's political economy. Suffice to say that the Gulf's continued willingness to peg to a depreciating dollar is a mystery, one that calls out for further investigation.
We do know though that a lot of countries haven’t made their willingness to intervene heavily to hold the dollar up contingent on any changes in US policy. That has reduced the need for formal coordination. We also know, I think, that the early defectors from the dollar financing cartel are currently paying a bit of a price – as they have allowed China to undercut their products in the global market. China’s ability to punish defectors by taking some of their global market share also reduces the need for formal coordination . Finally, the oil exporters aren’t spending all the funds they are taking in, and even if they are putting a smaller share of the flow into dollars, they are still adding quite significantly to their dollar portfolio. That too helps finance the US deficit.Three final points:
- One: It isn’t as if Europe and the advanced commodity exporting economies lack the resources needed to intervene on a sufficient scale to make an impact. China’s 2007 intervention in the foreign exchange market – counting funds shifted to the CIC – is likely to be well above 15% of China’s GDP. I haven’t done the math, but 15% of the combined GDP of the European Union would generate a sum closer to $2 trillion than $1 trillion. Academic theory on this isn’t totally clear, but I personally suspect intervention on that scale would have an impact on the dollar. Europe just doesn’t think it is in its interst to borrow a ton of euros and sell them for dollars. China, by contrast, still thinks it is its interest to borrow a ton of RMB and buy euros and dollars. And China is likely to take far larger losses on its euros and dollars than Europe would on its dollars.
- Two: This implies that China now provides a very large amount of financing to the US right now. CITIC’s $1b investment in Bear is offset by Bear’s investment in CITIC, and even if it wasn’t it amounts to less than a typcial business day’s worth of China’s likely purchases of US bonds. It isn’t unrealistic to think that Chinese state investors – the PboC/ SAFE, the CIC, CITIC, CDB and others – will aquire between $350 and $400b of US assets in calendar 2007. The vast majority will still be bonds. (These calculations assume that total chinese foreign asset accumulation will be close to $500b)
- Three: the earlier talk of the need for a new Plaza to bring the dollar down in an orderly way has effectively been superseded by talk of a new Louvre to keep the dollar from falling further. But in reality, the world could need both a new Plaza and a new Louvre. A Plaza might still be needed to bring the dollar down against many emerging currencies, though in all honesty the needed adjustment in the dollar could happen absent any Plaza II if China decided to let the RMB moved more. And a Louvre might be needed to keep it from free fall. The problem I have with the emerging world’s current intervention is that it is – by and large – designed to keep the dollar from falling at all.
The original Louvre came after the Plaza. The new emerging market Louvre -- today's massive intervention to support the dollar -- has come about without there ever being an emerging market Plaza.