June 18, 2025 • 61 mins
Barry Eichengreen joins Alan Dunne for a clear-eyed look at a system losing its anchors. The dollar’s standing, long insulated by trust and habit, now faces a different kind of test... one shaped less by challengers abroad than by fractures at home. They explore how rising debt, political entropy, and institutional strain are converging in ways that markets are only beginning to price. From the quiet retreat of safe haven flows to the uneasy future of central bank independence, this is a conversation about slow shifts with fast consequences, and what happens when credibility, not currency, becomes the liability.
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Episode TimeStamps:
00:09 - Introduction to Barry Eichengreen
03:51 - The Future of the Dollar: Concerns and Predictions
14:29 - Fiscal Challenges and Policy Responses
33:04 - Analyzing Economic Policies and Their Impacts
49:18 - Global Economic Perspectives: Trade Wars and Currency Alternatives
56:46 - The Future of Global Currency Systems
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Episode Transcript
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(00:06):
I think it's about to trade.The trade war of the 1930s spilled
over into all kinds ofdiplomatic and geopolitical problems.
So there's the danger of that.The US Then experienced three major
banking crises and everybodyliquidated their dollar reserves,
leaving not enough globalliquidity to go around. So one could
(00:30):
imagine a similar chain ofevents unfolding now.
Imagine spending an hour withthe world's greatest traders. Imagine
learning from theirexperiences, their successes and
their failures. Imagine nomore. Welcome to Top Traders Unplugged,
the place where you can learnfrom the best hedge fund managers
(00:52):
in the world so you can takeyour manager, due diligence or investment
career to the next level.Before we begin today's conversation,
remember to keep two things inall the discussion we'll have about
investment performance isabout the past, and past performance
does not guarantee or eveninfer anything about future performance.
Also understand that there's asignificant risk of financial loss
(01:13):
with all investment strategiesand you need to request and understand
the specific risks from theinvestment manager about their product
before you make investmentdecisions. Here's your host, veteran
hedge fund manager Niels Kaastrup-Larsen.
Welcome and welcome back toanother conversation in our series
(01:35):
of episodes that focuses onmarkets and investing from a global
macro perspective. This is aseries that I not only find incredibly
interesting as well asintellectually challenging, but also
very important given where weare in the global economy and the
geopolitical cycle. We want todig deep into the minds of some of
(01:55):
the most prominent experts tohelp us better understand what this
new global macro driven worldmay look like. We want to explore
their perspectives on a hostof game changing issues and hopefully
dig out nuances in their workthrough meaningful conversations.
Please enjoy today's episodehosted by Alan Dunne.
(02:16):
Thanks for that introduction,Niels. Today I'm delighted to be
joined by Professor BarryEichengreen. Barry is professor of
Economic and Political Scienceat University California, Berkeley.
He has written and researchedextensively on international monetary
affairs, international financeand economic history. He's the author
of a number of highlyacclaimed books including Exorbitant
(02:40):
Privilege and Hall of Mirrors.Barry, great to have you back on
Top Traders Unplugged. How are you?
Very well. Good to be backwith you Alan.
Great. Well you were aprevious guest back in 2023 I believe.
So if anybody wants to hearabout your background, the full story,
they can go back and check outthat episode. But it's very timely
(03:02):
obviously to have you onbecause obviously a lot of the research
and writing you've done hasbeen on international finance the
reserve role of the US dollar.And more recently you've written
a lot about debt as well. So Ithink we've lots of stuff to talk
about. You wrote an article inthe Financial Times at the end of
March which looks quiteprescient now, talking about some
(03:27):
of the risks to the USDollar's, I guess, international
standing and reserve status.And in that piece you pointed to,
I guess, some of the factorsthat tend to be less talked about,
namely the importance ofpersonalities and people over capital
markets and institutions. Sohave you become very concerned about
(03:48):
the longer term outlook forthe dollar?
I have grown very concerned.The book that you mentioned, Alan,
Exorbitant Privilege, came outin 2011 and I suggested that the
dollar's dominance as the goto currency for traders and financiers
(04:09):
and importers and exportersaround the world. That dominance
was likely to erode verygradually over time as the weight
of the US economy on theglobal stage similarly declined very
gradually over time. And Isuggested the dollar would have to
share the international stagewith other currencies such as the
(04:33):
euro and the Chinese renminbi.What I thought would be a gradual
glacial process of financialrebalancing has come forward in time.
Obviously, Mr. Trump hasbrought it forward in time and we
now face the possibility thatthere will be flight away from the
(04:55):
dollar due to unpredictableU.S. policies. And what could have
been an orderly process ofrebalancing could turn into a chaotic
period of financial turmoil.So I'm worried not only for the dollar,
but for the global economy andthe global financial system.
(05:18):
And I mean, it's interesting,I guess, people when they talk about
the dollar, I mean, sentimentalways seems to shift to the possibility
of an abrupt end to the dollarstatus. But obviously you've written
about this before withexorbitant privilege and you looked
at the scenario of the lastmajor transition, I guess, which
(05:39):
was sterling in the World Warperiod. And Sterling, I think reading
your book, it started to loseits status maybe in the 20s, but
sterling remained stable forquite a while after that. So I mean,
the dollar could lose itsreserve status without suffering
a major decline. But it soundslike there are concerns on both sides
(06:01):
now, isn't that fair to say interms of reserve status and just
general appetite forinternational appetite for the dollar?
Well, the dollar and the UStreasury market is important for
the world because dollars arethe grease and the wheels of globalization,
if you will. The dollar is thedominant form of international liquidity
(06:27):
that is used for commodity andmerchandise, imports and exports,
and cross border financialtransactions. Alike. But the US treasury
market is important for theUnited States itself. There's the
question of what interestrates the government will have to
pay to service its debt, andwhether there will continue to be
(06:51):
sufficient appetite for U.S.treasury securities to keep those
debt servicing costs undercontrol. So there is the issue of
fiscal and debt sustainabilityin the United States. And what happens
in the United States doesn'tstay in the United States. Financial
(07:14):
problems here tend to infectother countries and the globe as
a whole.
One of the interestingfeatures of, I suppose our experience
with the dollar in the lastfew years has been we've also had
these episodes of periodicspikes in the dollar and this idea
(07:34):
that the world is kind ofstructurally short dollars, but at
the same time you hear peoplebeing overweight dollar assets. And
I guess if you look at theexperience of the global financial
crisis, and again during COVIDwhen you had funding stress and the
scramble to raise dollars, thedollar spiked. So is that going to
(07:56):
be still a factor that we havethis huge issuance of dollar liabilities?
Will that always kind of causethe dollar to maintain this kind
of characteristic of in timesof stress, severe stress, it would
still benefit from thatdynamic? Or how do you reconcile
those two kind of country kindof perspectives?
(08:16):
There's no guarantee that whatwas true in the past will be true
in the future. That's ageneral rule of life, but it applies
here as well. What you'redescribing is the dollar's traditional
safe haven status, that the UStreasury market is the single largest
and most liquid financialmarket in the world. When there is
(08:40):
a crisis, when a bad thinghappens, investors rush into that
liquid market. They arereassured that if they hold U.S.
treasuries, they can buy andsell them at a relatively stable
price at will. So even whenthe US Caused Lehman Brothers to
(09:01):
fail, we did the bad thing. In2008, investors rusk in $2 into the
US treasury market and thedollar exchange rate strengthened.
That's the safe havencharacter of the dollar. What we've
seen in the last couple ofmonths, however, is that when the
vix, a measure of globalvolatility, spikes, when US interest
(09:29):
rates go up, investors moveout of dollars. I think we're seeing
the erosion of that safe havenstatus because the US treasury market
may be relatively liquid andstable at the moment, but the Trump
administration has. Members ofthe Trump administration have made
(09:51):
some peculiar suggestionsabout how that market might be managed
in the future that have causedinvestors to begin to doubt whether
the US treasury market is asafe place to park their funds.
As you're speaking obviously,I suppose it's clear that the outlook
(10:12):
for the dollar is kind ofinextricably linked with the outlook
for treasury markets. And manyof the same factors, I guess, are
driving the markets. I supposea big focus now in markets with the
passage of the big beautifulbill going through Congress is debt
and deficits. And a couple ofyears ago, you went to Jackson Hole
(10:35):
and presented a paper on debtand kind of the likelihood that high
debt levels are here to stay.I think bond yields are roughly where
they were then, but at thatpoint they were kind of trending
higher, and then after thatthey went up towards 5% in the 10
years. It certainly brought itonto the radar. I mean, what was
(10:58):
the discussion like in JacksonHole at the time? How was your paper
received? Was there generalacceptance that what you presented,
which was that higher debtsare here to stay, Was that the consensus,
would you say?
I think the policymakers inthe room were somewhat more optimistic
or committed to the idea thatgovernments were going to bring these
(11:24):
high debt levels back down inorder to restore government's capacity
to borrow in the future tomeet the next emergency, the next
pandemic or financial crisis,or whatever warranted a new round
of borrowing. In that paper,my co author and I looked at past
(11:48):
episodes. There were not alarge number, but there were some
past episodes wheregovernments did succeed in bringing
back down high levels of debt.We found two robust predictors or
correlates of success. One wasgrowing the economy, growing the
(12:10):
denominator of the debt to GDPratio. That's the painless way of
bringing down debt. And lowlevels of political polarization,
which enable countries to staythe course, if you will, even when
government changes, they cancontinue the process of fiscal consolidation
(12:33):
because there's a politicalconsensus around what needs to be
done. So against thatbackdrop, I've become more and more
pessimistic about the UnitedStates. Number one, the Trump administration
has cut the legs out fromunder American exceptionalism, out
(12:53):
from under the exceptionalperformance of the U.S. economy by
advanced country standards,based on research and development,
public private sectorcollaboration, the excellence of
our universities, you name it.There's more reason to worry about
American exceptionalism nowthan in the past. And the problem
(13:18):
of political polarization inthe United States, which has been
rising over time, shows nosigns, to put it mildly, of reversing
course. So that combination offactors makes me even more worried
about fiscal prospects in theUS and the big beautiful bill kind
of highlights that problem.
