Granularity Ltd

Mark Carney, Governor of the Bank of England until January 2020, has decided to make his final months in office quite lively, beyond and above the UK crashing out of the EU with Brexit.  On Friday he gave what is probably his most important speech ever, even if it barely made the headlines.  He delivered the luncheon keynote at the annual central bankers' jamboree at the Jackson Hole Symposium in Wyoming.  Paul Volker began dragging central bankers there each August to worry the local fish in lakes below the peaks of the Tetons a few decades ago.

The Carney speech was covered in Bloomberg, Reuters and the Financial Times, but otherwise widely ignored on a day that Fed Governor Jerome Powell assured Fed watchers he would "act as appropriate" but warned "there is no rulebook for a trade war" and Trump and Xi both massively escalated the trans-Pacific trade war with tit-for-tat tariff hikes.

Mark Carney went there.  He said it was time to shift the global monetary system away from the US Dollar, which has anchored the global economy since Bretton Woods, toward a  system reflecting the "diverse, multipolar global economy that is emerging".   It's not a great speech, a bit too long and not well structured, but like the talking dog, it's not so amazing what he said but that he spoke at all.

The United States has recently engineered the removal and deaths of leaders (Saddam, Khadafi) and devastated nations (Iraq, Libya, Syria) that attempted to de-dollarise their economies.  Iran's great offense is to attempt to trade oil for Renminbi and Euros.  Any threat to the dollar's primacy in the world is deemed an existential threat to the American way of life.  It's worth remembering that Bush 41, Dick Cheney and Bush 43 have all warned the world that "the American way of life is not negotiable".  Without Dollar monetary hegemony the United States would cease to be able to finance its $1 trillion federal budget deficits or export its sub-prime risky private mortgages, car loans, student loans, and credit card debts to yield-hungry banks and investors worldwide.  It might even have to raise taxes on the rich.

China's great offense in 2019 is not building better products more cheaply than America, it is refusing to buy more US Treasury securities with the proceeds of its trade surplus as monetary reserves.  China is recycling its US Dollars into the 'Belt and Road Initiative' instead, to build capacity and markets in the regions of the world too long marginalised by the OECD.  As far as the US is concerned, if America exports dollars they must come back to finance more American debt.  If they don't, then dollar hegemony is under threat.

Carney frames the challenges as short term (play the cards we are dealt), medium term (shuffle the deck), and long term (change the game).  Below are key excerpts from Carney's speech:  The Growing Challenges for Monetary Policy in the Current International Monetary and Financial System:
 

[Short Term - Dominant Currency Pricing in USD]

This same framework can be used to think through the implications of the dominance of the US dollar in international trade and invoicing. In particular, in a DCP world with sticky dollar prices, a depreciation driven by strength in the dollar will tend to result in additional imported inflation.Rather than tightening monetary policy to offset fully that exogenous increase in imported inflation through lower domestic inflationary pressures, policymakers would do better to trade off inflation and output volatility, accepting some increase in imported inflation to achieve a smaller reduction in domestic demand below potential. The ability of new exporters to benefit from the depreciation by undercutting existing dollar contracts would provide some boost to exports and help lessen the trade-off facing the monetary policy maker.

A similar strategy could be pursued in the face of large financial spillovers. The ability to do this depends heavily on the credibility of the monetary policy framework and the transparency with which the strategy is pursued. As I will go on to discuss, both can be reinforced by explicit recognition of the spillovers of the IMFS, particularly if recognised in IMF surveillance. . .

As the weight of EMEs in the global economy has steadily risen, the size of the spillbacks from a tightening in US financial conditions has tripled relative to its 1990 -2004 average. With EMEs projected to account for three quarters of the global economy by 2030, these spillbacks will only continue to grow (Chart10). 

[Medium Term - reshuffling the deck]

EMEs [emerging market economies] can increase sustainable capital flowsby addressing “pull” factors including:
-reinforcing monetary policy credibility including safeguarding the operational independence of central banks;
-building the resilience of their banks;
-deepening their domestic capital markets to reduce the reliance on foreign currency debt; and -expanding the scope and application oftheir macroprudential toolkits to guard against excessive credit growth during booms. Bank of England research finds that tightening prudential policy in EMEs dampens the spillover from US monetary policy by around a quarter.

