Exorbitant Privilege: The Rise and Fall of the Dollar

so I'm delighted to welcome everybody here tonight to the latest lecture in the sense of economic performances 21st anniversary series my name's John Vander ena and the director of the center on performance and we're very happy tonight to have professor Barry Eichengreen from the University of Berkeley okay in California it's a particularly good chance for Barry to speak tonight since it just published an excellent book which I could recommend to you by I mean his coffees outside and varied that he said he'll be prepared to stay behind afterwards to do some signings of the book so I'd encourage you to do that Barry doesn't really need much introduction from me he's a very well known as all of you oh I don't say a few words Barry got his PhD from Yale University but before moving on to Harvard as an assistant professor he then moved to to University of California at Berkeley in 1986 where he's essentially stayed with occasional jorts to do other things like advising being the senior policy adviser to the International Monetary Fund Barry is obviously a leading academic across many fields of international macro economic history globalization and labor and the subject of tonight's talk on international monetary systems but he's also in addition to that actively engaged in policy debates being a very frequent writer and speaker in the media and in the global blogosphere everyone to call it and I think that's extraordinary importance and then one of the things that's very admirable at Barry is that they're prepared to do top class economic research but also try and get that out in the real to interact with people who are policy makers of MEMS the public so that further ado actually said to Barry and subject of exorbitant privilege the rise in the fall of the dollar so thank you John for that the over kind introduction I'm happy to be here to help celebrate sieepiess 21st birthday it's also nice to be back in in this building and at this institution I am reminded that while I was finishing my dissertation I spent some time at the the public record office working away in the archives on devaluation of sterling in 1931 and among the things I did during that stay was I came over to the LSE to talk to Professor of Lionel Robbins who was very much here about his views of that devaluation and his dispute with Keynes in the early 1930s about what appropriate international monetary policy should be and and for me that was a memorable coffee and discussion we had together partly because he was a charming and somewhat self-effacing man who said something that I've never heard from an economist since which was I may have been wrong about that so if I'm around after a suitably long period of time you can come back and ask me if why I was wrong about any of what is about to follow what I do in a way is as as John kind of hinted is is to try to use economic history not only to understand the past although that is fundamentally what economic historians do but as a frame to try to think about the future as well so this book is once again one of my familiar efforts to do that but it is at the same time a little bit different than what I've written in the past in in that it's an attempt to speak to a broader audience so as part of that effort I have the the pleasure it is a pleasure to speak to informed audiences at institutions in halls like this one but also to do things like morning radio in the United States where the quality of the discourse the kind of questions you're asked and the kind of call-in commentary that you get is I could put it politely highly variable what I what I detect from that commentary though is a remarkably high level of anxiety in the United States about the prospects for and the and the future of the dollar so you will have noticed that many American politicians and journalists and I'm here to report this is true of the general public as well are quite concerned about inflation in the u.s. despite the fact that there is not a hint of inflation yet in the data that core inflation in the US and February year-over-year was running up 1.1 percent below the feds target but there are very serious problems about what might be coming in particular there is the problem that Peter Orszag will talk about in this forum in in in some weeks of a chronic US budget deficit and a dysfunctional political system that shows no signs of being able to bring that under control so people are worried and and here I would say with some grounds about the future of the dollar they're worried that the Fed which has already come under growing political pressure for a variety of reasons will similarly come under under under pressure to help with this fiscal burden as it grows and whether consciously or inadvertently it will be reluctant to raise interest rates and compound the difficulties of servicing the debt at the appropriate time and things could get quite out of hand so there are a number of indications I think of the extent of and anxiety the nature of the public discourse the level of gold prices which is another indication that there is less than full confidence in the dollar the bright side if you will is that for there to be flight away from the dollar there have to be places to flee and the the alternatives the potential rivals like the Euro have serious problems of their own and in addition the dollar is unique it has the singular advantage that has the exorbitant privilege to quote the then French finance minister Valery Giscard is saying that it's not only America's currency but but the world's so that is where the title comes from and that is on on what the book focuses the truly extraordinary extent to which the dollar remains the dominant vehicle for international transactions worldwide the Bank for International Settlements does a survey of foreign exchange markets every three years it released the most recent of those surveys about a month ago which showed that the dollar is still used in fully 85% of foreign exchange transactions globally I spend some of my time working on Asia and and visiting South Korea in particular I've discovered that the the featured wine and all academic conferences in South Korea is Montes Alpha imported from Chile because there's a free trade agreement between Chile and South Korea when a South Korean wholesaler wants to import Montes alpha he creates one for dollars and he uses those dollars in order to import the you know complete the transaction with Chilean supplier the data showed that 99 percent of all foreign exchange transactions involving Korean Juan are crates of one for dollars the data show that 99 percent of all foreign exchange transactions involving Chilean pesos are trades of pesos for dollars so all of these are reminders that although we live in an increasingly multipolar world where the u.s. is only 20% of the world economy the dollar is still remarkably dominant globally the latest data we have on the foreign exchange reserves of central banks and governments around the world shows that 61 percent of all foreign exchange reserves are still held in dollars I have some other examples in the book when Somali pirates ransom a ship they demand that the and some money be parachuted to them in dollars when Iran gives President Karzai's people bags full of money the money in question is presumably in dollars I suggest in the book and I would be prepared to argue further that this fact is not an entirely unmixed lesson for the United States it is a considerable convenience for US firms to be able to do do international business in their own currency and not to worry about currency conversion costs and exchange risk