The Future of the U.S. Dollar – end

Panelists discuss the post-COVID-19 role of the U.S. dollar, options for alternative currencies, and the impact of U.S. economic and foreign policy on both.

Speakers Eswar S. Prasad Tolani Senior Professor of Trade Policy, Cornell University; Senior Fellow, Brookings Institution

Carmen M. Reinhart Vice President and Chief Economist, World Bank Group; CFR Member

Benn Steil Senior Fellow and Director of International Economics, Council on Foreign Relations; @BennSteil

President Director

Laura D. Tyson Distinguished Professor of the Graduate School, Haas School of Business, University of California, Berkeley; CFR Member.


STAFF: We will take the next question from Tara Hariharan.

Q: Thank you so much. My name is Tara Hariharan. I work for a hedge fund based in New York. And my question is actually a direct extension of the previous question. I just wanted to drill down further on the sanctions issue. So how do you all weigh the risks near-term of the U.S. effectively cutting off Chinese financial institutions’ access to the global dollar payment system, because the Chinese media has been mentioning this risk quite often nowadays. And we’ve even been hearing that systemically important banks in China and Hong Kong are preparing for such a contingency. So how likely do you think this is? I mean, it is a nuclear option, but how likely? And does China have the resources and capacity to be able to weather that kind of situation? Thank you.

TYSON: Thank you. So Carmen, I’ll start with you there and ask if there are any historical analogies as well to this notion of trying to control those kinds of capital flows for geopolitical reasons.

REINHART: So let me flag two recent examples where I think even with sanctions, you run into the problem of lack of alternatives or limited alternatives, okay. Russia, you know, we know that if you look at Russia—one of the things Russia has done to try to move away from the dollar is more reserves are held in the form of gold. Okay, that is one alternative. Again, and this is not just Russia, we also see that in China to some degree but that is a market that also, you know, has its liquidity limitation.

TYSON: Liquidity problems.

REINHART: Another thing that China has done, for example, in recent years, in trying to wean itself from having had almost its entire stock of international reserves in dollars. And this is not in the context of sanctions, but as we all know in the context of the trade frictions and trade war that we’ve seen in recent years, it shifted more to other alternatives. One, we’ve seen China’s holdings of JGB bonds skyrocket, okay. Certainly, there’s no lack of those. But, you know, that is one venue. But another venue that they explored is a lot iffier at the moment, they also started diversifying much more into emerging market debt in their reserve holdings. At the moment that does look like an awfully risky proposition and what I’m getting at, and I take Benn’s point full stop that if you use the same weapon time and time again people are going to find alternatives. But I do want to hark back to the point that whether it’s China or Russia or any other case, the alternatives at the moment are still, you know, can only give you limited diversification because we also initially when U.S. rates started to plummet, I’m not talking about COVID, I’m talking about the global financial crisis once a well, you know, U.S. fixed income looks less attractive, right? But this meant simply a shift from U.S. fixed income to U.S. equity. We saw that in, you know, sovereign wealth funds and so on that there was a reshuffling but still within the so-called dollar block.

TYSON: Eswar, you’ve sort of started your comments with “it’s all relative,” do you see, and you also have talked in your work about going into more international payments, how would you answer the question that our member raised—Tara—what are the options here for the system to respond if the U.S. is trying to move people out of U.S. capital markets?

PRASAD: So let me first supplement Carmen’s important point. I think there are alternatives out there as reserve assets. But if you think about the providers of net reserve assets, countries that are willing to provide safe assets to the rest of the world and not shun those, that’s really just the U.S. The Swiss, the Japanese, the Europeans don’t want safe-haven inflows coming into their economies because that causes their exchange rates to appreciate and their economies are not willing to tolerate that. So it’s really the U.S. as a net provider of safe assets that remains, that has become even more dominant in some ways.

But there is an important game changer on the horizon. It’s not China’s digital currency. Most international payments are already digital, and as both Benn and Carmen have pointed out, the digital currency for electronic payments of China’s [inaudible] is meant for domestic use. What is the game changer is China’s Cross-Border Interbank Payments System, the CIPS. That is a part of an important aspect that Benn alluded to, the notion that there are countries around the world, that at this stage, are tired of U.S. sanctions, not only direct sanctions imposed against geopolitical rivals of the U.S., but indirect sanctions so that European firms, Chinese firms that engage in any form of business with companies and those countries are on the U.S.’s sanctions list, get sanctioned, and this throws a very broad net. So now you have a situation where China’s Cross-Border Interbank Payments System can, in principle, talk to other countries’ payments system, once it gets to the European payment system, so you could have a lot more payments being channeled through these alternative payments systems that bypasses the dollar-based financial system. So I think they’re going to see a bit of a bifurcation with the dollar’s role, especially if the U.S. continues using this bludgeon, the dollar’s role as a payments currency declining. But as a reserve currency, I don’t think any of this is going to make the least difference.

TYSON: Thank you. That’s, I think, a really important observation which was clearly implied by the panelists, but I think it’s important to underscore. I think we have time for a couple more questions. So next question, please.

STAFF: We will take the next question from Teresa Barger.

