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Sunday, February 14, 2016

Monetary Disorder: Some Views From France

One of the entertaining part of economics is the divergence of views on a national basis. Within a country, partisan political views create a spectrum of opinion, but we can usually identify an "establishment view." But those establishment views can be quite distinct across countries. As an example, the French establishment has a fixation upon exchange rate regimes, and an interpretation of the current monetary system which bears little resemblance with mainstream American views on the topic. This was apparent from reading Désordre dans les monnaies [Monetary Disorder]: L'impossible stabilité du système monétaire international?

This book was published in 2015, by Le Cercle Turgot, edited by Jean-Louis Chambon and François Meunier, and contains essays by 15 other writers. The authors are primarily at French institutions, although there is a Foreign Affairs essay by Barry Eichengreen that was translated into French.

Given that the book is available only in French and that I am writing in English, this is not an attempt at a book review. Instead, I want to discuss some of the essays within the book, which do not match up with received wisdom on this side of the Atlantic.

From One Bretton Woods To The Other

Chapter 3 by Isabelle Job-Bazille is titled "Financial imbalances: From One Bretton Woods to another" ("Déséquilibres financiers: d'un Bretton Woods à l'autre"). The title refers to the "New Bretton Woods" story of Dooley, Folkerts-Landau, and Garber (first developed in 2003), in which the commercial relationship between China and the United States is a reprise of the Bretton Woods system. China exports consumer goods to the United States, and recycles the proceeds into U.S. Treasurys. This arrangement echoes the export-led growth strategies of European countries and Japan during the Bretton Woods era.

Before the financial crisis, the fashionable worry was that this arrangement would come to an end, with a dollar financing crisis for the United States (a "sudden stop"). It was not that the mainstream did not expect a crisis, rather they expected the wrong one. 

However, there was a sudden stop in cross-border financing -- in the euro area. Job-Bazille notes the irony that the euro which was the "pretender to dethrone the dollar" was in hit by the financing crisis instead. She notes that the informal relationship between China and the United States was more durable than the formal institutions put into place in the euro area.

However, trade imbalance stories are much less plausible than it was before the crisis. The locus of the international crisis was in euro-U.S. dollar financing, while trade flows between the U.S. and the euro area were fairly close to balance. Very simply, the financing relationships that broke down had nothing to do with financing international trade. As a result, it is entirely reasonable that trade imbalance worries have dropped off the radar in discussions in the United States.

Fixing The Euro?

 In "The euro, crises and punishments" ("L'euro, crises, et châtiments"), Ludovic Sobran discusses the various problems facing the euro area. What should be noted is his various suggested solutions.
  • Debt mutualisation (issuance of jointly guaranteed eurobonds).
  • Create the position of euro area treasurer with a budget.
  • Somehow make the euro more attractive as a reserve asset.
What should be noted that the first two steps have been suggested, and proven to be politically impossible. And with the possibility of euro exit still remaining a possibility, the attractiveness of euro bonds as reserves (other than bunds) is questionable. In other words, there do not seem to many new ideas floating around that could fix the dysfunctional operation of the euro area.

Unfortunately, any plausible steps towards fiscal integration are dwarfed by the potential problems if the euro membership of the periphery is questioned; a process that appears to be under way again. 

Monetary Protectionism

Pascal Blanqué argues in "The return of monetary protectionism" ("Le retour  du protectionnisme monétaire") that the use of Quantitative Easing, and the entire "dollar bloc" system act as a form of protectionism.

His analysis of Quantitative Easing appears unremarkable [update: fixed accidental double negative] from a North American perspective, perhaps other than use of the word protectionist. To what extent Quantitative Easing works in stimulating the real economy, the only plausible mechanism is via weakening the domestic currency. That said, the same is true of interest rate cuts. Since the currency is a relative price, "easing" by one central bank can be offset by another central bank "easing" as well.

However, viewing the "dollar standard" as being a protectionist system would raise eyebrows amongst many Americans. Blanqué views this an external observer, and only notes the hyper-efficient Asian export machine (including offshored American production) which competes with European firms. From the perspective of an American, the ongoing destruction of their domestic manufacturing base hardly appears "protectionist."

SDR's To The Rescue?

The book ends with a suggestion by Jacques Mistral that the global monetary system can be stabilised by the expansion of Special Drawing Rights (SDR, known as DTS in French -  droits de tirage spéciaux)

By way of background, SDR's are a unit of account used by IMF, which is tied to a basket of major currencies (Wikipedia article). The idea is that SDR's can replace the use of dollars as reserve assets, which somehow will stabilise the global monetary system.