if the exchange rate moves against them it's similarly competitive advantage for for US banks and this exorbitant privilege that everybody wants our dollars is one factor that has allowed the United States as a country and US households to live beyond their means for as long as we we have we've been able to run large their current account deficits than would have been possible in the absence of this for Asia's appetite for dollars abroad because foreigners want our dollars to finance their international transactions they want accumulate dollars as insurance against unforeseen financial shocks so they're willing to lend to us in order to acquire them but the other side of this coin if you will is that if we in the United States are prone to financial excesses if for example we engage in frenzied real estate speculation then those foreign investors give us more rope I wouldn't go so far as to argue that the dollars exorbitant privilege and the fact that there was this appetite for dollars on the part of the People's Bank of China among others is the only factor that made for the financial crisis for the subprime crisis that we have just been through I I'm justified in using that the past tense but I would argue that this was an important confounding factor that we wouldn't have had this kind of real estate bubble this kind of mania and then bust if foreigners had not been willing to lend to us for as long and as low interest rates as was in fact the case so when we're in the United States willing to hang ourselves the rest of the world gives us gives us more rope as a result of the the dollars exorbitant privilege what I'd like to do is step back for a minute and talk about how we got into this peculiar situation where the u.s. is only a sliver a 20% sliver of the world economy yet the dollar is still essentially the only global currency I want to look back a little bit at the history in order to try to understand better what might come yet come next the history as always is the case when you look at it closely is a bit more complicated than the textbooks tell you the dollar gained its international preeminence the dollar became a leading international currency really in two steps a first step F during and after World War one when the dollar was first internationalized the the process that china is now initiating with respect to its own currency and then a second step after World War during and after World War two when the dollar went from a position really of coal equality with the pound sterling as one of two consequential international currencies to the far and away the dominant international currency after 1945 why it became so dominant after 1945 is no mystery you know the US was the only economy standing we were far and away the leading exporter we were far and away the leading foreign investor only the united states had deep and liquid financial markets open to the rest of the world so it made eminent sense for firms and banks and governments and central banks when they did international transactions to do them in dollars the US was so dominant and there weren't obvious alternatives that us-centric Western world is no longer with us as you know there was the post-war reconstruction man and and growth of Western Europe the post-war reconstruction and economic miracle in Japan the emergence of emerging markets so the u.s. is much less dominant economically than it was half a century ago but the dollar is still as dominant as it once was so why has the dollar held on to its preeminent position the commonplace answer is the advantages of incumbency so if under normal circumstances it's an advantage for a politician to be the incumbent in a contested election it's similarly at the advantageous for a national currency to be the incumbent global currency if everybody else is using your currency in their international transactions it's the incumbent global currency it similarly makes sense for other people to do the same everybody else is pricing and quoting their exports in dollars you want to break into international markets and you want to make it easy for customers to compare the the price of what you're selling with the price of what other people are selling with everybody else quoting prices or quoting prices financing their create in dollars it similarly makes sense for you to do the same the economists in the room will know that there is a name for this kind of situation this is a situation or a market characterized by Network externalities where it makes sense for everyone else for you to do what everyone else with which you're economically involved everyone else in your network so if everyone else is doing their international business and in dollars it makes sense for you to do the same and intuitively in this country you can see why in this kind of situation where it's a no-one's individual interest gift to an alternative this kind of market or situation will be characterized by high levels of persistence once a standard the dollar standard in this case is established it tends to persist it gets locked in so that's the standard argument what I now want to suggest is that while it may that argument may have had some validity in the past it's not likely to be valid in the meeting even the immediate future so the notion that importers exporters and and international investors bond on underwriters all will want to use the same unit as other importers exporters and bond underwriters holds less weight in a world where everybody carries in their pocket a device called a smartphone that can be used to compare currency values in real time once upon a time and in the not-too-distant past if you were doing financial business or or commercial business internationally getting a current foreign exchange location was not that straightforward you know you have to buy a newspaper go to the bank pick up the telephone now you just have to look at your your smartphone we live in a world where currency converter is one of the ten most downloaded absent that Apple AppStore so my argument is that even if the costs of switching and interchangeability switching from using one national currency for international transactions to another were high once upon a time this will decreasing ly be the case this this will no longer be the case in not very distant future so once upon a time people made these arguments about the importance of network effects and the dominance of one standard and lack of interchange ability for operating systems for for personal computers once upon a time we all believed that there was only room for one operating system unless you were a dedicated computer hobbyists with no and christen actually exchanging files with your co-workers and that standard was called called Windows or whatever preceded Windows who can recall back that far we have learned over time how to connect different standards we have built open standards enhanced interchangeability so now there there's room in the operating system market for not only for Windows but for the systems that Apple and Google and Linux have all been able to successfully disseminate so my argument is what is crew of operating systems or commercial computers will be true soon for International Finance once upon a time there was room for only one crew global currency and for combination of reasons good economic reasons and ancient history that one crew global currency was the dollar but now because switching and interchangeability costs have fallen there is room for there will be room for several international currencies so I I will argue that we're heading toward a world in which several currencies share the international stage I will argue further that that