Reports of the US dollar’s death have been greatly exaggerated

Srinivas Thiruvadanthai and I wrote a joint piece (with the above title) for Mint four months ago. Four months is a long time. Stocks double in value in this period. I do not know if Srini still stands by what we wrote then. Knowing Srini, it is very likely that he would. I do, for sure.

Several observers predicted the experiment will hasten the internationalisation of the renminbi and erode the status of the US dollar as the world’s only reserve currency. [Link]

That is from an article in FT on China’s new digital currency. I doubt if that ‘prediction’ would come true. Unlikely, in my view. What follows below is a modified and expanded version of the comment I left on the article in

Financial repression and treatment of foreign investors (covert or overt or both) do not facilitate internationalisation and reserve currency status. Store of value, medium of transaction are remote outcomes. Unit of accounting – yes, internally. Capital account convertibility is missing and will be missing in action for a long time. Relatively open societies and comfort with foreign ownership and CAC go together. 

America itself might be turning its back on these prerequisites but it is the incumbent global reserve currency. Incumbency is powerful. The analogy with Britain only goes thus far. Britain was groaning under the weight of debt from World War II and global imperial overreach. Its clout was weaker. More importantly, America was strong then – in every respect – fiscal, political and economic. The US dollar was ready to replace the pound sterling. Such is not the case with any other country in the world today.

There was another article in FT about how the pandemic was testing the confidence in the US currency. That article mentions the ‘exquisite timing’ of Jeffrey Frankel and Menzie Chinn in predicting the replacement of the US dollar by the Euro as the dominant global reserve currency by 2022 at the peak of the Euro valuation against the US dollar in 2008. That was the peak of the Euro in every respect. A recent temporary rally on the back of an alleged European debt mutualisation should not be misunderstood as a vote of confidence in the Euro as an alternative to the US dollar.

Read this article on how the ‘EU accord’ was secured and here is a delightfully outspoken sceptical voice from Finland – that of the former Foreign Minister of Finland, no less.  In case the letter is not accessible, pl. click here: FT_Letter_ Covid-19 aid package leaves EU looking like Hotel California _04082020.

No doubt, America is working very hard at undermining the confidence in the US dollar – with its open-ended liquidity provision and distortion of financial markets prices. But, the problem is that the rest of the world is no better off with their own ‘on-again, off again’ campaigns exhorting citizens to buy stocks, whenever the government wishes them to do so.

Further, China’s debt levels and deficit levels are re-stated by the IMF in its annual Article IV assessment by the IMF. In the last assessment published in August 2019, the IMF had projected that the government’s ‘augmented fiscal deficit’ would be persistent at 12% of GDP and that the ‘augmented general government debt’ would touch 100% of GDP. 

Yes, America is leading the charge of the central bank brigade at debasing currencies. There is no doubt about that.  If they keep at it – as is likely that they would – the day the world says enough will draw closer. However, what replaces it, if and when it happens, is anybody’s guess.  It is hard to bet on the other paper currencies or their digital clones as the alternative to the US dollar. They are all in it together. They will sink together. 

We need a global monetary order or ‘Rules of the Game’ and we may get it. It may not be dominated by any one currency and it may not be a fiat money arrangement.

For the time-being, whoever is behind this tweet and the beautiful collage has a lovely sense of humour:

I wonder what folks think about the dollar right now? [Link]

The text above was the descriptor for this collage:


Will other countries tolerate a weaker dollar?

Mr. Stephen Roach has written a sequel to his piece on the US dollar. The sequel is here and the link to the original is in the sequel itself. Well, he picks up the argument that there is no alternative to the dollar for rebuttal. He thinks that both the Chinese renminbi and Euro are ready for appreciation and so is the yen.

Not only does he gloss over the fundamental weaknesses of these economic regions and nations, he also does not address the issue of whether these countries/regions want their currency to strengthen against the US dollar.

Specifically on China, he writes the following:

As long as China stays the course of structural reform — shifting from manufacturing to services, from investment- and export-led growth to consumer-led growth — and embraces a further liberalization of its financial system, the case for further currency appreciation remains compelling, even in the face an increasingly fraught relationship with the U.S.

