Many people, including myself argued that resolution of global imbalances calls for further dollar wekaness. Actually the National Bank of Poland even took specific actions to hedge from such a scenario by reducing over the last 18 months dollar exposure from 50% to 40% of reserves and increasing British pound from 10 to 15% and Australian dollar from 0% to 5%. This is a part of the global diversification journey on which central banks embarked in the last few years, and which is apparently accelerating, see my paper coathored with Urszula Sowa.
I am trying to put few thoughts inspired by today’s dollar weakness.
- to solve global imbalances one would need dollar appreciating against Asian currencies, which is not happening amid renminbi slow crawling band, or policy actions aimed at raising US saving and reducing Chinese saving. Finally I subscribe to Caballero view that the key factor here are shortages of investable assets in Asia and in the Gulf.
- many people would say that Asian central banks would not welcome significant decline of the dollar as it would cause major valuation losses, however it applies only to appreciation of their local currencies it does not apply to situation when dollar goes down with respect to major currencies.
- after all, when Asian or Gulf investors buy US debt they are promised in return a certain amount of banknotes with US presidents, and with the possible absence of mark-to-market accounting practices it may not matter much what happens with the market value of this promise in the meantime. In other words, if the intention of large US debt holders is to keep it to maturity, they may exhibit large aversion to exchange rate risk (local currency) than to interest rate risk, on the assumption that in the long run the value of the banknotes with US president will be restored, ie. that current swings are transitory (will last few quarters or years rather than decade or more).
- why would large debt holders think in domestic rather than synthetic world currency terms. Because of investment protectionism present in US and in Eurozone they will not be allowed to buy sizeable assets (there are some cases when such purchases were blocked).
- could this lead to vicious circle that works like example below, I do not know, but it is worth conducting a thought exercise:
- faced with US pressure to enact anti-Chinese legislation and with pressure via enhanced IMF mandate to chase currency manipulators Asian central banks purchases of US debt may slow, leading via market expectations channel to dollar weakness
- oil exporters become very uncomfortable with situation when value of their commodity exports priced in dollars suffers from dollar weakness, and domestic currencies linked to dollar are fuelling already high inflation in some countries
- more oil exporters may decide to drop dollar pegs and move to different way of oil export invoicing, after all why expose their countries to such high currency risk.
this affects relative asset prices even more, with possible further dollar weakness and possible further gains for emerging market currencies. Dollar will further loose its appeal as reserve currency to reserve managers. Even if it gains in value, it will not regain it status.
- I wonder whether US senators proposing anti-Chinese legislation went through such a thought exercise. Mercantilist approach does not work in XXI global economy, simply some politicians fail to grasp it.