this word is to be welcomed rather than than feared if you you by my story that one important contributing factor to the the global economic and financial crisis through which we've been through is the mismatch the tension between our multipolar world economy and are still peculiarly dominated dollar dominated international monetary and financial system and we will be better off when we have a better match closer complementarity between the real economy and its monetary system that challenge being whether we can navigate the transition from here to there so that's my my pitch at a relatively high level of generality too high a level of generality to be satisfying no doubt several international currencies which ones I when I think about this I typically think on a 10-year horizon or something like that what will the the International Monetary and financial landscape look like in 2020 recent events remind me of the importance of cautioning myself and and everyone else that many unanticipated events can intervene between now and 2020 who would have imagined after all but it seems to me given what we know now it's clear that there will be three international currencies ten years from now and their names will be the dollar the euro and Chinese renminbi so I like to pause at this point and view expressions in the audience people are looking quizzically some people are smiling because they have doubts about one of these currencies they're skeptical that one of them will be a true global currency ten years from now that it'll be ready for primetime the point being that different people have doubts about different currencies I would suggest that the fact that there are at least some doubts about all three of them give us more grounds for thinking that no one will obviously be dominant but let me spend a few minutes reviewing the the three alternatives so I take that long flight flight from California I'll and and almost the the first thing my friends asked me about is not not not about the dollar of course but about the euro here as we approach yet another of the endless series of summits in Brussels there is an awful lot of euro doom and gloom that doom and gloom is not even for someone who believes in the euro I try as hard as I can to do so those doubts are not entirely unfounded it's not clear that the crisis countries of peripheral Europe being now being forced to impose draconian spending cuts can recover without reintroducing their own currencies so they can value the national currencies and and grow their exports keeping the the crisis countries in the euro area would require massive transfers from Germany and German voters it is argued would rather abandon the euro and reintroduce the deutsche mark then agree to this so you will anticipate given what I've already said that I do think that this euro doom-and-gloom is overdone and the summary are just given you entails a number of non sequiturs running from current to how they are likely to be resolved so I'm not by any means ruling out the possibility I'm tempted to say the the probability of a sovereign debt default by a country like Greece or Ireland or pick your favorite candidate but while a Greek or an Irish default can't be ruled out and either kind of default by the city of Los Angeles or by Nassau County Long Island and exactly in the same way here's where people like to argue with me about this point but I assert that it in exactly the same way that a debt default by the city of Los Angeles or Nassau County Long Island would not spell the end of the dollar area a default by Greece or Ireland would not spell the end of the euro and I would be prepared to argue as well that a country like Greece attempting to reintroduce its national currency as part of this if it's post crisis strategy would only be making its problems infinitely worse the euro is no bargain for the crisis countries but when you think about futures you have to think about possible futures and the alternative is even more dire to contemplate the one country that could in principle exit the euro area without precipitating a massive financial crisis would be Germany and I think they're two reasons to believe that that won't happen one is economic that the euro has been very good for German exports and German exports have been key for German economic growth in the last ten years a strong deutsche mark would not have produced the same export growth in the past and a future deutsche mark would be strong compared to the rump euro it's hard to dispute that more important in mind you is actually my reading of German politics so I continue to believe you may accuse me of wishful thinking but I continue to believe that Germany is committed to the larger European project that the euro is now intimately bound up with the larger European project 60 years of European history told me that Jeremy is locked into the European project and it's effectively locked in to the euro in my view there was a lot of talk in the last couple of years about how mrs. Merkel is a different kind of German Chancellor because she you know didn't live through World War two he wasn't educated in East Germany in the same way as prior chance post war counselors had been that she wouldn't value the European project like her predecessors did she may value it in a somewhat different way but I think the recent events remind us that German leadership German business remained committed to this project they have the small problem that they have to drag the voters you know the working class along with them but I history European history suggests to me that they will so the task now for Europe is to complete this monetary union Europe has shiny coins and beautiful banknotes and a tolerably good central bank but it doesn't have the other elements of a working monetary union and I view the difficult discussions that are going on now as number one trying to add the other elements of a working monetary union and I read them as Europe reluctantly stumbling toward doing that the father of European integration is all monet said Europe is forged in crises European leaders only do something hopefully the right thing when their backs are to the wall so soon again their their backs will reside and and I think they will take steps strengthen the weak banks they will rationalize the way bank regulation is done in Europe by giving the European Banking Authority Authority finally that will then enable to restructure the depths of the crisis countries without bringing down the banking system there will be very very limited pooling of fiscal capacity to properly fund the European Stability Mechanism there will be strengthened surveillance a shortlist of three or four items not just enumerated it gets much longer when you unpack it and think what it all involves but I think European leaders know euro area leaders know what is involved and they will move now fairly expeditiously at least by European standards to complete the process if anything I worry more about the dollar then I I do about international confidence in the dollar in some ways than I do about the euro you in in Europe you know the UK clearly but continental Europe as well are able to have a discussion over your fiscal problems and sketched out alternatives for dealing with them we are totally unable in the United States to have a constructive dialogue about fiscal problems so I am NOT the expert on u.s. fiscal policy that Peter Orszag is which permits me to say you will only need to address two problems in order to fix the gaping medium-term structural budget deficits that we have in the United States you need to deal with entitlement programs which means first and foremost Medicare