Yaah, right!

It is not that a 30% depreciation in the US dollar has not happened before. After all, since 1973, the yen, the Swiss franc and the Deutsche Mark appreciated against the US dollar until the new millennium. The Swiss franc and the yen had continued their appreciation while the Euro, the new Europe-wide incarnation of Deutsche Mark has not. Mr. Roach picks up his convenient starting points to make their case for undervaluation and hence, eventual recovery against the US dollar.

The point again is not that the dollar will not depreciate. He may well be right eventually but he does not make a case that is complete and internally consistent. The weaknesses that are there in the American economy are evident elsewhere in Europe and in China. Arguably, even bigger weaknesses exist.

The case he makes is an incomplete and weak one even if he turns out to be lucky with his prediction, eventually.

By the way, I did not find any horizon for the forecast of a crash in the trade-weighted inflation adjusted value of the US dollar by 35% in the latest article or its prequel. That is convenient.

Whither the dollar?

A friend forwarded the article by Stephen Roach on the fate of the US dollar. He is prophesying its crash and hence its eventual loss of status as the principal reserve currency in the world. America will keep interest rates low; American savings rates will plummet and current account deficits will soar and the dollar will crash.

He may well be right. But, the only question I had was whether any other currency in the world would be better placed to replace the US dollar. In fact, which other country or region that is big enough to mount a challenge to the US dollar whose economic fundamentals will be better than America’s?

However, by the end of the decade of the Twenties, depending on the kind of crises that America faces between now and then and depending on the leadership that it emerges post-2020 and post-2024 elections, the risk of the US dollar losing its pre-eminent global reserve currency status by the end of the decade is non-trivial. That is, in the end, the exorbitant privilege might just turn out to be an exorbitant burden for America to carry and it could fail.

So, in the (very) long-run, Stephen Roach might be correct although that is not what he is saying in the article.

Then, another friend sent me a report that was diametrically opposite of Stephen Roach’s prognosis. It was by Icecap Asset Management on the possibility of a revalued US dollar. Such a possibility – in terms of deliberate policy action – has been forgotten. It has been quite a while. They argue that a re-elected Trump might just do it. That would hurt China. They are right about it. But, as to its probability, it is a guesswork. I sent the following message to my friend who sent that report:

1) The premise that a strong USD hurts China more than it hurts the US or anyone else is broadly correct.

(2) Who is likely to use this? There is a higher chance that a re-elected Trump uses this weapon more than a Democratic President. The latter would be forced by the millennials to resort to ‘tax and spend’ and a weaker currency. That is my guess.

(3) The statement in (2) above was a relative one. Will Trump really use it, in an absolute sense? I wish I could be a bit more confident than I am. I recall what I wrote in 2017 for Mint. Reading this now brought a smile to my face. I enjoyed re-reading it as much as I enjoyed writing it then.

(4) The election which appeared a shoo-in for DJT in January (notwithstanding the valiant efforts of Michael Bloomberg and his cohort of opinion writers who are breathtakingly homogeneous 😊) has become too close to call now, in my view.

(5) Relatively speaking, India might be better off if this policy were to be pursued

(6) Surprised that the writers do not mention what Paul Volcker did in the 1980s (1982-85). That was to use the US dollar as a geopolitical weapon against Europe (who were feeling uppity in the late-Seventies) and the Marxian Latin American rulers as well as some bankers in the USA.

(7) Robert Rubin wielded the weapon to help EMU fructify in the mid-to-late Nineties

(8) In my Mint columns, at least twice, I had mentioned the rationale for (and even the need) America to wield monetary policy and the currency as a geopolitical weapon against China. This is a longer version, published by the Takshashila Institution in August 2015. Some of these predictions (or, wishes?) have, with the benefit of hindsight, proved to be premature.

The big question mark is whether America of today capable of taking even little pain for bigger gains.

Digital currencies

I read a few good pieces on China. Two on their plans for digital currency and one on returning scientists. I am focused on their macro and financial sector vulnerabilities. But, they do get things right in other areas. The article that I read remind me of that.