(13:40):
And you presented your paperin 2023, and at the Time you highlighted
that high levels of debt werelikely to stay, but at the same time,
you didn't see a fiscal crisisin the near term. I mean, your point
was that based on the broadparameters, the longer term trajectory
(14:00):
wasn't great, but it wasn'tunsustainable in the short term.
Is that shifting now, givenwhat we've seen in terms of deficits
in the last couple of years?And at what point would you know
or what would it take for youto say, okay, we could have a crisis
in the next one to two.
Years, in 2023, I could notimagine that our budget deficits
(14:23):
in the United States wouldkeep widening as they have. So back
then the deficit was 5 or 6%of GDP. Now it's 7% of GDP, presumably,
and heading higher, that thereis no constituency for addressing
this problem. And with aneconomy whose growth is likely to
(14:47):
slow Going forward, 7% of GDPdeficits are simply unsustainable.
So I'm more worried about thisnow than I was back then.
Okay. And obviously peoplefocus on this relationship, R minus
G, which is the rate ofinterest on the debt versus the growth
rate. I guess the optimistswould point to, you know, AI, the
(15:11):
possibility for productivityboom. We've seen better productivity
in the last one to two years,but that kind of followed a couple
of years of weak productivity.So averaging out, it's probably average
enough. But any, I mean, Iknow what you've written about how
some of the Trump policies interms of the universities are indeed,
(15:31):
et cetera, could undermineproductivity. What about AI? Is that
going to be a possible savior?
It's a possible savior, but Ithink all the evidence we have from
past general purposetechnologies, in other words, important
innovations that can beutilized across the economy, they
(15:55):
have to be utilized across theeconomy in order to boost productivity
economy wide. All the evidencewe have from the steam engine, the
internal combustion engine,computerization, suggests that this
takes time. Companies have tofigure out how to make productive
(16:20):
use of this new technology.They need to reorganize their affairs.
And it can take years, it cantake decades. It literally took decades
in the case of the steamengine, electricity, the internal
combustion engine, beforeproductivity economy wide responded.
Often, productivity economywide declined before it accelerated
(16:45):
because the process ofreorganization in order to capitalize
on these new technologies isdisruptive. So before electricity,
you had the steam engine, andfactories had machines, each of which
ran on a centralized steamengine connected to that engine with
(17:07):
a system of gears and pulleysthat ran overhead. All of that had
to be disassembled and thefactory floor had to be reorganized
to capitalize on theavailability of self standing electric
engines. So productivity wentdown for two decades before it began
to go back up. It's quitepossible, likely, in my view, that
(17:30):
we'll see something similar,maybe a bit compressed in time, but
still similar in the case of AI.
Okay. And I guess we'retalking about how the reaction you
got at Jackson Hole and theperspective of policymakers, once
debt levels and deficits gettoo large, you get this phenomenon
(17:50):
of fiscal dominance and theneed for monetary policy to be directed
towards, I guess, you know,trying to keep bond yields in check
and financing the government.I mean, that's, that's something
that's been talked about for awhile. I saw, I suppose we saw it
a little bit during COVID Wesaw it, you know, in the, in the
(18:11):
gilt market effectively, Ithink at that point in time. And
you could argue was the Fedeffectively doing that during COVID
as well? But I mean, is thatsomething that could really become
a feature of the landscape, doyou think, in the coming years?
Well, the answer depends, Ithink on the country that one is
talking about. So in theUnited States here I'm going to speak
(18:35):
like an economist. On the onehand, the Fed is independent and
the Supreme Court has justissued a judgment, if you will, that
the independence of the Fed isstronger than that of other supposed
(18:57):
independent agencies in theU.S. i think the Fed is deeply committed
to its inflation target andwould be reluctant to abandon that
in order to bail thegovernment out of its debt servicing
problems. On the other hand,however, Mr. Trump is a low interest
rate man. He's interested inlow interest rates for a variety
(19:20):
of reasons, but he will surelybe interested in them in the future
as a way of keeping debtservice and costs down and freeing
up government resources forother purposes, whatever. And he
will arm twist the Fed to keepinterest rates lower than otherwise.
(19:43):
So how that plays out overtime, none of us can predict. But
I think there is a scenariowhere the Fed feels intense pressure
to keep interest rates lowerthan otherwise because of debt servicing
problems. And one can imagineother countries where the central
bank is less independent,where that pressure is even more
(20:07):
effective.
I mean, I have seen it beingsuggested that we're already seeing
that in Japan. Obviously thebank of Japan is maintaining low
rates. Inflation has continuedto be at or above target. Now I guess
you can make the point thatthere's a question with how sustainable
those inflation rates are. Butis that the type of example that
(20:31):
comes to mind when you'retalking about some central banks
who might be less independent.
Not yet. So I think the BOJ isstill looking at the Japanese economy
through the rear view mirror.That's often what central banks do.
It is not convinced that thelong period of deflation is over,
(20:53):
so it's reluctant to raiseinterest rates faster. Now that it
sees a spike in JGB yields, itmay begin to worry about something
else, namely debt servicingcosts. But I, you know, it will begin
to look through the windshieldrather than the rear view mirror.
But for the time being, Ithink it's been responding to a history
(21:17):
of deflation and not worriedabout fiscal dominance at least yet.
And as you say, sorry, in yourpaper you pointed out the various
ways that can get reduced overtime and you mentioned higher growth
being one, and then actually,I guess fiscal rectitude being another
(21:38):
one. And then obviously peoplepoint to higher inflation has been
a third way to maintain,reduce the real value of debt. And
that, I guess has so far hadbeen successful. Well, had been a
positive side effect of theinflation we saw in the US And I
think I've asked this to someother academic guests before. I mean,
(21:59):
does that ever really become apart of the conversations in central
banks in the developed world?We should allow inflation to run
a little bit higher to helpour debt levels. Or is that really
more of a, as you say, aphenomenon that comes into play when
the central bank becomescompromised and less independent?
Or do you think you get thatkind of, I suppose, coordination
(22:19):
between the monetary andfiscal authorities in the developed
markets?
Well, we have seen it in thepast. Example would be the United
States during and immediatelyafter World War II, before the agreement
between the treasury and theFed in 1951, 52 that the Fed should
(22:42):
be left to its own devices andno longer aid the treasury in keeping
interest rates down andservicing the debt. Before the accord,
the Fed had basically given upits independence in the interest
of fighting the war. Quiteunderstandable under the circumstances.
(23:04):
So it kept interest rates downand that helped the treasury issue
more bonds and service themmore easily. I do think we are in
a different world now, atleast in the United States. And the
question is how long thatdifferent world, when the Fed is
independent and committed toits 2% inflation target, survives.
(23:31):
I think the other kind ofpolicy choice in the menu of policy
options for highly indebtednations is the idea of financial
repression. And this is whereyou either force certain institutions
or entities to buy bonds orencourage them in some way. In your
(23:51):
paper you were, I think, alittle Bit kind of skeptical about
the ability of authorities tomaybe engage in financial repression
to the extent that they mighthave maybe back in the 1970s. And
I guess the idea would be toforce banks or life insurance companies
to hold more Treasuries ormaybe even public pension funds or
(24:13):
entities like that. So why doyou think it's harder now to. To
do that?
Financial repression becauseof financial globalization, because
of financial liberalization? Ithink the toothpaste is out of the
tube and moving back to thekind of tightly regulated financial
markets we had in the 1950s,1960s is simply not possible at this
(24:40):
point in time. I haven'tinteresting, pleasant ongoing debate
with my Harvard colleagueCarmen Reinhart, who believes that
financial repression iscoming. I am more skeptical. This
may reflect a difference intemperament between the two of us
or it may reflect the factthat Carmen has much more experience
(25:03):
and knowledge in emergingmarkets where restrictions on financial
transactions have been andremain more prevalent. So he's familiar
with the world of financialrepression and more convinced than
I am that it is coming. Maybethis is an indication that it's coming
in certain parts of the world,but not others, like the United States,
(25:26):
where banks and others prefera world of free capital markets,
light touch regulation, andthey also have a lot of leverage
over the political system tomake their preferences known. The
other thing Alan, I want tosay that I missed out on earlier
(25:47):
on is I think inflation can beuseful for bringing down debt to
GDP ratios once, but can't beresorted to repeatedly because markets,
and therefore interest rateswill react more quickly after the
surprise inflation. Howfrequently can you surprise the markets?
(26:10):
Inflation surprised all of usin 2122 and that brought the debt
to GDP ratio down one time.But I don't think this will work
on an ongoing basis.
The other kind of lever. Well,there's a couple of other levers,
I guess the treasury has. Oneis this policy around the capital
(26:35):
treatment of bonds for banksthat was brought in during the COVID
crisis and it's due to comeback, I believe. I mean, would that
be significant enough to.Would that encourage banks to hold
a lot more Treasuries? Wouldthat be kind of a meaningful shift
in demand for Treasuries,would you say?
Well, with $30 trillion oftreasuries out there, I don't think
(27:03):
that is likely to make asignificant dent in. In the problem.
Again, if banks and insurancecompanies and other institutional
investors were all mandated tohold a lot more Treasuries, that
would make a difference, butthat would be your financial Repression
scenario, which I do not find plausible.
(27:24):
And given the, I guess,current tensions between Trump and
some US Universities, I mean,forcing endowments to hold more Treasuries,
things like that, could thatbe part of the landscape?
That one hadn't occurred tome. But I think if that's the bargain
that Trump is offering HarvardUniversity, if you hold more Treasuries,
(27:47):
we will otherwise be handsoff. Harvard would be wise to take
that deal.