Medicaid things like that and you need to do revenue enhancement because Americans are not allowed to say tax increases we have a few people who are prepared to address one or the other of those items but it is clear anyone who Ponder's the numbers for a few minutes that you will have to operate on both margins in order to solve this problem in the United States and there's no willingness to discuss that those who are willing to open their mouths about entitlements are unwilling to touch the other item and vice versa there is no sign to me that American politics are becoming less polarized in a fashion that would permit a meeting of the minds so nothing is happening now despite lots of chatter nothing will happen next year because it's a presidential election year and all the items that I've described you will be off the table during the electoral silly season so I think what the markets will be doing is looking to early 2013 after the election is over now the grown-ups can resurface and will they be serious about addressing these problems in it if they don't see it they will grow anxious about prospects for u.s. sovereign debt whether that that is going to inflate them away they observe already the Treasury trying fairly desperately to lengthen the term structure of the debt in the u.s. doing so would make it easier to inflate away its real value they see private you know the biggest private investors like pimp go down the coast from me in California getting out of the market already so there could come a point where foreign central bank holding a bunch of dollars doesn't want to be the one left holding the bag and it scrambles out and you get a cascade of central banks and other other investors scrambling out so in in the book I tell the story of how the the Bretton Woods system finally collapsed when Richard Nixon closed the gold window suspended the convertibility of the dollar into gold at a fixed price for official foreign holders in 1971 and the precipitating event was of course the decision by one one foreign central bank to convert it dollars into gold before it was too late that being the Bank of England so it can history tells us you know this kind of thing can happen you can hang together you can hang separately and sometimes the incentive to scramble out you end up hanging separately can be quite strong so I worry about that when I wrote the book I said optimistic things like the United States has five years to get its fiscal house in order the markets will take it that long I grow more worried with the passage of time I get reminded that financial crises almost always occur around the time of the letters or that's what history seems to suggest finally the Chinese renminbi China will have to surmount very significant challenges in order to internationalize its currency it will have to open its financial markets to foreign investors it will have to finish the process of commercializing its banking system in order to make it safe for capital inflows and outflows it will have to distance the banks from the state-owned enterprises that they subsidize it will have to move to a more flexible exchange rate to accommodate the disturbances that come with freer capital inflows and outflows it will have to establish rule of law in order to convince foreign investors that Shanghai is a safe place to park your money so this is not a process that that will be completed over I think it will be completed can be completed in as short a period as ten years so I get a lot of pushback from people I talk to like you you all about whether it can really be completed that quickly and I think it can really for two reasons number one the Chinese have articulated a strategy for internationalizing the renminbi this is their one of their priorities now they've said they want to elevate Shanghai to the status of the crew international financial center by 2020 we've underestimated them before should we underestimate them again they want to move gradually in the way the Chinese typically do they understand well that international currency status has different dimensions and it's safe to develop some before it's safe to develop the others so they're developing the role of the remnant renminbi and trade finance and trade settlements first they're developing the role of their currency as a currency in which to do nominee international bonds second other kinds of international finance will come third and the importance of the renminbi as a reserve currency will come last it's the last that people look at when they run horse races between currencies because the data on the currency composition of foreign reserves can just be snatched from the IMF website with some some caveats the Chinese understand that that's the caboose on the train and they they're doing other things first so in the last year we've moved from a position where the Renmin renminbi basically wasn't used at all for trade settlements to a point where 70,000 Chinese companies according to the latest figures i've seen have been using the renminbi in their cross-border settlements and and foreign purchasers have willingly in the other end of that there a latest report are something on the order of 46 international corporations that have issued dim sum bonds renminbi denominated bonds in Hong Kong and we know that this is the way that Chinese work they test it out in Hong Kong and if it works they bring it on shore so I think they're gonna be doing the same thing for select trustworthy foreign corporations in the not-too-distant future and if it's safe for McDonald's and caterpillar to issue in Shanghai they'll consider letting other other corporations do similarly so I think they are moving very fast and and we shouldn't underestimate them the reason they're moving so fast is they think dollar dependence has a variety of disadvantages among other things it's a disadvantage for their own banks and corporations to have to do business in somebody else's money to pay the costs of foreign exchange transactions to bear the exchange risk it makes life makes it more difficult for Chinese banks to acquire foreign market share so I can now open a renminbi denominated deposit account in New York through the Bank of China you know the commercial bank not the central bank the People's Bank of China its FDIC insured I don't I don't think you can do this from the UK but you know the miracles of the internet who knows for sure there is a cap on it those accounts are limited to $4,000 but you can see how it's going to go up over time and and this is all part of a strategy of reducing their their dependence on the dollar why do I think they can do it in a shorter period as 10 years one reason is that's the the target they've set for themselves and I think more generally they are committed to rebalancing their economy away from its old basis toward more more consumption more and more exchange rate flexibility etcetera etc and that they can successfully do that or make a lot of progress in that direction over the coming decade the other reason I think it can be done in a short appear at is 10 years is that 10 years was how long it took the United States to move from a position where the dollar was not used internationally at all at all to the position where the dollar was in fact the dominant international currency so the dollar was not used for trade invoicing or trade settlements at all in 1914 not even by us importers and exporters who if they wanted trade credit in order to import coffee beans from Brazil they would go to their local bank which would send a telegram to its London correspondent and the trade credit would come from London and be denominated in installing the