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
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TYSON: So Benn, you’ve written about the role of the frequent use of U.S. financial economic sanctions as something that leads to questions around the world of reliance on the dollar since basically the U.S. seems willing then to intervene in financial markets and pose economic sanctions in a way which other countries may not want to do. Do you think that looking forward—that’s related I think to Eswar’s point that the institutional framework has been weakened somewhat in the U.S.—what do you think are the main things that the U.S. can do to shore up (back up) its role as the global currency provider?
STEIL: Let me just briefly address the China question and then I’ll move into the U.S. question. First in terms of the Chinese government’s efforts to internationalize the RMB, there’s a long-term perspective and there’s a short-term perspective and they clash. Long term there’s no doubt that the Chinese government likes the idea of RMB internationalization and is taking steps to push it forward.
But in the short term, there are many things pushing against that. First of all, international transactions outside of China, still overwhelmingly denominated in dollars, so a lot of Belt and Road financing from China is not only in dollars when it’s in RMB, it often gets swapped into dollars. So there’s, you know, there’s little that China can do in the short run.
Secondly, China itself is conflicted, because in a crisis like we’re going through right now, capital flows are volatile, China often wants to encourage dollar inflows because it needs dollars. So in the short term we can expect China periodically to take actions that are going to push against the internationalization of the RMB.
With regard to the digital currency, I see that as having overwhelmingly domestic political and economic significance, not international significance. It will reinforce the power of the CCP over domestic financial transactions and weaken the power of private and state-owned financial institutions in the country, and it will push to reinforce CCP (Chinese Communist Party) control over social interactions. For example, the social credit system, to the extent that the government is controlling, in essence, all financial transactions, it can use access to that system as a very powerful tool to compel people to behave in one way and not another. So I see that significance being overwhelmingly domestic.
With regard to the U.S., you and I have discussed this before, I think the biggest threat to the continued dominance of the U.S. dollar internationally is the behavior of the United States. Over the past decade, in particular, we’ve used financial markets and sanctions increasingly aggressively for understandable reasons. They’re a very powerful tool to compel nations to behave in certain ways and not others because nations need access to U.S. dollars in order to conduct any sort of international financial transactions.
The problem is that the more you use this aggressive tool, the more we can expect the rest of the world to adapt to it, to find alternative mechanisms. It’s just like the overuse of antibiotics for treating specific types of bacterial infection. Antibiotics can be very powerful, but if they’re overused, you expect the bacteria to mutate and to become resistant to the antibiotic, and then you have to develop new antibiotics.
And indeed, we are seeing the world beginning to develop new antibiotics against U.S. financial sanctions. In particular, Iran, as you know, has given the European Union enormous impetus to begin developing an alternative international payments system that will not involve any role for the U.S. dollar-based payments system. It’s still embryonic, but again the more we continue to use this tool in ways that the rest of the world finds offensive, the more we can expect the world to invest in alternatives that could ultimately over time begin whittling (decrease) down the influence of the U.S. dollar internationally.
TYSON: It’s time to turn to the audience, but I want to take a moment to ask Carmen a question because it’s something that hasn’t come up here. So Carmen, you have written extensively on how countries can become over indebted, the debt-to-GDP ratio, the fact that a country can lose fiscal space by losing confidence. So the U.S. fiscal outlook has seriously deteriorated over the next decade clearly, and yet, we continue to see purchases of U.S. assets, federal government assets, and we continue to see very low borrowing rates. Are you concerned about the deficit outlooks for the United States and the implications for the dollar? And then I’ll turn it over to the members at that point.
REINHART: So, first of all, I want to clarify—Eswar I didn’t say 100 percent because it doesn’t look good. You know, it doesn’t look good in these things. So, the answer is yes, I am concerned and it is unclear over what horizon that plays out, okay. Before I launch into that, let me add one more thought on why the issue of what currency is dominant is important. Historically geopolitically, the correlation between dominant powers and dominant currencies is compelling. I mean, during the colonial, Spanish period it was Spanish silver that you would find in Asia and everywhere else. We had the UK in its heyday, the Dutch somewhere in between a little bit. And so those correlates are indicative of a much broader range of geopolitical issues, as well as economic ones. Now, what is the concern? I think the concern is, and this has been flagged in some recent academic papers by Helene Rey, by Maury Obstfel, sort of what is a modern-day Triffin dilemma* look like.
*Triffin’s Dilemma: If the United States stopped running balance of payments deficits, the international community would lose its largest source of additions to reserves. The resulting shortage of liquidity could pull the world economy into a contractionary spiral, leading to instability.
Let me translate that into the English language for a moment, you recall at the tail end of Bretton Woods, we were still linked to gold, so there was a gold content to the dollar and the U.S. was financing the Vietnam War, and there was great demand for dollar debt. And the U.S. because of its own involvement in Vietnam and other issues supplied that debt. However, the backing by gold shrank relative to the amount of debt outstanding, the amount of debt outstanding was meeting the global demand, and the outcome was, the breakdown of Bretton Woods, a big depreciation against the dollar, big depreciation against the dollar, versus the Deutsche mark and a period in which the dollar did not lose dominance, but it went through a very wobbly (unstable) phase.