You mentioned Carmen Reinhardtand her role in emerging markets
and other perspectives there.And I guess one of the features that
we're seeing in markets now isinvestors increasingly looking at
(28:07):
the US through an emergingmarket lens and an emerging debt
lens. And I guess obviouslyyou've done a lot of research on
economic history and not justin emerging markets, but developed
markets. If you go back intime, you have this idea of a sudden
stop in capital flows, as yousay. I mean, maybe it's more of an
(28:28):
emerging market phenomenon.But what are the typical triggers
for a very abrupt reversal incapital flows that could potentially
undermine the dollar?
Well, the trigger is often acombination of financial weakness
and political weaknessproblems in financial markets, which
(28:52):
going forward could emanatefrom the treasury market, as we've
discussed, or who knows, frominstability spilling over from the
crypto sphere intoconventional financial markets. We
don't know where the nextfinancial problem will pop up, but
(29:14):
we know there will always beone. And then the inability of a
government to, whether becauseof weak political support or simple
policy incoherence, to respondin a stabilizing fashion. So, you
know, when we talk aboutbanana republics, we talk about unsustainable
(29:37):
finances, but we also talkabout unsustainable politics, absence
of rule of law, division ofpowers, et cetera, et cetera. The
United States is clearlyshowing some of those problems. And
whether this treasury and thisgovernment, this White House, would
(30:00):
respond in a concerted,coherent manner to the next financial
problem I think is somethingto ponder.
And I mean, speaking ofpossible financial crises, I mean,
obviously when we had thefirst run up in yields, that was
kind of followed by thechallenges for SVB bank and with
(30:24):
banks having a lot of longduration assets under balance sheet
and then taking a hit on that.Now, the Fed did bring in some liquidity
measures to deal with that atthe time. Is that still out there
as a possible risk if we saw10 year yields surging hard again?
Or does that kind of liquidityprovision take care of that problem?
(30:47):
Or do you? I guess I'm tryingto think. Can you see kind of some
second order obvious Effectsof if we were to see kind of a sudden
move higher in US Yields.
So I certainly would not ruleout the idea that important institutional
investors, banks or otherswould be wrong footed by a spike
(31:09):
in yields. I'm not a closestudent of individual bank balance
sheets, so I can't give you awhere and when, but there are centuries
of history that suggest thatbanks take excessive risks in good
times, and when good timesturn bad, they.
(31:31):
Get caught out just on that. Imean, another part of the whole Trump
platform is deregulation. Andis there, you know, I think within
the banking system, obviouslywith respect to capital treatment
of bonds. That's one aspect.Are there other aspects of it that
could be more positive for themarket from a deregulation perspective,
(31:54):
notwithstanding the risksyou're talking about?
More positive from the pointof view the markets, I'm not sure.
One of the problems thattighter regulation has caused is
that the dealers, mainly ahandful of big banks that are at
the center of the treasurymarket, you know, they hold inventories
(32:16):
of Treasuries and they bookthe trades for buyers and sellers.
Tighter regulation limits howmany additional Treasuries they can
take on when theircounterparties want to sell. So loosening
those regulations couldeliminate or moderate this particular
(32:39):
pressure point. In thetreasury market, which became evident
in March of 2020 and again inMarch of 2023, the dealers hit their
limits, if you will, in howmany Treasuries they could buy. So
yields spiked. Lighterregulation would eliminate that problem,
(33:01):
but I think it would createthe potential for many others.
Okay, maybe just shiftinggears a little bit. I mean, a lot
of people have been scratchingtheir heads trying to understand
what the objective really iswith the tariffs. There's been so
on off, et cetera. But I guessthere has been, I suppose, a mercantilist
(33:24):
kind of policy underpinningthe Trump platform to date. I mean,
from your perspective, youknow, what do you think the administration
is trying to achieve? Is itkind of re industrialization of the
U.S. you know, is it primarilyto boost manufacturing, or do you
see it primarily tariffs as atool to address the deficit or a
(33:46):
bit of everything?
I think we have to be careful.We collectively imputing a strategy
to the administration. Youknow, we're trained to look for a
strategy and it could be thatthere in fact is none if I force
myself to impute a motive anda strategy. However, I would say
yes, there is a belief incrude mercantilism, that running
(34:10):
a trade surplus makes thecountry stronger, and somehow running
a trade deficit makes itweaker. There is a belief that manufacturing
jobs are still the best jobs.There are still good jobs for an
economy like the that of theUnited States. So that creating more
(34:31):
manufacturing will be good forliving standards in the US where
it, you know, if you look atauto plants in the American South,
a lot of workers are makingwhat, 14, 16, $20 an hour. Those
are not the best jobs in amodern 21st century economy. Finally,
(34:58):
I think there is in somecircles a coherent national security
argument for tariffs. Thatstrategic dual use technologies.
We can't rely on China tosupply them, we need produce them
at home. But implementation ofthat policy has been scattershot.
(35:23):
You know, for that you want todo what the Biden administration
had done previously, selectivetariffs and selective subsidies for
building the plants and theproductive capacity in those specific
sectors, not quote, reciprocaltariffs affecting all imports from
(35:43):
all economies.
I mean, if what we're sayinghere is the case, and that is the
strategy and kind of policykind of levels out reflecting that.
So tariffs would then be hereto stay. And there is this focus
on trying to growmanufacturing, rightly or wrongly.
I mean, what would you say arethe kind of economic impacts and
(36:06):
you know, would you expect tosee more companies relocating, more
manufacturing to actuallyrelocate to the US and would you
see, you know, that actually,you know, reducing the current kind
of deficit, even if that's bya weaker economic activity?
Well, I do think that somecompanies finding it more expensive
(36:28):
to produce abroad and exportto the United states, given a 10%
tariff or whatever the newnormal turns out to be, will build
more productive capacitydomestically. I don't think that
will raise US livingstandards, to the contrary, because
(36:50):
we will be paying higherprices for goods that will be more
costly to produce at home.Will it at the end of the day strengthen
the trade balance? That's aseparate question. So the trade balance,
or to go academic on you for amoment, the current account of the
(37:11):
balance of payments is thedifference between our investment
and our savings in the Unitedstates. Will a 10% tariff fundamentally
change the level ofinvestment? Will it encourage households
to save more? I don't reallysee it. So we may be importing a
(37:33):
bit less under this tariffridden new normal, but we may be
exporting a bit less as well.
Yeah, I mean, taking the otherside of it, obviously you talked
about the current accountdeficit and I guess some other economists
point to the capital accountsurplus has really been the thing
that's driving it. And I guessthe two things are coincidence. It's
(37:55):
hard to say which is thedriver But I suppose at the same
time, if you get less capitalinflows from abroad, then I guess
that would push up bond yieldsand that would force some of the
adjustment. Is that how itwould play out?
Yeah. So it. That would forceadjustment, but I think the main
thing it would do would be tocollapse investment. We would be
(38:19):
balancing trade by reducingthe gap between our investment at
home and our savings at home.And an economy that invests less,
other things equal, would notbe a faster growing economy. To the
contrary.
Yeah. And I mean, what we'vealready seen in, say, in Germany,
with their shift in policytowards higher investment in infrastructure
(38:42):
and defense, which willpresumably lead to a smaller German
surplus and less kind ofcapital to be then exported overseas.
So, I mean, do you think we'realready seeing some of the adjustment
already in terms of theseinternational imbalances?
I don't think we've seen verymuch yet. But as you say, if Germany
(39:06):
is investing more at home, itwill be exporting less capital and
its particular trade imbalancewill be somewhat smaller. But I don't
think there has been muchvisible adjustment yet in terms of
(39:26):
the German and the Europeanfiscal stimulus, more defense spending,
more infrastructure spending.It's still very early days. And one
important question unansweredis to what extent that will support
faster growth in Europe. Iactually have my doubts. I think
the multiplier, the fiscalmultiplier around defense spending
(39:49):
is relatively small. Andspillovers from defense spending
to the economy as a whole arerelatively small. And some of the
German economic institutesthat have raised the forecast for
German economic growth overthe next decade by percentage point
a year or by percentage pointand a half a year are being overly
(40:13):
optimistic.
And why is that multiplier soweak? Does the. I mean, will it go
to domestic production largelyor not? Would you do you understand?
Yeah. Well, because we have alot of experience that suggests that
defense production is not themost productive part of the economy
(40:35):
or the part of the economywhere output per worker rose most
rapidly. The US during WorldWar II is an example of an economy
where we ramped up defensespending a lot, but the productivity
of that spending wasrelatively low. The economist Alexander
(40:56):
Field has written a great bookon that experience, and more generally,
another economist, ValerieRamey at UC San Diego and now the
Hoover Institution, has spenther career studying the impact of
fiscal policy impulses on theeconomy and concludes that the spillover
(41:19):
effects are small.
I mentioned one of the booksyou wrote, which was called hall
of Mirrors, which kind of drewparallels between the great financial
crisis and the GreatDepression, obviously back in the
1930s. Part of the feature wasthe tariff war that we saw back then.
How bad would things have toget now for a parallel to be relevant
(41:43):
between now and the 1930s interms of trade tensions?