Q: Hi, thank you. So I just wanted to raise my hand earlier, I just wanted to go back to this capital markets nationalism, and I’m interested that Benn had already done work on it. Just today we had a Chinese company that’s an ADR listed in the U.S., announced that Goldman Sachs and Morgan Stanley were going to arrange its new listing in Hong Kong and it went up 13 percent. And I don’t think that this is a matter of waiting for an administration to change because there was an unanimous vote in the Senate for the “Holding [Foreign] Companies Accountable Act” that basically gave companies three years to cure the fact that the U.S. couldn’t audit the auditors. But when the secretary of state wrote to universities, he said, “Hey, you’ve got two years,” because he was referring to what might be an executive action on it. So I think there’s a bipartisan push here, and I’m just wondering, especially maybe Benn’s crystal ball, if $1.8 trillion of ADRs leave the U.S., go into China, some of those will list both in Shanghai and Hong Kong. And then, you know, to the extent that Hong Kong is not independent and gets more and more drawn into China where erosion of the rule of law follows things like the very bad enforcement of corporate governance. Then are we really speeding up this plan that China had to become the second most powerful capital markets force in the world, but with this major blockage they have which is capital controls and a controlled currency? Where does that go?

TYSON: So Benn, I think that’s directed largely to you to follow up with.

STEIL: Yes, with regard to Shanghai and Hong Kong, I had again twenty years ago seen them as being indistinguishable in the long term, because the Chinese government was eventually going to determine that one or the other, for political reasons, was going to be the international hub. And there was no reason why it had to be Hong Kong anymore. And, of course, now that Hong Kong has been totally absorbed into the Chinese legal system, there really isn’t any compelling reason to give it space in the international arena. Shanghai and Hong Kong already have an electronic interconnection that can at almost a moment’s notice be transformed into a complete merger. So we need to understand, first of all, that when we talk about equity markets, for example, being located in different national jurisdictions, these aren’t geographical distinctions anymore. These are pure legal distinctions. An institutional investor in the United States doesn’t have to go anywhere to trade abroad, it’s simply a different window on the screen. That window, of course, that separate window represents an entirely different legal and political infrastructure, but it is still remarkably easy for investors to switch their jurisdictions as the rule base changes.

So I do believe that the Chinese government is actually welcoming this aspect of American decoupling policy, because they know perfectly well that U.S. institutions who dominate our equity markets don’t give a damn about whether the security is available on the New York Stock Exchange or Nasdaq. They’re going to go where the security is most liquid, and as you yourself pointed out, Laura, we could eventually, and this is the way sanctions always work, right? It’s whack-a-mole, okay. We can go after the institutions and say, aha, you institutions can’t go abroad to invest anymore. And guess what, within a few months they’re Dublin-based financial institutions, they’re no longer American institutions. So really, I think we have to take a deep breath and ask ourselves what it is we’re trying to accomplish, and whether a capital market sanctions are really helping us get towards our geostrategic goals, or whether they’re impeding the achievement of these goals.

TYSON: So I believe we may have time for one more quick question and I’d like to try to do that. So let’s see. Do we have one other question we can end with?

STAFF: We will take our last question from Anders Aslund.

Q: Thank you very much. I wanted to follow up on a Laura Tyson’s last question to Carmen about debt. You are traditionally a fiscal conservative, and you recently written a couple of articles warning for the big debt burden in the world. Now the IMF came out and said, “Take more debt, invest in infrastructure, the interest rates are so low now.” How do you balance this? Thank you for your good presentations.

TYSON: Great, Carmen to you.

REINHART: So, one tiny follow up on the previous discussion, I wanted to say that the very relevant literature to that discussion is an old literature on financial transactions taxes, in which every time an equity market introduced the transactions tax, what you would see as diversion, and in effect, mark the end of the Osaka Exchange in favor of other regional alternatives and so on, so it’s very germane to that.

Now turning to Anders’s question. So I think the view that I’ve expressed on the current situation is that we are at—Anders—we’re in the middle of war, okay, so, you know, you first worry about winning the war, and then you worry about how you pay for the war. Now, you know, the timeline of course, is very different across countries, I think, you know, the emerging market, the low income, the emerging market prices is very much at the very, you know, close end. And so, you know, how do you reconcile? You reconcile that at the moment—I’m not talking about fixed investment in terms of, you know, this is the time to engage in grandiose, you know, infrastructure investments and other investment—but certainly, there’s huge emergency spending needs that, you know, can’t be denied. And so ultimately, I think, for many of the emerging markets, the next step is debt restructuring meaning engaging in a process that is very familiar to us, for those of us that lived through the ’80s and went through the ’80s.

I think, now, for the advanced economies, the advanced economies, of course, have much longer rope than the emerging markets, but I don’t think that, you know, I’m not talking about taking advantage of low interest rates and that narrative, I’m talking about, you know, if you need to have a bigger deficit now because, you know, the share of population living below the poverty line has skyrocketed and they don’t have any kind of social safety net and you have all kinds of issues, you have to cope with that. And then that restructuring is likely to follow, but you know, that’s I think where we are given the depth and breadth of the crisis we’re in.

TYSON: So, I think that’s a terrific note on which to end, and I want to thank all of the members for joining us today. And special thanks, of course, to our outstanding panelists. You know, each of these people has written extensively on these issues, and I would encourage all of you to visit their websites, visit the Council’s website, and to read what they have been saying as well. Please note that the transcript and the audio of today’s meeting will be posted on CFR’s website so you can go back and revisit the answers if you want. And, again, thanks very much. I learned a tremendous amount. Thank you so much for taking time out of your very busy lives, my distinguished panelists, and taking time to work with us and with the members of the Council. Thank you.


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