dollar was the currency of denomination for zero percent of international bonds floated by third countries prior to 1914 the dollar accounted for zero point zero percent of foreign exchange reserves worldwide in 1914 and all that had changed by 1924 so what what I say now is different from what the history textbooks say but it reflects the the research that I've been doing in recent years by 1924 that the dollar have surpassed sterling already as the leading reserve currency by a small margin by 1924 the dollar had surpassed sterling as leading currency in which third countries denominated the bonds they wanted to sell international investors by 1924 more trade credit worldwide was sourced in New York and denominated in dollars than was sourced in London and denominated in sterling it can be done in a decade it was done largely because US policymakers set out to do it for exactly the same reasons that Chinese policymakers now want to internationalize the renminbi they saw us banks and firms having to do business and other people's money as a competitive disadvantage so people like Benjamin strong JP Morgan's right-hand man and the 1907 financial crisis Frank Vanderlip the financial journalist who became the highly successful president of National City Bank Nelson Aldrich who was the senator from Rockefeller he was a senator from Rhode Island he was a rock rockefeller relative by marriage they set out to create institution to backstop the market in securitized trade credits they set out to write an act that would permit US banks to branch abroad and originate international financial business they went JP Morgan's hunting preserve off the coast of Georgia and grafted what became the Federal Reserve Act after a couple of years so the the argument is if you provide the relevant institutional supports if you create the infrastructure now the liquid market needs and and that is consistent with the maintenance of economic and financial stability you can complete this transition in in a short period of time I know that Chinese policymakers study or have studied the same experience so to some extent perhaps they interpret the relevant history in the same way I do there are people in this audience who will recall that other events intervened of course between 1914 and 1924 World War one had a good deal to do with the changing of the guard from from the dollar to sterling every period however is from from that changing of the guard every period is special and complicated when you look at it closely but I do think that you that the relevant US history demonstrate that if you make it a policy priority it is possible to complete this transition relatively swiftly so clearly each of the three candidates for international currency status the euro the dollar the renminbi all have problems they all face challenges but I think that's a itself another reason to think that no one of them will necessarily dominate and that there can be room on the international stage for all of them so if you buy my my premise that multiple a global monetary and financial system organized around multiple international currencies is coming the final question one would want to ask it is should we worry yes and no that's always the economists answer depends a lot on what you think the problems coming down the road will be if you think the United States for example is a serial bubble lower that you know that the the next time a financial bubble comes along it may not be in the housing market but it will be somewhere else you know in a world where there exists alternatives to the dollar or people doing international business and for central banks and governments wanting liquidity insurance the US will feel market discipline earlier and more regularly you know that bubble will tend to be reined in before it is allowed to get as out of hand as the last one what the stability of the system hinges on like the stability really of any system is the policies of the Reserve issuing reserve currency countries so it's trite to say the most important thing is sound in stable policies in the u.s. euro Landon and China but it but it's also true that that's what the stability of the system will will hinge on there is a darker scenario where one of the reserve currency issuing countries screws up and then there can be you know it's light out of its currency by private and and official holders alight because there will exist alternatives so you know these sound and stable policies that economists talk about are important they're always important they will be equally important doubly important in in in this new system that is coming what I don't think would be helpful is efforts to stabilize in one way or another the exchange rates between the dollar of the euro and the renminbi economic conditions will continue to differ between the US for Landin and China therefore appropriate monetary policies will continue to differ and different monetary policies are not compatible with stable exchange rates I was therefore disturbed alarmed when last August French president Sarkozy made a widely reported speech to Frances foreign ambassadors about the country's agenda when it assumed the chairmanship of the group of twenty in 2011 and he said we need a new Bretton Woods system we need stable exchange rates between the dollar the euro and renminbi he was of course channeling French history where the French have been saying similar things for a long time fortunately he's been back pedaling as as possible ever since so I think the French government and the g20 have heard the objections that different people have made to such a scheme they now understand that an effort stabilized exchange rates between the leading reserve currencies would quickly come unraveled and attempting to stabilize them would in the end only have tarnished the credibility of the countries involved in that effort so the French talk and and the g20 talks about a multipolar monetary and financial world about creating alternative sources of liquidity about strengthening the incentives for the reserve currency issue in countries to follow sound and stable policies I find the evolution of thought that we've seen in the last year reassuring so let me conclude on that I note if you buy my argument then you should see our recent economic monetary and financial difficulties in no small part as a consequence of the imbalance or the tension or the incompatibility between our multipolar world economy and our peculiarly dollar dominated monetary and financial system the good news then is that this is a problem that should solve itself if we give it time time to work given ten years or so the good news is that there should be a better match between the real economy and its monetary and financial system the bad news is that economic history tells us that financial crises come along every three years or so so on that note let me conclude thank you well thank you very much very for really stimulating and interesting a talk so I think we have up to half an hour now for questions is it a roving mic roving around yes there is so if you could raise your hands yeah because I think I might my name is Edward eyerman on the an analyst at Fitch Ratings here in London and my question is relating to the current fiscal architecture for the European Union in particular and is there a need for a single fiscal centralized agency but when to pay euro Treasury bond in order to alleviate the stress is on the euro at the moment I think thanks a little participation in your lecture I don't think you know what clears to death who you are again who are you I am an economist president African bank ok your lecturer I don't think you mentioned a