So given that we’re not connected to gold, why bring up the modern version of the Triffin dilemma, is the rest of the world wants less debt, wants to hold dollar-denominated debt. But in so supplying the external demand for debt, it begins to hit up against its own domestic objective of debt sustainability, and the backing here is not gold, it is goods and services, it is the size of the U.S. economy in the global context. If you look at the last 50–60 years, especially in the last twenty, the U.S. share of global GDP has been on a downtrend. So the combination of debt as a rising share of global GDP to meet the demand from abroad and a shrinking share of global GDP, not as rapidly shrinking as Europe’s, but nonetheless shrinking, can give rise to the Triffin dilemma which, you know, could undermine at some point. And that’s the million-dollar question, which I won’t tackle with a ten-foot pole, what that moment, that turning point, when that might be because I would recall that the U.S. hasn’t been alone in accumulating a lot of debt during the recent past.
TYSON: Okay, so I’ve already taken time from the members and I apologize for that. I want to point out that in the last remark, one of the things we could talk about and maybe members might be interested in, when we’re talking about the global status of the dollar, it’s not inconsistent with, as you pointed out, a significant depreciation of the dollar at a certain point. I mean the dollar could remain the global currency, but its value might actually at a certain point undergo some significant adjustment. Let me turn to the members. And a reminder that this is all on the record. And the way this will be handled is there’s someone at the Council who will recognize a question and direct it either to a particular panelist or to the panel overall. So let me turn it over and see if there are questions from the members.
Members
STAFF: first question from Fred Hochberg.
Q: Thank you, this is great. I get a mixed message here. To what extent is the sanctions we’ve done with Iran and others sort of a theoretical threat or real threat to the dollar? It’s not clear from—maybe there may be three different opinions—and if it is a real threat, how do we explain that to American voters that this is important and therefore impacts them directly? Because I think it feels like too much of a theoretical or elite argument and not something that everyday voters and everyday even businesspeople have an understanding of.
TYSON: So Benn, you’ve actually written about the importance of these sanctions. Maybe what you might want to talk about is have they had an effect so far, or will they undermine going forward, because you’ve mentioned that the rest of the world is looking for alternatives? We’ve encouraged them to look for alternatives.
STEIL: Well, if the EU succeeded in building a credible infrastructure for international payments, that quarantines the U.S. financial system. That would most likely encourage more international transactions to be done in Europe. So that’s one possibility, but I should also emphasize to make it more practical, which is what Fred’s asked for, to give you an example of ways in which we have over the past two decades, in fact, tried to apply financial market sanctions in ways that are totally counterproductive in terms of our purposes.
For example, one of the things I’ve written about is so-called capital market sanctions, which went into hiatus (gap,break) for a long period but is now coming back again as a very, very popular way to bludgeon (hammer) China. In other words, to try to stop Chinese companies from raising capital in the United States. I wrote extensively about that twenty years ago, so I was surprised to see how it has come back. And here’s the problem, Chinese companies typically list domestically or in Hong Kong first and then they come to the U.S. markets—Nasdaq or the New York Stock Exchange. And they’re mostly using that as number one, a branding tool. But there are alternative branding tools to listing on a U.S. exchange and the second, to acquire retail order flow. In other words, retail participation in the stock, which is again is primarily a branding tool because overwhelmingly stock investment, particularly in this country, is institutional.
So two decades ago, I had looked at a major capital market sanctions campaign against Petro China, which a number of prominent congressmen were trying to stop from listing on the New York Stock Exchange. Now Petro China was also listed in Hong Kong, so I investigated. I first had meetings with large institutional investors to find out if they were investors in Petro China—they did, Petro China was eventually allowed to list on the New York Stock Exchange—to find out where they bought it.
And overwhelmingly they told me they bought it in Hong Kong, they would not buy the shares in New York. Why? Because that’s where they were liquid. I found that the biggest international investor in Petro China’s shares was Warren Buffett. So I investigated—where did Warren Buffett buy his shares? 95 percent of the shares he bought in Petro China were bought through Hong Kong, not through the New York Stock Exchange.
So to the extent that we are successful in stopping Chinese companies from listing in the United States, we will encourage American institutional investors to go to China to buy those shares where their transparency, of course, will be considerably less, and they will be able to buy them in alternative currencies like RMB or Hong Kong dollars or something else, non-dollar alternatives. So we’re actually promoting less transparency in terms of the behavior of these Chinese companies, and we are encouraging American institutions to go abroad to bypass our own system in order to participate in this financing. So we need to think in a more sophisticated way about how we use this tool.
TYSON: So I will go to another question. But I would just want to do an “unless” to what you just said. Unless another administration sometime in the future decides not just to prohibit purchases of certain products from China, that prohibit—
STEIL: That’s right.
TYSON: —institutional investors in the United States from investing in those companies. And I added within the realm of at least I’m sure configuration of some. STEIL: That can happen. I would just point out that those institutions have international businesses. Of course they can simply redomicile their investments to London or to Paris or to Amsterdam or to Dublin. It’s very difficult in an environment of mobile international [inaudible].
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