In terms of the impact oftariffs, I think there is more at
risk for the United States andthe global economy today than there
was in the 1930s because theUS trades more today than it did
back then, because globalsupply chains, global value chains
(42:07):
are a thing today when theyweren't back then. So the supply
side disruptions from tariffscould be more severe. And we're about
to see them show up on USShores. Container traffic from Asia
to the US has gone down, butthe impact of that hasn't hit the
(42:28):
store shelves quite yet. Ithink it's about to the trade war
of the 1930s build over intoall kinds of diplomatic and geopolitical
problems. So there's thedanger of that. Yet again. Trump
has just now put his, what wasit, 50% tariff on imports from the
(42:51):
euro on hold for a month and ahalf or however long it takes us
to get to early July. Buttensions, diplomatic tensions between
the US And Europe are alreadyhigh because of the spat around NATO
and all that. So yes, I amworried about all that and to circle
(43:15):
back to where we started. Theother thing that happened in the
1930s was a global liquiditycrisis as international investors
fled the dollar. The dollarand sterling were the two global
reserve currencies in the1930s. The US then experienced three
(43:37):
major banking crises andeverybody liquidated their dollar
reserves, leaving not enoughglobal liquidity to go around. So
one could imagine a similarchain of events unfolding now.
Interesting. I mean, from yourperspective, looking at the Fed at
the moment, they're obviouslysaying it's too early to call the
(43:59):
impact of the tariffs. You'vegot an inflationary impact, you've
got an adverse impact ongrowth. Is it any sense on which
of those two will dominate inthe near term or over the next few
months?
Well, this is clearly a nightmerit scenario for a central bank.
On the one hand, they want toraise interest rates because of inflation
(44:20):
that is coming. On the otherhand, they want to lower rates because
of the distinct possibility ofrecession coming. So what to do?
My guess is that they willraise before they lower, that the
inflation will show up inconsumer prices soon and recession
(44:41):
will take time to develop.Recessionary trends are not evident
in the data yet, and I thinkit may take some quarters until the
end of the year. But thisscenario of Raising rates to reiterate
the Fed's commitment to itsprice stability target will not calm
(45:02):
the President and will make itharder for the Fed to say we did
the right thing once therecession materializes. So it is,
as I said, kind of a nightmarescenario for the Fed. There's no
easy way out. There's nosimple solution. But I think both
for political and economicreasons, it will raise before it
(45:27):
cuts.
Interesting. I mean, themarket has taken out its, well, a
lot of the easing it hasfactored in. But even at the last
press conference, I think thegeneral sense was either pause or
cut, but nobody was actuallyasking about the possibility of rate
hikes. I think that wouldcertainly be quite a shock to the
market. As you say, thatscenario is unlikely to go down well
(45:49):
at the White House. I guesswe're already now into talking about
who might be a replacement forPowell. Any thoughts on that? I mean,
you mentioned how Trump couldsee a scenario where Trump is arm
twisting the Fed. Who would bethe kind of potential successors
for a Powell that would bemost amenable to that?
(46:12):
Well, there have been a coupleof Kevins who have been mentioned,
but the point I would make isthat the chair doesn't make policy
that there are 12 members ofthe FOMC. They are experienced policymakers
and financial hands, and Ithink only one of them comes up for
(46:33):
renewal or replacement in thenext 12 months. So if past practice
continues, Trump can't packthe Federal Resort Reserve Board,
much less the Federal OpenMarket Committee on which set six
regional Reserve bankpresidents that are appointed not
by the US President but bytheir own separate boards of directors.
(46:59):
It is costly and embarrassingfor the Fed Chair to dissent from
the rest of the committee. Sothis has happened, for example, in
the late 1970s and the thenFed chair, G. William Miller was
quickly replaced by PaulVolcker. So I think the discipline
(47:21):
of the committee as a whole isimportant. Which of the two Kevins
gets appointed as the next Fedchair? Less important.
I think even Volcker gotoutvoted at times as well as Fed
Chair. But I guess people morenaturally think of the Arthur Burns
experience through much of the70s with Nixon. And I guess even
(47:46):
without having beendramatically pursuing the wrong policies,
but just the Fed Chair isstill influential. I guess it could
still tilt the conversation toa more dovid stance. That would be
reasonably easy to envisage,wouldn't you say?
Yeah, Nixon's plumbers plantedstories in the press about Burns
(48:09):
wanting a pay increase, whichwhen the US Was under wage and price
controls and nobody else wasgetting a wage increase and did a
variety of other things topressure Burns to keep interest rates
down when Nixon was runningfor reelection in 1972. So that was
an. And Burns did so that wasan example of successful presidential
(48:33):
pressure. But the moreimportant point is that Burns didn't
believe that the Feddetermined the rate of inflation.
He believed that wage pressurefrom unions and markups from big
corporations were thefundamental drivers of inflation.
And doctrine and belief is nowvery different. Everybody in the
(48:54):
Fed realizes that they are thefundamental shapers of inflation
and that they have to do whatit takes to keep inflation under
control.
Just coming back to the maybeto the US Dollar outlook which we
touched on at the start, Imean, we've talked a little bit,
I guess, about the USperspective and the risks from a
(49:16):
credibility perspective anddebt levels, et cetera. I mean, parallel
to that, the question is, isthere an alternative? And for a long
while it had been. Tina, Thereis no credible alternative, but I
guess it is shifting slowly. Imean, and I know when we spoke before
you talked about how evennotwithstanding the kind of the slow
(49:40):
growth of the euro andrenminbi and reserve holders, even
smaller currencies in thedeveloped markets were growing in
terms of their allocation. Butmaybe focusing on the renminbi and
the euro, do you see reasonsto think that this is their moment
now to step up and to assume alarger position in international
(50:03):
portfolios?
I think there's scope for thisthem to assume a slightly larger
position, but the fundamentalconstraints on their replacing the
dollar on the global stageremain. So in the case of the euro,
I think the most important oneis shortage of safe euro assets,
(50:23):
AAA rated government bondsavailable to the rest of the world
for use as reserves inpayments and so forth. Back when
we spoke, only three euro areagovernments had AAA ratings from
all three rating agencies.That remains true today. And many
(50:44):
of their bonds have to be heldby Europe's own banks, so they're
not available to the rest ofthe world. One could imagine Europe,
the European Union creatingmore safe assets by buying bonds
from the member states andcrushing them into a safe slice and
(51:05):
a secondary less safe slice.Markus, Bruno Meyer at Princeton
and others have suggestions tothis effect. Nothing has been done
in three, four, five yearssince these proposals have been floating
around because it's kind ofviewed as a further expansion of
(51:26):
the role of the EuropeanCommission and the European Union.
And the membership statesstill are reluctant about that prospect.
In the case of China, therestill are capital controls. China
is starting out way behind theUnited States. It still accounts
for only 3.5% of paymentsthrough the through SWIFT and through
(51:50):
the global payment system.Only 2% of global foreign exchange
transactions, only 2 pluspercent of global foreign exchange
reserves. So I think the roleof the renminbi is growing fairly
rapidly, but it is so farbehind the U.S. they've been doing
currency internationalizationfor 15 years. We've been doing it
(52:12):
in the U.S. for 115 years. Sothe euro and the renminbi can gain
ground on the dollar, on themargin and they will gain ground
on the dollar faster now thatthese new doubts about the stability
and prospects of the greenbackhave been heightened. But the danger,
(52:34):
it seems to me, is if theydevelop really serious concerns about
the dollar and there isliquidation of dollar reserves and
flight away from the dollar.Tina is the problem. And we end up
with inadequate globalliquidity to support 21st century
(52:55):
globalization as we know it.
I think there was a story outearlier today about the PBOC mandating
local banks to invoice more indollars or to increase that level.
I think the threshold had been25% and they're pushing it up to
40% for internationaltransactions. So there does seem
(53:16):
to be an incremental shiftthere. For a long time there was
a sense that the Chinese werereluctant to fully internationalize.
I mean from a policy or fromtheir own appetite perspective, do
you think that is becominggreater and the challenges, just
as you say it's starting off alow base or how would you see that
kind of appetite to take.
On a bigger role then PBoCgovernment Governor Zhao made a famous
(53:42):
speech in 2009 about theproblems of a dollar based system
and that led to the currentthe renminbi internationalization
push. They pushed hard andthey moved in the direction of liberalizing
access to their financialmarkets until they had a stock market
(54:02):
crash in 2015. Since thenthey've been moving carefully, slowly,
deliberately, and I think theywill continue to do that. They're
following the Fed's early 20thcentury playbook in promoting use
of the renminbi for tradesettlements first and assuming that
(54:25):
that will spill over into useof the currency in financial transactions
over time. So a majority ofChina's own imports and exports are
now invoiced and settled inthe country's own currency. Financial
transactions still much lessso. But that's the way dollar internationalization
(54:46):
work in the first half of the20th century as well. So I think
it's a sound strategy. Itwon't transform renminbi into a leading
international currencyovernight, however, and we're seeing.
And hearing more and morecalls for digital currencies, even
(55:06):
from official circles. SoChristine Lagarde at the last press
conference has Precib kind ofcalling on the Commission to make
further progress on Savingsand Investment Union, but also I
think plans for a digitaleuro. I mean, how does that alter
the landscape, if any? If youhave a digital renminbi, a digital
(55:29):
euro, talk of kind of banks inthe US issuing a joint stablecoin,
I mean, where does that fitinto the whole debate about reserve
currencies?
Well, I think for the euroarea or the United States, it doesn't
make a great big difference.Our financial markets and financial
(55:51):
transactions are alreadyheavily digital and fedwire is now
24 7. In other words, we haveexisting digital payments technologies
and a central bank digitalcurrency might lower costs and increase
speed on the margin. But Idon't think that would be transformative.
(56:15):
What would be transformativein terms of payments would be if
China and some of itspartners, allied countries, if you
will, create a common platformthat would render their central bank
digital currencies directlyinterchangeable for one another so
(56:37):
they wouldn't have to gothrough Swift and the dollar and
the US correspondent bankingsystem when making payments. So the
fact of the matter is thistechnology already exists. It's called
Project Enbridge. It's beenunderway for three or four years
(56:59):
originally with coordinationfrom the bank for International Settlements.