single time the currency of the second or third most important economy in the world so again and I would like to know Europeans on how that is developments happened over the years what lessons there are four related question is in that process of internal nationalization is is it's a given data currency has to appreciate or the openness of the capital account goes both ways and then one more question I think forget when the blue shirt thank you I'm sorry goddamnit student here is II um I would like to know a little bit more about them the connection between the rise of the renminbi and the political process in China so do you think that it is necessary that China reforms itself in order to become what the supply of them of the leading currency or is that the second step so the remedy arises and then that will lead to reform in China is there no connection at all so to remind you that first question was about this capacity and the pooling of that fiscal capacity in Europe so no I don't think that Europe needs to move to completely in the direction of pooling it its fiscal capacity or toward a system of fiscal federalism how far it needs to go depends on what it does on other margins so for example with a stronger set of a set of national banking systems it doesn't it's not necessary to have such a large emergency financing mechanism to deal with the banks when things go wrong I think that Europe will need an adequately funded ESM European Stability Mechanism but what it does on other fronts in terms of restructuring public debts where they're borderline on sustained what it does about restructuring problem banks where they could could become borderline understand unsustainable will determine how big an es em they have to build and therefore how much of their national fiscal capacity has to be pooled on the other hand I think we know that for a set of sovereign bonds denominated in Euros to be attractive to international investors the collectivity of euro area countries have to have sufficient fiscal capacity to you know stay current on those bonds and ensure the maintenance of confidence by international investors in those bonds so I would draw a distinction between pooling fiscal capacity about which there is real resistance in the European countries that feel like they're going to be doing most of the pooling and and collectively having a collectively but separately having adequate physical capacity there's another related issue here as you know which is that sovereign bond markets in Europe are far from homogeneous and the fact that they are segmented along national lines makes them less liquid than they would be and therefore less attractive to international investors and than they would be otherwise could that change well we'll have to see what happens with the e bonds that are going to be a few very small numbers initially and then it could become larger numbers subsequently the second question I'm not sure I heard I was able to hear the whole thing so the second part is what was what might happen to the Chinese renminbi when the capital account in when the concrete liberalizes it was capital account the first part was about the Japanese yen quite here well I'm gonna I will be careful to suppress my normal jokes about Japan they're not appropriate you know kidding about this is far from a appropriate on under the circumstances but you know the Japanese economy has not grown to a first approximation for 20 years they're demographically stagnant so a global currency needs a sufficiently large platform and Japan doesn't have one looking forward so the US and the euro area are the are the two big economy center and they will be joined in in my view by China but you're right that the end peaked that as a reserve currency and I think more broadly as an international currency in the late 1980s again the Chinese studied that experience quite closely they understand the arguments for how the particular manner in which the Japanese did financial liberalisation led to their bubble in their crash and and they want to avoid that and they do now seem quite serious bubble fighters it seems to me in Beijing and I'm not gonna touch your your second question which is the exchange rate forecasting one above my paygrade seriously economic models are are not good at short term exchange great forecasting we can all imagine scenarios in which the renminbi goes up because of capital inflows but where it goes down because of capital outflows and we will see episodes of both I think as chyna liberalizes financially how is this process of renminbi internationalization related to the broader process of Chinese reform the gentleman who asked the question was careful not to specify economic or political reform so I find it easy to answer the question about economic reform that renminbi internationalization is part of a larger reform strategy that the Chinese have in mind they understand that they need to rebalance away from exports and that in order to attract this international banking business that they want to acquire that they're going to have to engage in phase capital account liberalisation they understand that will require more flexible exchange rate they are running as fast as they can which is slowly given the large and complex economy they have to complete this process of economic reform so you will know that there are two interpretations of Chinese economic experience the experimentalists interpretation where there's something unique and different that the Chinese officials have discovered through a process of trial and error where the end point will be different than in a normal social market economy and the convergence view which says they're going to end up where the rest of us are more or less I'm a believer in the convergence of interpretations so I you know I think they're reforming as quickly as they are able and the domestic reforms go together with the renminbi internationalization they are all part of a package the issue of what this implies for political reform I acknowledge that I don't have my mind around that entirely there will have to be effective checks and balances on arbitrary and opportunistic behavior by the Chinese government that you know if it occurred would antagonize foreign investors before foreign investors who are willing to Park significant amounts of their portfolios and Shanghai and the issue of whether checks and balances require full-blown democracy or I don't know in the age of Facebook and Twitter can occur thank you at simulating economic history today you told us the dollar is 85% of foreign exchange but you're predicting is going to fall and we'll have a multi currency world so what do you think that figure will be in five years and ten years Renaud Casey from Warwick University I want to pick up something you said at the beginning and something you said at the end you started off by saying even when we want to hang ourselves that the rest of the world gives us more home but of course if the rest of the world keeps on giving one rope one can't hang one so because pain requires a shock but equally a shock on the road also moves over or potentially pulls over the person who's paying out the rope so there are limits it seems to me to where we might be going and then I wanted to do when you're concluded which was this sort of multi popular or three polo of where the weapon her hands have three reserve currencies and three units now the point is that in this multi-role artwork of each of the poles is dealing with one another if there are substantial swings between at the currencies of each of the three Purple's what are the implications of that because it seems to eat one still needs