The “flight-to-safety” describes the tendency to hold a assets denominated in a robust currency. This has been true for the US dollar during the post-war period. Ilzetzki, Reinhart, and Rogoff (2018) studied the issue and found that the US dollar remains the preferred anchor and reference currency despite the introduction of the Euro and the rise of the Chinese currency.[1]
Recently, a number of an online journalistic articles argued that there have been some underlying political-economy sort of events that might undermine the dominance of the US dollar.
One of these events is the financial money-transfer system, e.g., SWIFT - the Society for Worldwide Interbank Financial Telecommunication. Clearly, this system is highly influenced, or even dominated, by the United States, is it not? The trouble might stem from the US decision, for whatever reason, maybe political, to cut off countries such as Russia or China, or Iran, etc. from that system. There has been a strong push against Russia and China in the US recently.
That led Russia and China to creating an alternative system.
Moreover, the EU decided, including the UK, to continue to trade with Iran in defiance of the US. The EU announced that it had created a new system, INSTEX - Instrument in Support of Trade Exchange - to bypass the international system, which is under the control of the US, in order to facilitate payments with Iran, and other countries that have bad relationships with the US. This must be an important development in the international monetary arrangement, and must have some implication for the US dollar domination, now and in the future.
There is no doubt that there is a rising tension between the US and the EU regarding the latter's economic ties with Iran, Russia, and China. Trump has a very different stance on globalization and international trade from previous governments. INSTEX could be used in case the US decided to punish the EU for importing gas from Russia, for example, could it not.
The market value of the US dollar, and a lot more currencies, are highly affected by trade, i.e. the price of a currency in terms of another (exchange rate) is a function of trade issues.
The tariff war on China may not be benign, or a bluff. It does affect the exchange rates among other things. It increased uncertainty. Uncertainty is not something one could insure against; it would distort prices and affect the volume of trade. What if no deal is reached and tariffs increased by 25 percent?
So the straightforward implication of the break of the US dollar dominated international monetary arrangement, which has been in place since 1945, may be at the end of the day only a declining global demand for the USD, thus, a depreciated currency.
A depreciation of the USD itself is not a major cause of a concern for economists.
Countries with fixed exchange rate such as China and Russia and most of the oil-producing rich countries hold a huge amount of US dollar debt and reserves. Although the interest rate paid on US debt is low, these countries would also lose a great deal if they undermine the US dollar, don’t they? In other words, dumping the US dollar is costly.
However, something else could jeopardize the supremacy of the US dollar.
Modern Monetary Theory, which is advocated by some Democrats in the U.S. today, proposes to use the Fed balance sheet to, permanently, finance social programs. The issuing of more debt would put upward pressure on interest rate. If the debt issuing is persistent or permanent, it might have some damaging effect to the US dollar.
In my paper with Moosa (here) “Monetary Policy, Corporate Profit, and House Prices,” we show, using US data, that there is a strong relationship between corporate profit and asset prices such as housing prices and stock prices. Monetary policy drives all these variables. The increase in interest rate and / or the reduction of the money stock reduce both corporate profits and asset prices (different magnitudes).
A permanent change to monetary policy along the lines suggested by the Modern Monetary Theory would induce a secular decline in corporate profits, and asset and share prices that could cause a permanent decline in the demand for US dollars and setup the way to ending its dominance at some future point.
That is a testable scenario.
[1] Ethan Ilzetzki, Carmen M. Reinhart, Kenneth S. Rogoff, February 2017, Exchange Arrangements Entering the 21st Century: Which Anchor Will Hold? NBER Woking Paper No. 23134.
Recently, a number of an online journalistic articles argued that there have been some underlying political-economy sort of events that might undermine the dominance of the US dollar.
One of these events is the financial money-transfer system, e.g., SWIFT - the Society for Worldwide Interbank Financial Telecommunication. Clearly, this system is highly influenced, or even dominated, by the United States, is it not? The trouble might stem from the US decision, for whatever reason, maybe political, to cut off countries such as Russia or China, or Iran, etc. from that system. There has been a strong push against Russia and China in the US recently.
That led Russia and China to creating an alternative system.
Moreover, the EU decided, including the UK, to continue to trade with Iran in defiance of the US. The EU announced that it had created a new system, INSTEX - Instrument in Support of Trade Exchange - to bypass the international system, which is under the control of the US, in order to facilitate payments with Iran, and other countries that have bad relationships with the US. This must be an important development in the international monetary arrangement, and must have some implication for the US dollar domination, now and in the future.
There is no doubt that there is a rising tension between the US and the EU regarding the latter's economic ties with Iran, Russia, and China. Trump has a very different stance on globalization and international trade from previous governments. INSTEX could be used in case the US decided to punish the EU for importing gas from Russia, for example, could it not.
The market value of the US dollar, and a lot more currencies, are highly affected by trade, i.e. the price of a currency in terms of another (exchange rate) is a function of trade issues.
The tariff war on China may not be benign, or a bluff. It does affect the exchange rates among other things. It increased uncertainty. Uncertainty is not something one could insure against; it would distort prices and affect the volume of trade. What if no deal is reached and tariffs increased by 25 percent?
So the straightforward implication of the break of the US dollar dominated international monetary arrangement, which has been in place since 1945, may be at the end of the day only a declining global demand for the USD, thus, a depreciated currency.
A depreciation of the USD itself is not a major cause of a concern for economists.
Countries with fixed exchange rate such as China and Russia and most of the oil-producing rich countries hold a huge amount of US dollar debt and reserves. Although the interest rate paid on US debt is low, these countries would also lose a great deal if they undermine the US dollar, don’t they? In other words, dumping the US dollar is costly.
However, something else could jeopardize the supremacy of the US dollar.
Modern Monetary Theory, which is advocated by some Democrats in the U.S. today, proposes to use the Fed balance sheet to, permanently, finance social programs. The issuing of more debt would put upward pressure on interest rate. If the debt issuing is persistent or permanent, it might have some damaging effect to the US dollar.
In my paper with Moosa (here) “Monetary Policy, Corporate Profit, and House Prices,” we show, using US data, that there is a strong relationship between corporate profit and asset prices such as housing prices and stock prices. Monetary policy drives all these variables. The increase in interest rate and / or the reduction of the money stock reduce both corporate profits and asset prices (different magnitudes).
A permanent change to monetary policy along the lines suggested by the Modern Monetary Theory would induce a secular decline in corporate profits, and asset and share prices that could cause a permanent decline in the demand for US dollars and setup the way to ending its dominance at some future point.
That is a testable scenario.
[1] Ethan Ilzetzki, Carmen M. Reinhart, Kenneth S. Rogoff, February 2017, Exchange Arrangements Entering the 21st Century: Which Anchor Will Hold? NBER Woking Paper No. 23134.