Andy Mukherjee does a very good job of taking the readers through the implications of China’s digital currency initiative and that digital currencies, in general. His two-line explanation of blockchain is a gem:

When Peter in Vancouver agrees to send money to Paul in Singapore, they’re forced to use a chain of interlinked intermediaries because there’s no ledger in the world with both of them on it. Blockchain’s distributed ledgers make trust irrelevant. Paul devises a secret code, and shares its encrypted version with Peter, who uses it to create a digital contract to pay Paul. A cumbersome and expensive network of correspondent banks becomes redundant, especially when it comes to the $124 trillion businesses move across borders annually. Imagine the productivity boost; picture the threat to lenders.  [Link]

While it could and would end banking as we know it (should anyone shed tears?), Andy does point out its downside:

Token transactions will be pseudonymous: If the central bank wants to see who’s spending where, it can. Anonymity disappears when cash does. While that will make life difficult for money launderers and terrorists, it could also become a tool to punish political activism. Meanwhile, currency as a foreign policy weapon loses some sting. [Link]

While you are at it, read the Kenneth Rogoff piece in ‘Project Syndicate’:

when China announces its new digital currency, it will almost surely be “permissioned”: a central clearing house will in principle allow the Chinese government to see anything and everything. [Link]

Further, Ken Rogoff also puts in perspective the potential (o, the lack thereof) for the yuan to displace the dollar:

America’s deep and liquid markets, its strong institutions, and the rule of law will trump Chinese efforts to achieve currency dominance for a long time to come. China’s burdensome capital controls, its limits on foreign holdings of bonds and equities, and the general opaqueness of its financial system leave the renminbi many decades away from supplanting the dollar in the legal global economy. [Link]

USD above 7 CNY

This morning, as I type this, the USDCNY exchange rate is 7.0445. Bloomberg sends out a daily newsletter called ‘Bloomberg Opinion Today’. The remarkable convergence of the views stated therein tells me that reading all of them is a waste of time. For everything that happens, Donald Trump is to be blamed. Period. There are no shades of grey nor nuances. Whether Trump is being shrewd or smart or miscalculating or bumbling from one step to another or that he throws his rivals off-balance, these can be debated ad nauseam. We will not know until a good deal of time has passed. But, to provide no scope for alternative points of view speaks poorly of the platform.

America has labelled China a currency manipulator. Treasury department makes the call and it leads to some punitive actions. It is one of those unilateral measures that America takes, in many areas. Back in the early-2000s and even after 2008, Fed monetary policy stance could have been termed currency manipulation. In any case, China technically does not meet the criteria America has set out for currency manipulation and yet it was tagged. But, the punitive actions that have to follow have no sting because China does not have any US government contracts nor does it receive development funding. See this well-written news-story in Bloomberg.

George Magnus has a piece on it in Bloomberg. It says a lot but says nothing much that is new. The path of yuan from hereon will determine global currency arrangements. Possible. Methinks that the elections next year, the Federal Reserve policies and a possible bitter fight between an incumbent President fighting for re-election and the central bank in America will play a big role in the global confidence on the US dollar.

But, unfortunately for others and fortunately for America, there are many other factors that would play a big role in influencing the trajectory of the continued global role of the US dollar. All those factors underpin dollar’s strength because they undermine the claims of other currencies and countries to dethrone the US dollar.

For example, sample this comment from Magnus’ article:

A major Chinese investment bank recently suggested the industrial sector has lost about 5 million jobs in the last year, almost half of which are attributable to the trade war.  [Link]

Vladimir Putin who is widely hated by the mainstream English media has suddenly become quotable for them because Russia is coming good on its threat to diversify out of US dollar. Mildly interesting news but nothing more, for now.

Trump’s fights with the Federal Reserve on American monetary policy stance are more critical, as far as I am concerned, to the path and fate of the US dollar.

John Authers wrote, after the Federal Reserve Board Open Market Committee Meeting last week in which they cut the Federal Funds rate by 25 basis points, that Trump escalates the stakes in the trade war with China to force the hand of the Federal Reserve. I find the logic weird.