a measure tape of some form to judge any one of the three elements against and there seems to be a potential for quite substantial instability in a multipolar or a tri-polar world and there's much instability is in the universe business daily I have two questions maybe it's just one depending on yarns it's relating to currency wars a couple of months ago there was a discussion going on about currency wars and I would be interesting in what what you what do you think about it do do do we still do we already have a currency war are there any risks and my second question is related to qe2 and the question what it needs fall for the external value of the dollar slightly different guys the issue here is the global responsibilities of the central bank that that issues the global currency and the fact that the Federal Reserve doesn't take much to come out of its double responsibilities in normal times in highly abnormal times the country's issuing the international currencies admirably extended credit lines to form central banks and governments they understood their singular responsibility for supporting the liquidity of the markets abnormal in exceptional times and exceptional steps were taken the the problem is that under more normal times like today the Fed for example has a dual mandate where it is supposed to pursue low inflation and and full employment and the idea that foreign financial stability the stability of the Brazilian financial system should also be on the beds radar screen it's not there so the currency wars problem is that the Brazilian finance minister thinks it should be and and and the Fed is not permitted it and it doesn't have much incentive taken to account the foreign repercussions of its policies people like the the Princeton professor young-shin who spent a lot of time in London has shown us has emphasized how sensitive the global banking system global financial markets are to changes in the availability of dollar liquidity that may be entirely appropriate for US economic circumstances but are not appropriate for the circumstances of countries liked like Brazil that are booming ahead so the Fed says that's your problem in Brazil you have instruments with which to deal with it that explains in part why the global dialogue over an attitudes toward exchange toward capital controls have changed over time that we acknowledge that there are circumstances the IMF acknowledged the US government acknowledges I guess in private that there are circumstances under under which utilizing capital controls so that monetary and financial conditions do differ across countries where appropriate is not an entirely bad thing in in in the future there will be this problem about the policies of the Fed and the European Central Bank and the People's Bank of China they will all be making policy with local economic conditions primarily in mind and I think this is the the state of the world what we can do about it is we can increase the the range of instruments that the innocent bystanders can deploy to protect themselves so studying the study of capital controls and the like should continue and you know understanding better which one's work and which ones don't under what circumstances is once needed I think there can be subtle pressure through the g20 process and through the IMF to encourage the central banks of the that issued international currencies to place us likely higher weight place a modestly positive weight on the implications of their actions for the global economic and financial system and there can be better appreciation of the feedbacks from the rest of the world to those countries the g20 is working on that so there's a little bit of hope there in my talk to turn briefly to the previous question I observed that the main things supporting the the dollar was that the alternatives have problems of their own so it is central to the logic of my argument that there being viable alternatives full worried about the prospects or the dollar Kim look in the course of the next ten years to the euro and the Chinese renminbi and and that that's my my belief is there will be those viable alternatives I think if you want to look out twenty years to countries with reasonably well regulated banking and financial systems large platforms for their national currencies and favorable demographics are Brazilian and India twenty years from now I would probably add them to the list as well but it is separate to the logic of my argument that that people worried about the dollar have somewhere to turn and that's why I think the the fact that people were predicting the demise of the dollar as an international currency after the Bretton Woods system collapsed and were wrong that fact is compatible with my conjectures about the future because there were no alternatives to the dollar to speak of back then there well could be in the future so Tim asked me for numbers so I thought all only financial journalists quite - can you down by I had a guy earlier this this afternoon asked me about the dollar crash and I said well we need to think about it but he said what probability would you attach to it and I said non-negligible it's a little bit like that it all depends on on lots of things on on no I mean it depends first and foremost on US policy and how are the balls you know in the scenario that I hope for in my heart of hearts and as a patriotic American I do attach the highest probability to when we have our financial backs to the wall we will do the right thing in the end and craft and the fiscal compromise and in that situation where weekend rx together and the Chinese do and the Europeans do I would say the ten years from now the 85% of foreign exchange transactions declines 65 percent or 70 percent so the advantages of incumbency don't disappear entirely thank you Robert Wade I wondered what scope you think there is for regional monetary funds and if you do think there's scope for growth of regional Monetary Fund's what would be the relationship between bodies like the IMF and the regional ones what kind of role with the IMF as the apex body play relative to the regional ones thank you you made the nice point before that there is one country that could leave the eurozone without the financial crisis that would be Germany I'm actually not quite so sure looking at the exposure of Germany's public banks to southern Europe and so my question to you is would the scenario of southern Europe breaking away from the euro and of Germany breaking away from the euro really be so radically different from each other the second question is about the UK you didn't speak much about the okay tonight although the starting as an international reserve currency is not entirely compact no speak on mountainous banking places to live at kicking and so is is that a good predictor for water for what would happen to either Europe or the US in the distant future or are we going to see something rather different and of course what's the kind of advice that you would give to Mervyn King Andy my name is Mark Thomas student at LSE I was just I just have a question quite relevant to the previous one how do you think stepping down of accent labour as a governor of Bundesbank but the do you think that weakens or strengthens your opinion that euro will be one of the surviving currencies and how do you think it has that doesn't have any impact on the probability of Germany actually leaving the Europe or does it have no impact so I never thought that Robert Wade's question about regional funds would be the easy one of this set it's clear that regional funds are coming they're coming first in Europe through the European monetary fund oops I meant to say European