What to Make of the Global Dollar Shortage?

Position:A SYMPOSIUM OF VIEWS
 
FREE EXCERPT

The global shortage of dollars has wreaked havoc on emerging market economies, particularly in Latin America. The shortage is a result of dollar flows back into the United States as a result of changes in U.S. corporate tax treatment, deficit spending, and the Federal Reserve's tightening of monetary policy at a time when the major global economies, with the exception of the United States, appear to be sluggish.

But what about China, which is accountable for one-half of the emerging markets' dollar-denominated debt? Chinese officials appear to have been clever at disguising the threat of the global dollar shortage at a time when a lot of Chinese-held dollar-denominated corporate debt will soon mature and will need to be either rolled over or paid off. Some financial strategists suggest Chinese policymakers will have no choice in a world with the dollar still the reserve currency but to continue expanding monetary policy, which could lead to further currency depreciation.

But at a time of huge global trade tensions, would a Chinese turn to further currency depreciation be like throwing a match on the world's stock of political kerosene? Will the trade war ratchet up to a higher level? Or will China figure a way to manage itself out of such a scenario, as it has in the past managed itself out of other predicted policy conundrums?

DESMOND LACHMAN

Resident Fellow, American Enterprise Institute

According to a Wall Street adage, when the winds are strong, even turkeys fly. This adage might have particular relevance for today's emerging market economic outlook at a time when many years of ultra-easy global liquidity conditions are coming to an end.

During the years when the world's major central banks maintained extraordinarily low interest rates and expanded the combined size of their balance sheets by some US$ 10 trillion, the emerging market economies had little difficulty in tapping the international capital market. Indeed, emerging market corporates managed to increase their borrowing by some US$15 trillion between 2008 and 2017. And they did so at interest rates that did not nearly compensate investors for the default risk associated with this borrowing.

Equally striking is the fact that last year a country with as checkered a default record as Argentina could issue a 100-year bond on relatively favorable terms. Or that investors eagerly snapped up sovereign bond issues by countries with as dubious economic and political fundamentals as Iraq, Kenya, Mongolia, and Tajikistan.

Sadly, for the emerging market economies the strong winds of very easy global liquidity conditions are now rapidly dying down. The Federal Reserve is now well on its way to normalizing interest rates and reducing the size of its balance sheet. At the same time, the European Central Bank has announced that it will stop its quantitative easing program by year-end.

Further clouding the emerging market outlook is the pursuit of an expansive fiscal policy by the Trump Administration at this late stage in the U.S. economic cycle. By putting upward pressure on U.S. interest rates and the U.S. dollar, that fiscal policy reinforces the capital flow reversal from the emerging markets already being induced by the more attractive interest now on offer on U.S. Treasury issues.

The last thing that the emerging market economies now need is a slowing in the Chinese economy and a depreciation of its currency. Not only would that crimp demand for international commodities, which is the lifeblood of many emerging market economies. It would also heighten the risk that China and the United States would drift further towards a full-scale trade war that might derail the global economic recovery.

Yet it is difficult to see how China can succeed in avoiding a slowing in its economy as it tries to address its own domestic credit bubble of epic proportions. And if the Chinese economy does slow, it is all too likely that the Chinese authorities will be tempted to allow their currency to weaken to provide some support to the economy.

The emerging market economies' immediate daunting challenges have clear implications for both the U.S. and the global economic outlook. After all, the emerging market economies now account for over 50 percent of the global economy and are hugely indebted to the global financial system. This has to make one think that the U.S. administration is ignoring at its peril the adverse impact of its budget and America First trade policies on the emerging market economies.

DARRY EICHENGREEN

George C. Pardee and Helen N. Pardee Professor of Economics and Political Science, University of California, Berkeley

The editors of TIE ask an interesting question, but it is not clear that the implication follows from the premise. While scarce or expensive dollar funding will make it more difficult for Chinese corporates to service and repay their dollar-denominated debts, more expansionary monetary policy in China won't make this task any easier. If anything, the consequent renminbi depreciation will make servicing dollar-denominated debt even more difficult.

It could be that the editors have in mind that difficulties of corporate debt service will mean less investment and weaker economic growth. It is then conceivable that the Chinese authorities, seeking to keep growth near target, will turn to a more expansionary monetary policy designed to boost spending in response. If so, they will then have to find other instruments for dealing with corporate indebtedness, such as stepping up their effort to selectively restructure problem debts. And indeed, a weaker renminbi is all but guaranteed to fuel trade tensions with the United States.

From this I conclude that a more expansionary monetary policy is not the best response on the part of Chinese officialdom. Better would be to accept the reality of a somewhat slower growth rate now that the growth of global trade is slowing and the United States has become a more problematic partner.

ADAM S. POSEN

President, Peterson Institute for International Economics

Repeatedly, since the start of the financial crisis, observers have mistaken real phenomena for monetary mischief. Talk about a global dollar shortage is another instance of this error. There is a shortage of safe assets in the world, given real dangers--inflation and instability in Latin America, inability of the euro or the yuan to take on a global role, and most of all low returns on many forms of investment due to slow productivity growth. The world has had multiple reserve currencies and thus a variety of places in which to put savings for safety at other times in history. It is the lack of those alternatives, not the short-term U.S. macro policies, however irresponsible on the fiscal front, which are causing capital outflows from emerging markets to the United States.

Even the fiscal binge of the Trump Administration and Congressional Republicans isn't causing a dollar shortage. By creating more U.S. government debt through deficit spending, they are creating more safe assets for people to hold, and to borrow against. By expanding the U.S. current account deficit at a time when a few economies are slowing down, the United States is being accommodative of emerging market growth. By having the dollar appreciate when the United States is relatively if unsustainability outperforming, the United States is rebalancing growth back to other economies. There are problems with races to the bottom in corporate tax rates and loopholes, as well as obviously with trade war, but again, those are changes to the real return on assets and to volatility. It isn't about currency shortage.

As for China, a market-driven depreciation of the yuan versus the dollar is natural and to be expected when there are tariffs being put on Chinese exports by the Trump Administration. Trump may still try to claim a currency war, even when the Chinese government is not manipulating (and if anything intervening to keep on capital controls and limit currency decline), but he will fail in waging one. The tariffs and fiscal deficits, along with creating uncertainty more broadly, all create upward pressure on the dollar.

The Chinese government can cope by using their ample fiscal space for domestic stabilization whenever they are ready to do so. If they mess up their situation by easing domestic credit standards and creation instead, as they seem to be doing, that will have nothing to do with dollar shortage either.

JOSEPH E.GAGNON

Senior Fellow, Peterson...

To continue reading

REQUEST YOUR TRIAL