A far more reasonable proposition is that he wants monetary policy to help cushion the shock coming from his long-standing and long-running trade battle with China. He is anxious and he knows that market sentiment would sour as he escalates the fight with China. He wants the Federal Reserve on his side to cushion the impact on market sentiment.

Be that as it may, he is risking a big setback to global comfort with and confidence on the US dollar by haranguing the Chairperson of the Federal Reserve. Fed policy is already a slave to stock market gyrations. Trump’s tweets and angry comments are compounding the blows to the Fed’s already-battered credibility. That is the big threat to the US dollar. Not the path of China’s yuan.

If anything, China’s currency war games are a double-edged sword.

What a time we are living through

Almost back-to-back shootings in the US – in Texas and in Ohio in the weekend prompts the American President to condemn racism, bigotry and white supremacy. Is it or is it not a tad too late? WSJ article linked in line 1 says that it was the 251st mass-shooting in 2019.

From 2006 to 2016, the number of public mass shootings each year was relatively flat, with about four or a five a year, according to the AP/USA Today/Northeastern University Mass Murder Database. That number has risen in recent years, with seven public mass shootings in 2017 and 10 in 2018.

The Government of India has abrogated Article 370 of the Indian Constitution that conferred special status to the state of Jammu & Kashmir. Useful links to read/listen are here, here and here.

On the face of it, the BJP had done what it promised in its election manifestos both in 2014 and in 2019. Many Indians have questioned the special status for the state of Jammu & Kashmir in the past. After all, the decision integrates the state with the rest of India. Of course, the Government of India has also divided the state into two Union Territories.

The fact is that Article 370 begins as follows:

Temporary provisions with respect to the State of Jammu and Kashmir

Also, Article 370 (1) (3) states the following:

(3) Notwithstanding anything in the foregoing provisions of this article, the President may, by public notification, declare that this article shall cease to be operative or shall be operative only with such exceptions and modifications and from such date as he may specify:
Provided that the recommendation of the Constituent Assembly of the State referred to in clause (2) shall be necessary before the President issues such a notification.[16]

There is no constituent assembly in J&K. The Government of India in the past has substituted it with the words, ‘Legislative Assembly’ and since the Legislative Assembly in J&K has been suspended, the recommendation of the Governor of J&K has been deemed sufficient.

A friend raised the question of whether Article 370 has indeed been abrogated. The Government of India appears to have done it indirectly (?) through amendment to Article 367 of the Constitution of India. But, in the gazette notification published in ‘Economic Times’ should clause 4(c) have come before clause 4(b)? See here.

The Presidential order issued on August 5, 2019 extends the Constitution of India, in its entirety, with all its amendments, to the state of J&K. Thus, it effectively neutralises Article 370. There is no direct reference to Article 370. However, the Presidential order, by superseding the Constitution Order 1954, directly abrogates Article 35A since that Article was inserted as per the Constitution Order of 1954, as per the Wikipedia entry.

It is interesting that the Wikipedia article mentions that the President of India has issued a series of orders since 1950 under clause (1) of Article 370. There have been at least fifty such orders extending the applicability of the Constitution of India to the state of J&K.

But, a few questions will remain for which no clear answer will emerge for a long time: the timing of this decision (why now?), the long-term consequence of this decision in the state of J&K, Pakistani reaction, the impact of incidences of terrorism in the state and in India and the legal admissibility of the decision if someone chooses to challenge it in the Supreme Court.

The Chinese yuan has weakened to over CNY7.00 per US dollar. This is seen as China’s retaliation to the latest round of tariffs levied by the American President. President Trump calls it a major violation.

If China uses the yuan as a lever against the American trade war, two questions arise: will capital not flee China somehow?

Second, has America (acting in concert or not, with the UK?) the Hong Kong lever? See here and here.

In the meantime, late in July, News that Huawei helped build the mobile phone network in North Korea, carried by the Washington Post, was cited by CNN here. A very long article from the Wall Street Journal published in May 2019 on how Huawei grew and the methods it followed is well worth a read.