The BIS is now withdrawnbecause the US observed that this
kind of platform could also beused as a backdoor for payments for
countries like Russia. But thecode for Project Enbridge was written
in the Digital institute ofthe PBoC. The PBoC and the Saudi,
(57:25):
UAE, Thai central banks andthe Hong Kong Monetary Authority
are the five partners in thisexperiment. They're doing actual
transactions using it already.So the problem question is how many
countries might participate?Would they be happy with a system
(57:48):
dominated by the PBoC? Couldthe level of transactions be significantly
scaled up from its currentrelatively low level? But that's
the context in which I thinkCBDCs could make a first order difference
for the structure of theglobal system.
And we're talking about apayment clearance system as opposed
(58:12):
to currencies wouldn't be tiedin any sense, but just they would
all use the common platform.
Right. They could all run on asingle private permission blockchain.
That's basically what ProjectEnbridge is.
Yeah. Just one final questionon this whole topic, which is, you
know, we had during thefinancial crisis the extension of
(58:32):
these dollar swap lines,which, you know, were seen to really
embed the dollar even more asthe anchor to the system, you know,
and to facilitate thattransmission of liquidity in times
of stress. And I think theywere further extended in Covid. I
mean, there was always aquestion whether they would remain.
You know, they kind of came inunder the radar in some sense without
(58:56):
kind of requiring anypolitical approval. Would they be
at risk, do you think, in anyscenario? And do their existence
still kind of give the dollarthat stronghold in the international
system?
I think their existence iscritically important. Dollar swap
lines enable foreign centralbanks to get their hands on dollars
(59:18):
when they need them. And thatin turn allows foreign central banks
to be more accommodating oftheir local banks and firms when
the latter borrow dollars andneed dollars and use dollars in their
own transactions. So the swaplines are important for cementing
the dollar's global role. Ithink the Fed fully understands that
(59:43):
and appreciates the value ofthese swap lines. But that's a little
bit like saying the U.S.defense Department appreciates the
value of NATO. One can imaginea U.S. president who says, if we're
going to give you these swaplines, you have to give us something
in return, and I'm going tosuspend the swap lines or force the
(01:00:05):
Fed somehow to suspend theswap lines until you give us that
other thing in advance. So CEAChair Steven Mehran has this famous
white paper from Novembersaying the US can't keep on providing
(01:00:25):
global public goods freely tothe rest of the world. We can't afford
it, he asserts, and I suspecthe would view swaplines as a global
public good that the US isfreely giving away where it should
be, charging a user fee.
Interesting. Well, I thinkthis could be a topic we're hinting
(01:00:48):
at, could come on the radar atsome point, but there's been so much
to touch. Thanks very much fortaking the time. So, as you can hear,
we're at a critical junction,certainly in terms of the outlook
for U.S. treasuries and thedollar. So stay tuned and follow
Barry's work for more. But fornow, from all of us here on Top Traders
(01:01:12):
Unplugged, thanks for tuningin and we'll be back again soon.
Thanks for listening to TopTraders Unplugged.
If you feel you learntsomething of value from today's episode,
the best way to stay updatedis to go on over to itunes and subscribe
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(01:01:32):
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next time on Top Traders Unplugged.
I think it's about to trade.The trade war of the 1930s spilled
over into all kinds ofdiplomatic and geopolitical problems.
So there's the danger of that.The US Then experienced three major
banking crises and everybodyliquidated their dollar reserves,
leaving not enough globalliquidity to go around. So one could
(00:30):
imagine a similar chain ofevents unfolding now.
Imagine spending an hour withthe world's greatest traders. Imagine
learning from theirexperiences, their successes and
their failures. Imagine nomore. Welcome to Top Traders Unplugged,
the place where you can learnfrom the best hedge fund managers
(00:52):
in the world so you can takeyour manager, due diligence or investment
career to the next level.Before we begin today's conversation,
remember to keep two things inall the discussion we'll have about
investment performance isabout the past, and past performance
does not guarantee or eveninfer anything about future performance.
Also understand that there's asignificant risk of financial loss
(01:13):
with all investment strategiesand you need to request and understand
the specific risks from theinvestment manager about their product
before you make investmentdecisions. Here's your host, veteran
hedge fund manager Niels Kaastrup-Larsen.
Welcome and welcome back toanother conversation in our series
(01:35):
of episodes that focuses onmarkets and investing from a global
macro perspective. This is aseries that I not only find incredibly
interesting as well asintellectually challenging, but also
very important given where weare in the global economy and the
geopolitical cycle. We want todig deep into the minds of some of
(01:55):
the most prominent experts tohelp us better understand what this
new global macro driven worldmay look like. We want to explore
their perspectives on a hostof game changing issues and hopefully
dig out nuances in their workthrough meaningful conversations.
Please enjoy today's episodehosted by Alan Dunne.
(02:16):
Thanks for that introduction,Niels. Today I'm delighted to be
joined by Professor BarryEichengreen. Barry is professor of
Economic and Political Scienceat University California, Berkeley.
He has written and researchedextensively on international monetary
affairs, international financeand economic history. He's the author
of a number of highlyacclaimed books including Exorbitant
(02:40):
Privilege and Hall of Mirrors.Barry, great to have you back on
Top Traders Unplugged. How are you?
Very well. Good to be backwith you Alan.
Great. Well you were aprevious guest back in 2023 I believe.
So if anybody wants to hearabout your background, the full story,
they can go back and check outthat episode. But it's very timely
(03:02):
obviously to have you onbecause obviously a lot of the research
and writing you've done hasbeen on international finance the
reserve role of the US dollar.And more recently you've written
a lot about debt as well. So Ithink we've lots of stuff to talk
about. You wrote an article inthe Financial Times at the end of
March which looks quiteprescient now, talking about some
(03:27):
of the risks to the USDollar's, I guess, international
standing and reserve status.And in that piece you pointed to,
I guess, some of the factorsthat tend to be less talked about,
namely the importance ofpersonalities and people over capital
markets and institutions. Sohave you become very concerned about
(03:48):
the longer term outlook forthe dollar?
I have grown very concerned.The book that you mentioned, Alan,
Exorbitant Privilege, came outin 2011 and I suggested that the
dollar's dominance as the goto currency for traders and financiers
(04:09):
and importers and exportersaround the world. That dominance
was likely to erode verygradually over time as the weight
of the US economy on theglobal stage similarly declined very
gradually over time. And Isuggested the dollar would have to
share the international stagewith other currencies such as the
(04:33):
euro and the Chinese renminbi.What I thought would be a gradual
glacial process of financialrebalancing has come forward in time.
Obviously, Mr. Trump hasbrought it forward in time and we
now face the possibility thatthere will be flight away from the
(04:55):
dollar due to unpredictableU.S. policies. And what could have
been an orderly process ofrebalancing could turn into a chaotic
period of financial turmoil.So I'm worried not only for the dollar,
but for the global economy andthe global financial system.
(05:18):
And I mean, it's interesting,I guess, people when they talk about
the dollar, I mean, sentimentalways seems to shift to the possibility
of an abrupt end to the dollarstatus. But obviously you've written
about this before withexorbitant privilege and you looked
at the scenario of the lastmajor transition, I guess, which
(05:39):
was sterling in the World Warperiod. And Sterling, I think reading
your book, it started to loseits status maybe in the 20s, but
sterling remained stable forquite a while after that. So I mean,
the dollar could lose itsreserve status without suffering
a major decline. But it soundslike there are concerns on both sides
(06:01):
now, isn't that fair to say interms of reserve status and just
general appetite forinternational appetite for the dollar?
Well, the dollar and the UStreasury market is important for
the world because dollars arethe grease and the wheels of globalization,
if you will. The dollar is thedominant form of international liquidity
(06:27):
that is used for commodity andmerchandise, imports and exports,
and cross border financialtransactions. Alike. But the US treasury
market is important for theUnited States itself. There's the
question of what interestrates the government will have to
pay to service its debt, andwhether there will continue to be
(06:51):
sufficient appetite for U.S.treasury securities to keep those
debt servicing costs undercontrol. So there is the issue of
fiscal and debt sustainabilityin the United States. And what happens
in the United States doesn'tstay in the United States. Financial
(07:14):
problems here tend to infectother countries and the globe as
a whole.
One of the interestingfeatures of, I suppose our experience
with the dollar in the lastfew years has been we've also had
these episodes of periodicspikes in the dollar and this idea
(07:34):
that the world is kind ofstructurally short dollars, but at
the same time you hear peoplebeing overweight dollar assets. And
I guess if you look at theexperience of the global financial
crisis, and again during COVIDwhen you had funding stress and the
scramble to raise dollars, thedollar spiked. So is that going to
(07:56):
be still a factor that we havethis huge issuance of dollar liabilities?
Will that always kind of causethe dollar to maintain this kind
of characteristic of in timesof stress, severe stress, it would
still benefit from thatdynamic? Or how do you reconcile
those two kind of country kindof perspectives?
(08:16):
There's no guarantee that whatwas true in the past will be true
in the future. That's ageneral rule of life, but it applies
here as well. What you'redescribing is the dollar's traditional
safe haven status, that the UStreasury market is the single largest
and most liquid financialmarket in the world. When there is
(08:40):
a crisis, when a bad thinghappens, investors rush into that
liquid market. They arereassured that if they hold U.S.
treasuries, they can buy andsell them at a relatively stable
price at will. So even whenthe US Caused Lehman Brothers to
(09:01):
fail, we did the bad thing. In2008, investors rusk in $2 into the
US treasury market and thedollar exchange rate strengthened.
That's the safe havencharacter of the dollar. What we've
seen in the last couple ofmonths, however, is that when the
vix, a measure of globalvolatility, spikes, when US interest
(09:29):
rates go up, investors moveout of dollars. I think we're seeing
the erosion of that safe havenstatus because the US treasury market
may be relatively liquid andstable at the moment, but the Trump
administration has. Members ofthe Trump administration have made
(09:51):
some peculiar suggestionsabout how that market might be managed
in the future that have causedinvestors to begin to doubt whether
the US treasury market is asafe place to park their funds.