Stability Mechanism and you can see from the ESM framework how it's gonna work together with the IMF not unlike the way in which the rescue funds for Greece and and Ireland were structured one-third from the fund and two-thirds from one one-third from the IMF two-thirds from the European monetary fund with negotiations over conditionality spearheaded by the IMF because it's delicate for neighbors stuff set down conditions other neighbors I I would you know I I do think that the same thing we'll probably similar things will develop in other parts of the world over time I see no hope for the Chiang Mai initiative multilateral ization in Asia to be delinked from the IMF so the big effort last year to do that was to create AMRO the Asian what assets tend for Asian monetary review macroeconomic macroeconomic weekend right so I I think they they're gonna have an either Carter even harder job then then Europe has had in terms of doing effective surveillance and once they have the surveillance documents doing anything about them so if there's gonna ever going to be any any lending who the Chiang Mai initiative which there hasn't yet I think it's going to occur in conjunction with the fund the Latins are talking about floor their Latin American reserve fund as well which is small and and peculiar but is the scene from which the larger regional fund could grow these things are I think are going to be part of the solution insofar as countries have only one place to go at the moment for international liquidity and insurance and in the future may may have only three places to go reserve pooling is an alternative to that and I think the arguments for it our economic arguments for it are compelling shots are less than perfectly correlated across neighbors across regional neighbors there are other links among these economies that make cooperation possible but they're also big political obstacles to to making that happen the Asians have been crying now for more than ten years and they're still kind of at square two on Germany I think Albert rip CIL's point was on the mark that there would be a variety of other economic and financial problems for Germany itself were there to be this bifurcation between up Northern European your own southern European lira or whatever whatever they would be I agree with that I will not touch the one on giving Mervyn King or the British government advice on you know the the grounds that I've only been here for 24 hours ask me tomorrow and hazard and strongly held opinions on Axel Weber and ECB do I want to touch that one it seems to me the number one that these are are are times when you need intellectually flexible politically adept ECB President and mr. cliche has been intellectually flexible and politically adept the second thing Europe need the euro area needs to do is move beyond the point where these kind of appointments are talking about in terms of nationalities and where the most qualified person is ultimately chosen so how that all that plays out we will have to see whether the most qualified person is ultimately chosen so it's that adequate way of evading your question okay I think we've got any time for one last oh well maybe two it's two last question so you cook you and make sure thank you Sheila page a trained economist y3y or alternatively why any global currency your point about the smartphone and you can see it if you've ever watched the broadcast of a Sotheby's auction they have five currencies automatically displayed implies we don't reckon he need a global unit of account in the same way we did before and you already moving your three up to five should we stop thinking about global currencies or thinking about currencies with various different global roles alternatively why not just one I mean the arguments for that in terms of costs of conversion knowledge of costs of knowledge of risk remain and we've moved from three to four - two - three - two - one why should we give those up thank you very much didn't have international political economy from the North Warwick my questions up during the summer of 2008 after the financial crisis hit a wall street united state governments came with a package of rescue measures including to use a public phone - about private phones it is a signal for future regulation the financial regulation change in the future and how much the will will cost for the future financial regulation in US and in the world thank you I'm not sure I heard the entirety of the last question I think it was to ask my opinion about the adequacy of financial reform in the United States reform is still underway clearly I think the progress that the United States that has made it's deeply disappointing compared to what we were hoping for a couple of years ago a crisis is a terrible thing to waste it's disappointing it seems to me are the standards of the UK which has gone further or appears to be gone further I guess we'll learn more after the vicar's report and its reception than we know now but seems to be going further than the United States we say in the u.s. it's not possible to do more than tinkering around the margin of the financial system because the banks are big and the financial system is so strong so important for our economy so I find it a little bit hard to understand how it is in the UK where the banks are big and the financial system is so important for the economy it has been possible politically to go further it's not as if you exactly had a more serious crisis than we did ours was darn serious as well so I hope that the process of financial reform is not over I think when it comes to the US authorities to actually implement the new ball three capital and liquidity standards we do it in a serious way rather than in a token way but I I'm worried the other question was why not just one global currency I am struck by the fact that we got all the way to this point in our discussion without talking about the IMF Special Drawing rights which is kind of the closest thing we have to a proto global currency I think the answer is that except for Euro land which is soui generous and which illustrates the difficulties of building of constructing a regional or a global currency currencies rest on the fiscal capacity in the political capacity of issuing entity that's what the discussion about the process of European reform in some level about as well the way I put it in the book is no global government means no global central bank which means non global currency who would who would regulate the issuance of this global currency who would decide more had to be issued overnight in a crisis would we delegate those formidable powers to mr. strauss-kahn who is you know weakly overseen by the governors of the International Monetary Fund who actually assemble only twice a year so a global currency seems to me very far away it's worth thinking about respectable people like Robert Mandel and Richard Cooper at Harvard think about it but I don't think it's a productive direction for actually trying to pursue policy reform so I think the good burger that end the session also thanks once again it's very clear pass

Channel: LSE

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Keywords: LSE, London, School, of, Economics, London_School_of_Economics, University, College, Public, Lecture, Event, Seminar, Talk, Speech, socialscience, Professor, Barry, Eichengreen, Barry_Eichengreen, book, Exorbitant, Privilege, The, Rise, and, Fall, the, Dollar, reserve, currency, American, US, USA, hegemony, economic, power, international, finance, economist, academic, monetary, market, history, business

Id: w--Pv8edD6M

Length: 85min 1sec (5101 seconds)

Published: Thu Mar 24 2011