This Reuters article on the 5G fight also published in May is well worth a read, for how Australia blew the whistle on Huawei. Two points from the article are worth noting:

The United States and its allies were derelict in not developing a 5G supplier, former Australian Prime Minister Malcolm Turnbull said in a speech in London in March. “With the benefit of hindsight it beggars belief that the countries which pioneered wireless technology – the United States, the UK, Germany, Japan and with wifi, Australia have got to the point where none of them are able to present to one of their own telcos a national, or a Five Eyes, champion in 5G,” he said.

What is 5G all about?

5G isn’t only about faster data. The upgrade will see an exponential spike in the number of connections between the billions of devices, from smart fridges to driverless cars, that are expected to run on the 5G network. “It’s not just that there will be more people with multiple devices, but it will be machines talking to machines, devices talking to devices – all enabled by 5G,” said Burgess, the Australian Signals Directorate chief, in his March address.

This configuration of 5G networks means there are many more points of entry for a hostile power or group to conduct cyber warfare against the critical infrastructure of a target nation or community. That threat is magnified if an adversary has supplied equipment in the network, U.S. officials say.

Lastly, Japan and South Korea are bickering more bitterly than they did before.

In short, my article in Mint published on July 26 appears to have been timed well, by sheer coincidence.

Sovereign dollar bonds

Many of you might have noticed that the Indian government announced a plan to borrow in dollars in international capital markets. It will be India’s first foreign currency sovereign borrowing from capital markets.

In one short sentence, it is ill-advised. If you thought that the issue of ‘Masala’ bonds (rupee bonds issued for foreigners to subscribe) were safer, that is wrong too. Happy to elucidate. Have done so here.

I wrote about it in my column on the budget published the day after the budget was presented:

One headline that grabbed attention pertains to the government announcing its intention of issuing sovereign debt in foreign currencies. Apparently, India thought of it in 2013 but did not go ahead as the macro fundamentals were deemed dodgy then. But, probably the best time to borrow would be when the domestic currency is undervalued. The Indian rupee in the second half of 2013 was close to being undervalued. Right now, India’s macro fundamentals are not weak, although big question marks remain over the economy’s growth rate, its sustainability and vulnerability to a global stock market correction. In other words, the risk is tilted towards further weakness of the Indian rupee. In 2013, it was tilted towards its strengthening after a hefty correction.

On the other hand, the timing is opportune in another sense because global central banks are back to considering further crazy monetary easing moves. To that extent, raising foreign currency borrowing now is a case of good timing. Another upside is that the government would not be crowding out domestic savings, which have declined in recent years and show no signs of reviving. That is a good thing. [Link]

The above two paragraphs only focused on the micro issue of timing the bond issuance in foreign currency. But, the argument in favour of issuing foreign currency denominated bonds in terms of it not crowding out domestic borrowers is not entirely correct, I admit, because Dr. Y.V. Reddy had pointed out lucidly as to why it is no help to domestic non-sovereign (private sector borrowers).

The argument is this: if India’s safe current account deficit is 2% of GDP and if Government of India borrows from foreigners (it is part financing of the CAD), then the amount available for other domestic borrowers in foreign currency is going to be reduced by that amount. The ‘ceiling’ is unofficially set by the ‘safe’ current account deficit for the country.

Then, on July 9, I wrote more extensively for MINT on the dangers of the Indian government borrowing in foreign currency. [Link]. It might open the door, together with other measures announced in the budget, for greater financialisation of the economy at a time, when its macro-economic health and performance are brittle.

Besides Dr. Y.V. Reddy’s piece, one of the best comments on this subject came from Sanjaya Baru. It is well worth a read.

In this piece, Shankkar Aiyar suggests alternatives to raising dollar resources through sale of sovereign bonds:

Yes, India must raise additional resources and in dollars to finance the aspiration for high growth. Why not raise dollar resources by listing LIC? Why not aggregate surplus land with government into a land bank and call for bids? Why not transfer government ownership of public sector banks and enterprises into an exchange-traded sovereign fund?

Yuan prospects

Read this in John Authers’ missive:

On the yuan, I found this point from Michael Howell of CrossBorder Capital very interesting:

The China currency is getting traction and could displace the USD in Asia (China’s stated aim). What is not well understood is that China still has an immature financial system which forces it to accumulate USD (from trade which is USD denominated) and manage them centrally via the State. Domestic institutions, unlike in the West, have predominantly Yuan liabilities and so cannot afford to take this forex risk. China initially used forex reserves to buy US Treasuries, but now invests via FDI, e.g. Belt and Road. This external infrastructure programme will help to establish the wider use of the Yuan across Asia and get China off the US dollar hook. Do not underestimate the value of this seigniorage for growth.