As you're speaking obviously,I suppose it's clear that the outlook
(10:12):
for the dollar is kind ofinextricably linked with the outlook
for treasury markets. And manyof the same factors, I guess, are
driving the markets. I supposea big focus now in markets with the
passage of the big beautifulbill going through Congress is debt
and deficits. And a couple ofyears ago, you went to Jackson Hole
(10:35):
and presented a paper on debtand kind of the likelihood that high
debt levels are here to stay.I think bond yields are roughly where
they were then, but at thatpoint they were kind of trending
higher, and then after thatthey went up towards 5% in the 10
years. It certainly brought itonto the radar. I mean, what was
(10:58):
the discussion like in JacksonHole at the time? How was your paper
received? Was there generalacceptance that what you presented,
which was that higher debtsare here to stay, Was that the consensus,
would you say?
I think the policymakers inthe room were somewhat more optimistic
or committed to the idea thatgovernments were going to bring these
(11:24):
high debt levels back down inorder to restore government's capacity
to borrow in the future tomeet the next emergency, the next
pandemic or financial crisis,or whatever warranted a new round
of borrowing. In that paper,my co author and I looked at past
(11:48):
episodes. There were not alarge number, but there were some
past episodes wheregovernments did succeed in bringing
back down high levels of debt.We found two robust predictors or
correlates of success. One wasgrowing the economy, growing the
(12:10):
denominator of the debt to GDPratio. That's the painless way of
bringing down debt. And lowlevels of political polarization,
which enable countries to staythe course, if you will, even when
government changes, they cancontinue the process of fiscal consolidation
(12:33):
because there's a politicalconsensus around what needs to be
done. So against thatbackdrop, I've become more and more
pessimistic about the UnitedStates. Number one, the Trump administration
has cut the legs out fromunder American exceptionalism, out
(12:53):
from under the exceptionalperformance of the U.S. economy by
advanced country standards,based on research and development,
public private sectorcollaboration, the excellence of
our universities, you name it.There's more reason to worry about
American exceptionalism nowthan in the past. And the problem
(13:18):
of political polarization inthe United States, which has been
rising over time, shows nosigns, to put it mildly, of reversing
course. So that combination offactors makes me even more worried
about fiscal prospects in theUS and the big beautiful bill kind
of highlights that problem.
(13:40):
And you presented your paperin 2023, and at the Time you highlighted
that high levels of debt werelikely to stay, but at the same time,
you didn't see a fiscal crisisin the near term. I mean, your point
was that based on the broadparameters, the longer term trajectory
(14:00):
wasn't great, but it wasn'tunsustainable in the short term.
Is that shifting now, givenwhat we've seen in terms of deficits
in the last couple of years?And at what point would you know
or what would it take for youto say, okay, we could have a crisis
in the next one to two.
Years, in 2023, I could notimagine that our budget deficits
(14:23):
in the United States wouldkeep widening as they have. So back
then the deficit was 5 or 6%of GDP. Now it's 7% of GDP, presumably,
and heading higher, that thereis no constituency for addressing
this problem. And with aneconomy whose growth is likely to
(14:47):
slow Going forward, 7% of GDPdeficits are simply unsustainable.
So I'm more worried about thisnow than I was back then.
Okay. And obviously peoplefocus on this relationship, R minus
G, which is the rate ofinterest on the debt versus the growth
rate. I guess the optimistswould point to, you know, AI, the
(15:11):
possibility for productivityboom. We've seen better productivity
in the last one to two years,but that kind of followed a couple
of years of weak productivity.So averaging out, it's probably average
enough. But any, I mean, Iknow what you've written about how
some of the Trump policies interms of the universities are indeed,
(15:31):
et cetera, could undermineproductivity. What about AI? Is that
going to be a possible savior?
It's a possible savior, but Ithink all the evidence we have from
past general purposetechnologies, in other words, important
innovations that can beutilized across the economy, they
(15:55):
have to be utilized across theeconomy in order to boost productivity
economy wide. All the evidencewe have from the steam engine, the
internal combustion engine,computerization, suggests that this
takes time. Companies have tofigure out how to make productive
(16:20):
use of this new technology.They need to reorganize their affairs.
And it can take years, it cantake decades. It literally took decades
in the case of the steamengine, electricity, the internal
combustion engine, beforeproductivity economy wide responded.
Often, productivity economywide declined before it accelerated
(16:45):
because the process ofreorganization in order to capitalize
on these new technologies isdisruptive. So before electricity,
you had the steam engine, andfactories had machines, each of which
ran on a centralized steamengine connected to that engine with
(17:07):
a system of gears and pulleysthat ran overhead. All of that had
to be disassembled and thefactory floor had to be reorganized
to capitalize on theavailability of self standing electric
engines. So productivity wentdown for two decades before it began
to go back up. It's quitepossible, likely, in my view, that
(17:30):
we'll see something similar,maybe a bit compressed in time, but
still similar in the case of AI.
Okay. And I guess we'retalking about how the reaction you
got at Jackson Hole and theperspective of policymakers, once
debt levels and deficits gettoo large, you get this phenomenon
(17:50):
of fiscal dominance and theneed for monetary policy to be directed
towards, I guess, you know,trying to keep bond yields in check
and financing the government.I mean, that's, that's something
that's been talked about for awhile. I saw, I suppose we saw it
a little bit during COVID Wesaw it, you know, in the, in the
(18:11):
gilt market effectively, Ithink at that point in time. And
you could argue was the Fedeffectively doing that during COVID
as well? But I mean, is thatsomething that could really become
a feature of the landscape, doyou think, in the coming years?
Well, the answer depends, Ithink on the country that one is
talking about. So in theUnited States here I'm going to speak
(18:35):
like an economist. On the onehand, the Fed is independent and
the Supreme Court has justissued a judgment, if you will, that
the independence of the Fed isstronger than that of other supposed
(18:57):
independent agencies in theU.S. i think the Fed is deeply committed
to its inflation target andwould be reluctant to abandon that
in order to bail thegovernment out of its debt servicing
problems. On the other hand,however, Mr. Trump is a low interest
rate man. He's interested inlow interest rates for a variety
(19:20):
of reasons, but he will surelybe interested in them in the future
as a way of keeping debtservice and costs down and freeing
up government resources forother purposes, whatever. And he
will arm twist the Fed to keepinterest rates lower than otherwise.
(19:43):
So how that plays out overtime, none of us can predict. But
I think there is a scenariowhere the Fed feels intense pressure
to keep interest rates lowerthan otherwise because of debt servicing
problems. And one can imagineother countries where the central
bank is less independent,where that pressure is even more
(20:07):
effective.
I mean, I have seen it beingsuggested that we're already seeing
that in Japan. Obviously thebank of Japan is maintaining low
rates. Inflation has continuedto be at or above target. Now I guess
you can make the point thatthere's a question with how sustainable
those inflation rates are. Butis that the type of example that
(20:31):
comes to mind when you'retalking about some central banks
who might be less independent.
Not yet. So I think the BOJ isstill looking at the Japanese economy
through the rear view mirror.That's often what central banks do.
It is not convinced that thelong period of deflation is over,
(20:53):
so it's reluctant to raiseinterest rates faster. Now that it
sees a spike in JGB yields, itmay begin to worry about something
else, namely debt servicingcosts. But I, you know, it will begin
to look through the windshieldrather than the rear view mirror.
But for the time being, Ithink it's been responding to a history
(21:17):
of deflation and not worriedabout fiscal dominance at least yet.
And as you say, sorry, in yourpaper you pointed out the various
ways that can get reduced overtime and you mentioned higher growth
being one, and then actually,I guess fiscal rectitude being another
(21:38):
one. And then obviously peoplepoint to higher inflation has been
a third way to maintain,reduce the real value of debt. And
that, I guess has so far hadbeen successful. Well, had been a
positive side effect of theinflation we saw in the US And I
think I've asked this to someother academic guests before. I mean,
(21:59):
does that ever really become apart of the conversations in central
banks in the developed world?We should allow inflation to run
a little bit higher to helpour debt levels. Or is that really
more of a, as you say, aphenomenon that comes into play when
the central bank becomescompromised and less independent?
Or do you think you get thatkind of, I suppose, coordination
(22:19):
between the monetary andfiscal authorities in the developed
markets?
Well, we have seen it in thepast. Example would be the United
States during and immediatelyafter World War II, before the agreement
between the treasury and theFed in 1951, 52 that the Fed should
(22:42):
be left to its own devices andno longer aid the treasury in keeping
interest rates down andservicing the debt. Before the accord,
the Fed had basically given upits independence in the interest
of fighting the war. Quiteunderstandable under the circumstances.
(23:04):
So it kept interest rates downand that helped the treasury issue
more bonds and service themmore easily. I do think we are in
a different world now, atleast in the United States. And the
question is how long thatdifferent world, when the Fed is
independent and committed toits 2% inflation target, survives.
(23:31):
I think the other kind ofpolicy choice in the menu of policy
options for highly indebtednations is the idea of financial
repression. And this is whereyou either force certain institutions
or entities to buy bonds orencourage them in some way. In your
(23:51):
paper you were, I think, alittle Bit kind of skeptical about
the ability of authorities tomaybe engage in financial repression
to the extent that they mighthave maybe back in the 1970s. And
I guess the idea would be toforce banks or life insurance companies
to hold more Treasuries ormaybe even public pension funds or
(24:13):
entities like that. So why doyou think it's harder now to. To
do that?