Unfortunately, as even Barry Eichengreen observes within the volume, the SDR is really just a basket of currencies, with a heavy weight on the U.S. dollar. The private sector does not use such a basket of currencies, and so users of the currency would need to trade SDRs for a local currency to transact. Meanwhile, a country has to run an external deficit to allow net accumulation of financial assets in its currency. Are the Germans about to accept running significant current account surpluses just so other Europeans can crow about being a "reserve currency"?

Every central bank with significant reserves runs its reserve assets as a portfolio, and they allocate their portfolio based on the significance of the currency for their local trade, and their ability to invest in government bond portfolio. For example, until the bottom fell out of the oil market, many central banks bought as many Canadian government bonds as they could, which is to say, not a lot, given the small size of the market. Whether that basket of bonds in the portfolio are labelled "SDR's" or not is essentially cosmetic.

What is interesting within the article is that essentially offers no explanation why such a change is of interest to the United States. Such a move meets the French national interest of reducing the role of the dollar (although the authors of the essays spend little time discussing the costs of running persistent current account deficits that being a reserve currency implies). Mistral argues that the size of dollar reserves results in a "Sword of Damocles" hanging over the conduct of U.S. monetary policy. Although he might have found Americans who agreed with that sentiment in 2007, it sounds quaint in 2016. The Fed has demonstrated an ability to purchase trillions of Treasurys, offsetting any potential foreign bank selling, while at the same time threatening the bond market with negative interest rates. At most, we are looking at "The Pen-Knife Of Damocles" hanging over the conduct of American monetary policy.

The divergence of national interests, and lack of comprehension of how others see the world, makes it supremely likely that we will have French books discussing the exorbitant privilege of the United States twenty years from now (and which will similarly not be read by Americans).

See Also:

  • Barry Eichengreen discusses the history of the disputes over "reserve currency" status in the post-war era in "Exorbitant Privilege." 
(c) Brian Romanchuk 2015


  1. "Before the financial crisis, the fashionable worry was that this arrangement would come to an end"

    I presume because the Chinese would by then have worked out how to export to Mars.

    1. I said it was fashionable, not that it made any sense.

      Basically, people just assumed that China would be perfectly happy to blow up the value of their foreign currency portfolio, and destroy their export growth model, just so they could make up scare stories about the Treasury market. Yeah, funnily enough, that did not happen.

    2. :-)

      I wonder how many fortunes were made selling the scare story and buying the result?

  2. Thanks for another very thoughtful post with a lot of comprehensive insight. These thoughts fit into the pattern I have described for a while now. Of course, there are some divergences.

    I begin with this quote (from your post) as a starting point to describe (what I see as) a more inclusive pattern:

    "China exports consumer goods to the United States, and recycles the proceeds into U.S. Treasurys."

    Correct. We need to add the sources and tail to this observation.

    First, the Chinese can only purchase U.S. Treasuries if they are first available. (The Chinese could not purchase the U.S. Treasuries if they did not exist.) This fact leads us to think that the annual deficits of the U.S. Government must play a role in this export-import saga.

    Second, the Chinese workers producing goods for export ALL WORK FOR YEN. Chinese workers do not work to earn dollars despite the fact that their labor ultimately earns dollars (or we might more accurately say "U.S. Treasuries".)

    If the Chinese workers do indeed only work for yen, some entity must supply the yen. I think that entity must be the Chinese Government, acting through the Chinese Central Bank.

    You can draw your own conclusions on how this continuing accommodation influences the macro-economic distribution of goods. Maybe Donald Trump has a valid point but, if valid, how do you decide how to re-distribute the benefits which have certainly come from this symbiotic relationship?

    Massive, repeated, applications of debt can certainly distort economic patterns!

    1. It would be difficult for the banking system to cope with government liabilities (Treasurys, reserves); but that holds for domestic reasons as well.

      The Japanese had relatively smaller reserves than the Chinese because they lack the capital controls of China. The Chinese central bank has no choice but to recycle export proceeds into Treasurys, since they do not allow the private sector to hold assets outside of China (beyond some permitted amounts). (Whether those capital controls are porous is another question.) Without those capital controls, the Chinese private sector could hold USD assets, and would probably mainly hold privately issued securities. The Chinese government cannot do this, as it would be an embarrassingly large holder of private bonds if it tried to diversify. Reserve asset managers are not set up to handle bankruptcy workouts.

      As a result, the relationship with US fiscal policy is not obvious.

  3. "Somehow make the euro more attractive as a reserve asset."

    Won't that mean a rise in the euro level and less growth and exports?

    1. Probably. That side of the equation was ignored (as usual).

      The justification appears to be a study by Gourinchas & Rey (2007 - in volume "G7 Current Account Imbalances: Sustainability and Adjustment") where reserve privilege allegedly lowers U.S. Financing costs by 50 basis points. (How that can be squared with how monetary policy is supposed to work is hard to see.)