[Long Term - changing the game]

Transitions between global reserve currencies are rare events given the strong complementarities between the international functions of money, which serve to reinforce the position of the dominant currency. . . However, for the Renminbi to become a truly global currency, much more is required. Moreover, history teaches that the transition to a new global reserve currency may not proceed smoothly. . . The experience of the interwar period is a cautionary tale.When it comes to the supply of reserve currencies, coordination problems are larger when there are fewer issuers than when there is either a monopoly or many issuers. While the rise of the Renminbi may over time provide a second best solution to the current problems with the IMFS, first best would be to build a multipolar system.The main advantage of a multipolar IMFS is diversification. Multiple reserve currencies would increase the supply of safe assets, alleviating the downward pressures on the global equilibrium interest rate that an asymmetric system can exert. And with many countries issuing global safe assets in competition with each other, the safety premium they receive should fall. . . Technology has the potential to disrupt the network externalities that prevent the incumbent global reserve currency from being displaced. . . The Bank of England and other regulators have been clear that unlike in social media, for which standards and regulations are only now being developed after the technologies have been adopted by billions of users, the terms of engagement for any new systemic private payments system must be in force well in advance of any launch.As a consequence, it is an open question whether such a new Synthetic Hegemonic Currency (SHC)would be best provided by the public sector, perhaps through a network of central bank digital currencies. 

[Conclusion]. 

Even a passing acquaintance with monetary history suggests that this centre won’t hold. We need to recognise the short, medium and long term challenges this system creates for the institutional frameworks and conduct of monetary policy across the world. Given the experience of the past five years, I will close by adding urgency to Ben Bernanke’s challenge. Let’s end the malign neglect of the IMFS and build a system worthy of the diverse, multipolar global economy that is emerging.

Carney is far from the first to think the dollar's days are numbered, it's just that no one knows how to manage the transition.  The usual course of transition from one currency hegemon to another is imperial collapse, world war, and genocide.  Trump and Xi may be moving along that trajectory, but the rest of us should be looking to better methods of distributing monetary collaboration among the world's diverse developed and emerging economies.

There is quite a bit of new thinking coming forward, even among economists.  In his book Exorbitant Privilege: The Rise and Fall of the Dollar, Barry Eichengreen canvasses the history of global monetary cooperation and systems and points out quite convincingly that it is possible to have multiple reserve currencies in a stable system.  His follow up book, How Global Currencies Work: Past, Present and Future, builds on the ideas to suggest some options for transition to a more stable monetary order.   'Exhorbitant privilege' was coined by Valerie Giscard d'Estaing as French treasury minister under De Gaulle for the US Dollar's role in the Bretton Woods and Bretton Woods II systems.  He conceded then that that world accepted the cost of US Dollar hegemony in exchange for the US role as the 'trusted steward' of the free world economic order during the Cold War.  Under Trump the 'trusted steward' has become the senile, crazy uncle shouting abuse at the youngsters around the table of the global economic order.  Mark Carney actually accused the US of exporting destabilisation in recent years, which is true, of course, but almost never alluded to in polite company.

Carney waffles a bit around the emergence of the Renminbi as a monetary currency, which he confirms is problematic and a long way off, and then digresses to suggest a new 'synthetic hegemonic currency' building on the Special Drawing Right and perhaps launched as a cryptocoin like Facebook's Libra.  Yeah, right.  Renminbi as a reserve currency will likely happen first, as any new basket to be representative will require US participation.  The US is unlikely to back another basket currency where they will not have future dominance.  Frankly, the 'synthetic hegemonic currency' bit of the speech made me wonder what job Carney is angling for next, or whether his old firm Goldman Sachs is developing the 'synthetic hegemonic currency' for taking over global monetary policy.  The news that Carney met secretly with Zuckerberg in April makes a move to Silicon Valley next January more likely, although the vacancy at the top of the IMF is still open too.

The problem with 100 per cent reserving is that it is never 100 per cent for very long.  The US dollar was 100 per cent reserved against gold at $35 dollars per ounce.  That was abandonned with Bretton Woods II.  Banks used to be 8 per cent reserved against, well, reserves.  That was abandonned with Basle Accords II.  Libra says it will be 100 per cent reserved, at least until we find they've lost the reserves on some side speculation - er, investment - by the depositories involved.  Then we have Libra II.  The demand for crypto coins is a symptom of the pathology of the global monetary order, not a cure for de-dollarisation.

The most important thing Carney did on Friday was make it mainstream and respectable to suggest that the days of US Dollar hegemony in the global monetary order are numbered.  His most important message is that there needs to be sensible planning and collaboration now in the short, medium and long term to manage the transition to a diverse, multipolar monetary order peacefully, preserving the prosperity of recent advances in the global economy that have lifted billions out of poverty.  That is something we can all work together to achieve.