Financial repression becauseof financial globalization, because
of financial liberalization? Ithink the toothpaste is out of the
tube and moving back to thekind of tightly regulated financial
markets we had in the 1950s,1960s is simply not possible at this
(24:40):
point in time. I haven'tinteresting, pleasant ongoing debate
with my Harvard colleagueCarmen Reinhart, who believes that
financial repression iscoming. I am more skeptical. This
may reflect a difference intemperament between the two of us
or it may reflect the factthat Carmen has much more experience
(25:03):
and knowledge in emergingmarkets where restrictions on financial
transactions have been andremain more prevalent. So he's familiar
with the world of financialrepression and more convinced than
I am that it is coming. Maybethis is an indication that it's coming
in certain parts of the world,but not others, like the United States,
(25:26):
where banks and others prefera world of free capital markets,
light touch regulation, andthey also have a lot of leverage
over the political system tomake their preferences known. The
other thing Alan, I want tosay that I missed out on earlier
(25:47):
on is I think inflation can beuseful for bringing down debt to
GDP ratios once, but can't beresorted to repeatedly because markets,
and therefore interest rateswill react more quickly after the
surprise inflation. Howfrequently can you surprise the markets?
(26:10):
Inflation surprised all of usin 2122 and that brought the debt
to GDP ratio down one time.But I don't think this will work
on an ongoing basis.
The other kind of lever. Well,there's a couple of other levers,
I guess the treasury has. Oneis this policy around the capital
(26:35):
treatment of bonds for banksthat was brought in during the COVID
crisis and it's due to comeback, I believe. I mean, would that
be significant enough to.Would that encourage banks to hold
a lot more Treasuries? Wouldthat be kind of a meaningful shift
in demand for Treasuries,would you say?
Well, with $30 trillion oftreasuries out there, I don't think
(27:03):
that is likely to make asignificant dent in. In the problem.
Again, if banks and insurancecompanies and other institutional
investors were all mandated tohold a lot more Treasuries, that
would make a difference, butthat would be your financial Repression
scenario, which I do not find plausible.
(27:24):
And given the, I guess,current tensions between Trump and
some US Universities, I mean,forcing endowments to hold more Treasuries,
things like that, could thatbe part of the landscape?
That one hadn't occurred tome. But I think if that's the bargain
that Trump is offering HarvardUniversity, if you hold more Treasuries,
(27:47):
we will otherwise be handsoff. Harvard would be wise to take
that deal.
You mentioned Carmen Reinhardtand her role in emerging markets
and other perspectives there.And I guess one of the features that
we're seeing in markets now isinvestors increasingly looking at
(28:07):
the US through an emergingmarket lens and an emerging debt
lens. And I guess obviouslyyou've done a lot of research on
economic history and not justin emerging markets, but developed
markets. If you go back intime, you have this idea of a sudden
stop in capital flows, as yousay. I mean, maybe it's more of an
(28:28):
emerging market phenomenon.But what are the typical triggers
for a very abrupt reversal incapital flows that could potentially
undermine the dollar?
Well, the trigger is often acombination of financial weakness
and political weaknessproblems in financial markets, which
(28:52):
going forward could emanatefrom the treasury market, as we've
discussed, or who knows, frominstability spilling over from the
crypto sphere intoconventional financial markets. We
don't know where the nextfinancial problem will pop up, but
(29:14):
we know there will always beone. And then the inability of a
government to, whether becauseof weak political support or simple
policy incoherence, to respondin a stabilizing fashion. So, you
know, when we talk aboutbanana republics, we talk about unsustainable
(29:37):
finances, but we also talkabout unsustainable politics, absence
of rule of law, division ofpowers, et cetera, et cetera. The
United States is clearlyshowing some of those problems. And
whether this treasury and thisgovernment, this White House, would
(30:00):
respond in a concerted,coherent manner to the next financial
problem I think is somethingto ponder.
And I mean, speaking ofpossible financial crises, I mean,
obviously when we had thefirst run up in yields, that was
kind of followed by thechallenges for SVB bank and with
(30:24):
banks having a lot of longduration assets under balance sheet
and then taking a hit on that.Now, the Fed did bring in some liquidity
measures to deal with that atthe time. Is that still out there
as a possible risk if we saw10 year yields surging hard again?
Or does that kind of liquidityprovision take care of that problem?
(30:47):
Or do you? I guess I'm tryingto think. Can you see kind of some
second order obvious Effectsof if we were to see kind of a sudden
move higher in US Yields.
So I certainly would not ruleout the idea that important institutional
investors, banks or otherswould be wrong footed by a spike
(31:09):
in yields. I'm not a closestudent of individual bank balance
sheets, so I can't give you awhere and when, but there are centuries
of history that suggest thatbanks take excessive risks in good
times, and when good timesturn bad, they.
(31:31):
Get caught out just on that. Imean, another part of the whole Trump
platform is deregulation. Andis there, you know, I think within
the banking system, obviouslywith respect to capital treatment
of bonds. That's one aspect.Are there other aspects of it that
could be more positive for themarket from a deregulation perspective,
(31:54):
notwithstanding the risksyou're talking about?
More positive from the pointof view the markets, I'm not sure.
One of the problems thattighter regulation has caused is
that the dealers, mainly ahandful of big banks that are at
the center of the treasurymarket, you know, they hold inventories
(32:16):
of Treasuries and they bookthe trades for buyers and sellers.
Tighter regulation limits howmany additional Treasuries they can
take on when theircounterparties want to sell. So loosening
those regulations couldeliminate or moderate this particular
(32:39):
pressure point. In thetreasury market, which became evident
in March of 2020 and again inMarch of 2023, the dealers hit their
limits, if you will, in howmany Treasuries they could buy. So
yields spiked. Lighterregulation would eliminate that problem,
(33:01):
but I think it would createthe potential for many others.
Okay, maybe just shiftinggears a little bit. I mean, a lot
of people have been scratchingtheir heads trying to understand
what the objective really iswith the tariffs. There's been so
on off, et cetera. But I guessthere has been, I suppose, a mercantilist
(33:24):
kind of policy underpinningthe Trump platform to date. I mean,
from your perspective, youknow, what do you think the administration
is trying to achieve? Is itkind of re industrialization of the
U.S. you know, is it primarilyto boost manufacturing, or do you
see it primarily tariffs as atool to address the deficit or a
(33:46):
bit of everything?
I think we have to be careful.We collectively imputing a strategy
to the administration. Youknow, we're trained to look for a
strategy and it could be thatthere in fact is none if I force
myself to impute a motive anda strategy. However, I would say
yes, there is a belief incrude mercantilism, that running
(34:10):
a trade surplus makes thecountry stronger, and somehow running
a trade deficit makes itweaker. There is a belief that manufacturing
jobs are still the best jobs.There are still good jobs for an
economy like the that of theUnited States. So that creating more
(34:31):
manufacturing will be good forliving standards in the US where
it, you know, if you look atauto plants in the American South,
a lot of workers are makingwhat, 14, 16, $20 an hour. Those
are not the best jobs in amodern 21st century economy. Finally,
(34:58):
I think there is in somecircles a coherent national security
argument for tariffs. Thatstrategic dual use technologies.
We can't rely on China tosupply them, we need produce them
at home. But implementation ofthat policy has been scattershot.
(35:23):
You know, for that you want todo what the Biden administration
had done previously, selectivetariffs and selective subsidies for
building the plants and theproductive capacity in those specific
sectors, not quote, reciprocaltariffs affecting all imports from
(35:43):
all economies.
I mean, if what we're sayinghere is the case, and that is the
strategy and kind of policykind of levels out reflecting that.
So tariffs would then be hereto stay. And there is this focus
on trying to growmanufacturing, rightly or wrongly.
I mean, what would you say arethe kind of economic impacts and
(36:06):
you know, would you expect tosee more companies relocating, more
manufacturing to actuallyrelocate to the US and would you
see, you know, that actually,you know, reducing the current kind
of deficit, even if that's bya weaker economic activity?
Well, I do think that somecompanies finding it more expensive
(36:28):
to produce abroad and exportto the United states, given a 10%
tariff or whatever the newnormal turns out to be, will build
more productive capacitydomestically. I don't think that
will raise US livingstandards, to the contrary, because
(36:50):
we will be paying higherprices for goods that will be more
costly to produce at home.Will it at the end of the day strengthen
the trade balance? That's aseparate question. So the trade balance,
or to go academic on you for amoment, the current account of the
(37:11):
balance of payments is thedifference between our investment
and our savings in the Unitedstates. Will a 10% tariff fundamentally
change the level ofinvestment? Will it encourage households
to save more? I don't reallysee it. So we may be importing a
(37:33):
bit less under this tariffridden new normal, but we may be
exporting a bit less as well.
Yeah, I mean, taking the otherside of it, obviously you talked
about the current accountdeficit and I guess some other economists
point to the capital accountsurplus has really been the thing
that's driving it. And I guessthe two things are coincidence. It's
(37:55):
hard to say which is thedriver But I suppose at the same
time, if you get less capitalinflows from abroad, then I guess
that would push up bond yieldsand that would force some of the
adjustment. Is that how itwould play out?
Yeah. So it. That would forceadjustment, but I think the main
thing it would do would be tocollapse investment. We would be
(38:19):
balancing trade by reducingthe gap between our investment at
home and our savings at home.And an economy that invests less,
other things equal, would notbe a faster growing economy. To the
contrary.
Yeah. And I mean, what we'vealready seen in, say, in Germany,
with their shift in policytowards higher investment in infrastructure
(38:42):
and defense, which willpresumably lead to a smaller German
surplus and less kind ofcapital to be then exported overseas.
So, I mean, do you think we'realready seeing some of the adjustment
already in terms of theseinternational imbalances?