He could even back it up with an anecdote:

I attended the LSE launch of George’s book. There I met an ex-Central Bank Governor from Central Asia who shared my scepticism about George’s Yuan point. “I will show you,” she said and pulling out her iPhone she shared a photo of her at a formal signing ceremony for a several billion Yuan swap line with the Chinese Finance Minister. Proof she claimed that this underlying use of the Yuan is already the reality across Asia.  [Link]

Let me now do what my good friend Amol Agrawal of ‘Mostly Economics’ usually does.


Amusing and priceless

This is the amusing stuff:

“Juncker vows to turn euro into reserve currency to rival US dollar”

He must pay close attention at least the topline results of the PEW Survey I had blogged on earlier.

A quick recap:

Underneath Mr. Macron’s pro-European rhetoric, the French people are only closely behind Italy in their distaste for the European project. Politicians do not command much trust. The public is confused and worried on immigration. Distrust of media is rather high as it is the case with financial institutions.

(2) This is priceless stuff:

“Aung San Suu Kyi defends verdict against Reuters journalists”

This underscores the ‘free lunch’ of being a ‘Liberal’ outside the government and how difficult it is to govern as a ‘Liberal’. Indeed, there is an inherent contradiction being in government and being Liberal.

Two years of Patel, the RBI Governor

My friend Gulzar Natarajan drew my attention to an article by Andy Mukherjee and an Edit in MINT on the second anniversary of Dr. Urjit Patel as the Governor of the Reserve Bank of India. I had read the Mint Edit myself.

Andy’s piece is an interesting one. I do not recall readily if he had been critical of the RBI Governor’s role in demonetisation and in the ‘Reverse Bank of India’ moniker that was slapped on the institution in the initial weeks and months of the demonetisation exercise. My vague recollection is that he was. But, in any case, this amounts to a retraction of such criticisms, if he had made them earlier.

More substantively, the Governor has breathed some credibility into the Monetary Policy Committee (MPC) and the Non-Performing Asset (NPA) resolution mechanism. Arguably, he had to take tougher decisions on these than his predecessor. During RR’s period, the NPA problem was beginning to come to light. Very few had a clear idea of either the dimensions or the complexity of the problem. Of course, RR took the bold call to order Asset Quality Reviews (AQR) which allowed both of the above to be revealed. That was very important at that time. Now, Dr. Patel has to navigate the political economy of resolution which is perhaps a stiffer challenge than the political economy of disclosure. May be, I am just splitting hairs, here.

Also, the other challenge that Dr. Patel is facing is the Fed tightening and an ‘election-mode’ government both of which, collectively, bring pressure on the fiscal, current account balances and consequently on the Rupee. Popular commentary on the Rupee weakness is unhelpful to the Governor.  It bleats about the Rupee weakness as though it is a problem in and of itself. It is not. The problem is with the underlying low productivity of the economy – especially in its farm and factory sectors. On top of them, fiscal policy has quietly but steadily slipped at a general government level.

Collectively, the farm loan waivers announced by State governments – BJP and Congress-Ruled – have been more than two and half times the farm loan waiver that the UPA-1 government had announced in 2007-08. The general government fiscal deficit for 2017-18 is 7.0% as per IMF estimates. The two rate increases in June and August announced by the RBI are very important and may prove to be very important and useful in ensuring monetary and exchange rate stability.

As for macroeconomic stability, it is in the hands of the Government and not the RBI. Raghuram Rajan was right to stress its importance going into an election, in his Bloomberg interview at Jackson Hole recently.

In short, yes, the Governor has quietly re-established his personal credibility and that of the institution he heads and that can only be good news for the country.

[Post-script: Tamal Bandyopadhyay adds his two cents worth of tribute to Urjit Patel while Amol Agrawal provides the much-needed alternative perspective]