I don't think we've seen verymuch yet. But as you say, if Germany
(39:06):
is investing more at home, itwill be exporting less capital and
its particular trade imbalancewill be somewhat smaller. But I don't
think there has been muchvisible adjustment yet in terms of
(39:26):
the German and the Europeanfiscal stimulus, more defense spending,
more infrastructure spending.It's still very early days. And one
important question unansweredis to what extent that will support
faster growth in Europe. Iactually have my doubts. I think
the multiplier, the fiscalmultiplier around defense spending
(39:49):
is relatively small. Andspillovers from defense spending
to the economy as a whole arerelatively small. And some of the
German economic institutesthat have raised the forecast for
German economic growth overthe next decade by percentage point
a year or by percentage pointand a half a year are being overly
(40:13):
optimistic.
And why is that multiplier soweak? Does the. I mean, will it go
to domestic production largelyor not? Would you do you understand?
Yeah. Well, because we have alot of experience that suggests that
defense production is not themost productive part of the economy
(40:35):
or the part of the economywhere output per worker rose most
rapidly. The US during WorldWar II is an example of an economy
where we ramped up defensespending a lot, but the productivity
of that spending wasrelatively low. The economist Alexander
(40:56):
Field has written a great bookon that experience, and more generally,
another economist, ValerieRamey at UC San Diego and now the
Hoover Institution, has spenther career studying the impact of
fiscal policy impulses on theeconomy and concludes that the spillover
(41:19):
effects are small.
I mentioned one of the booksyou wrote, which was called hall
of Mirrors, which kind of drewparallels between the great financial
crisis and the GreatDepression, obviously back in the
1930s. Part of the feature wasthe tariff war that we saw back then.
How bad would things have toget now for a parallel to be relevant
(41:43):
between now and the 1930s interms of trade tensions?
In terms of the impact oftariffs, I think there is more at
risk for the United States andthe global economy today than there
was in the 1930s because theUS trades more today than it did
back then, because globalsupply chains, global value chains
(42:07):
are a thing today when theyweren't back then. So the supply
side disruptions from tariffscould be more severe. And we're about
to see them show up on USShores. Container traffic from Asia
to the US has gone down, butthe impact of that hasn't hit the
(42:28):
store shelves quite yet. Ithink it's about to the trade war
of the 1930s build over intoall kinds of diplomatic and geopolitical
problems. So there's thedanger of that. Yet again. Trump
has just now put his, what wasit, 50% tariff on imports from the
(42:51):
euro on hold for a month and ahalf or however long it takes us
to get to early July. Buttensions, diplomatic tensions between
the US And Europe are alreadyhigh because of the spat around NATO
and all that. So yes, I amworried about all that and to circle
(43:15):
back to where we started. Theother thing that happened in the
1930s was a global liquiditycrisis as international investors
fled the dollar. The dollarand sterling were the two global
reserve currencies in the1930s. The US then experienced three
(43:37):
major banking crises andeverybody liquidated their dollar
reserves, leaving not enoughglobal liquidity to go around. So
one could imagine a similarchain of events unfolding now.
Interesting. I mean, from yourperspective, looking at the Fed at
the moment, they're obviouslysaying it's too early to call the
(43:59):
impact of the tariffs. You'vegot an inflationary impact, you've
got an adverse impact ongrowth. Is it any sense on which
of those two will dominate inthe near term or over the next few
months?
Well, this is clearly a nightmerit scenario for a central bank.
On the one hand, they want toraise interest rates because of inflation
(44:20):
that is coming. On the otherhand, they want to lower rates because
of the distinct possibility ofrecession coming. So what to do?
My guess is that they willraise before they lower, that the
inflation will show up inconsumer prices soon and recession
(44:41):
will take time to develop.Recessionary trends are not evident
in the data yet, and I thinkit may take some quarters until the
end of the year. But thisscenario of Raising rates to reiterate
the Fed's commitment to itsprice stability target will not calm
(45:02):
the President and will make itharder for the Fed to say we did
the right thing once therecession materializes. So it is,
as I said, kind of a nightmarescenario for the Fed. There's no
easy way out. There's nosimple solution. But I think both
for political and economicreasons, it will raise before it
(45:27):
cuts.
Interesting. I mean, themarket has taken out its, well, a
lot of the easing it hasfactored in. But even at the last
press conference, I think thegeneral sense was either pause or
cut, but nobody was actuallyasking about the possibility of rate
hikes. I think that wouldcertainly be quite a shock to the
market. As you say, thatscenario is unlikely to go down well
(45:49):
at the White House. I guesswe're already now into talking about
who might be a replacement forPowell. Any thoughts on that? I mean,
you mentioned how Trump couldsee a scenario where Trump is arm
twisting the Fed. Who would bethe kind of potential successors
for a Powell that would bemost amenable to that?
(46:12):
Well, there have been a coupleof Kevins who have been mentioned,
but the point I would make isthat the chair doesn't make policy
that there are 12 members ofthe FOMC. They are experienced policymakers
and financial hands, and Ithink only one of them comes up for
(46:33):
renewal or replacement in thenext 12 months. So if past practice
continues, Trump can't packthe Federal Resort Reserve Board,
much less the Federal OpenMarket Committee on which set six
regional Reserve bankpresidents that are appointed not
by the US President but bytheir own separate boards of directors.
(46:59):
It is costly and embarrassingfor the Fed Chair to dissent from
the rest of the committee. Sothis has happened, for example, in
the late 1970s and the thenFed chair, G. William Miller was
quickly replaced by PaulVolcker. So I think the discipline
(47:21):
of the committee as a whole isimportant. Which of the two Kevins
gets appointed as the next Fedchair? Less important.
I think even Volcker gotoutvoted at times as well as Fed
Chair. But I guess people morenaturally think of the Arthur Burns
experience through much of the70s with Nixon. And I guess even
(47:46):
without having beendramatically pursuing the wrong policies,
but just the Fed Chair isstill influential. I guess it could
still tilt the conversation toa more dovid stance. That would be
reasonably easy to envisage,wouldn't you say?
Yeah, Nixon's plumbers plantedstories in the press about Burns
(48:09):
wanting a pay increase, whichwhen the US Was under wage and price
controls and nobody else wasgetting a wage increase and did a
variety of other things topressure Burns to keep interest rates
down when Nixon was runningfor reelection in 1972. So that was
an. And Burns did so that wasan example of successful presidential
(48:33):
pressure. But the moreimportant point is that Burns didn't
believe that the Feddetermined the rate of inflation.
He believed that wage pressurefrom unions and markups from big
corporations were thefundamental drivers of inflation.
And doctrine and belief is nowvery different. Everybody in the
(48:54):
Fed realizes that they are thefundamental shapers of inflation
and that they have to do whatit takes to keep inflation under
control.
Just coming back to the maybeto the US Dollar outlook which we
touched on at the start, Imean, we've talked a little bit,
I guess, about the USperspective and the risks from a
(49:16):
credibility perspective anddebt levels, et cetera. I mean, parallel
to that, the question is, isthere an alternative? And for a long
while it had been. Tina, Thereis no credible alternative, but I
guess it is shifting slowly. Imean, and I know when we spoke before
you talked about how evennotwithstanding the kind of the slow
(49:40):
growth of the euro andrenminbi and reserve holders, even
smaller currencies in thedeveloped markets were growing in
terms of their allocation. Butmaybe focusing on the renminbi and
the euro, do you see reasonsto think that this is their moment
now to step up and to assume alarger position in international
(50:03):
portfolios?
I think there's scope for thisthem to assume a slightly larger
position, but the fundamentalconstraints on their replacing the
dollar on the global stageremain. So in the case of the euro,
I think the most important oneis shortage of safe euro assets,
(50:23):
AAA rated government bondsavailable to the rest of the world
for use as reserves inpayments and so forth. Back when
we spoke, only three euro areagovernments had AAA ratings from
all three rating agencies.That remains true today. And many
(50:44):
of their bonds have to be heldby Europe's own banks, so they're
not available to the rest ofthe world. One could imagine Europe,
the European Union creatingmore safe assets by buying bonds
from the member states andcrushing them into a safe slice and
(51:05):
a secondary less safe slice.Markus, Bruno Meyer at Princeton
and others have suggestions tothis effect. Nothing has been done
in three, four, five yearssince these proposals have been floating
around because it's kind ofviewed as a further expansion of
(51:26):
the role of the EuropeanCommission and the European Union.
And the membership statesstill are reluctant about that prospect.
In the case of China, therestill are capital controls. China
is starting out way behind theUnited States. It still accounts
for only 3.5% of paymentsthrough the through SWIFT and through
(51:50):
the global payment system.Only 2% of global foreign exchange
transactions, only 2 pluspercent of global foreign exchange
reserves. So I think the roleof the renminbi is growing fairly
rapidly, but it is so farbehind the U.S. they've been doing
currency internationalizationfor 15 years. We've been doing it
(52:12):
in the U.S. for 115 years. Sothe euro and the renminbi can gain
ground on the dollar, on themargin and they will gain ground
on the dollar faster now thatthese new doubts about the stability
and prospects of the greenbackhave been heightened. But the danger,
(52:34):
it seems to me, is if theydevelop really serious concerns about
the dollar and there isliquidation of dollar reserves and
flight away from the dollar.Tina is the problem. And we end up
with inadequate globalliquidity to support 21st century
(52:55):
globalization as we know it.
I think there was a story outearlier today about the PBOC mandating
local banks to invoice more indollars or to increase that level.
I think the threshold had been25% and they're pushing it up to
40% for internationaltransactions. So there does seem
(53:16):
to be an incremental shiftthere. For a long time there was
a sense that the Chinese werereluctant to fully internationalize.
I mean from a policy or fromtheir own appetite perspective, do
you think that is becominggreater and the challenges, just
as you say it's starting off alow base or how would you see that
kind of appetite to take.
On a bigger role then PBoCgovernment Governor Zhao made a famous
(53:42):
speech in 2009 about theproblems of a dollar based system
and that led to the currentthe renminbi internationalization
push. They pushed hard andthey moved in the direction of liberalizing
access to their financialmarkets until they had a stock market
(54:02):
crash in 2015. Since thenthey've been moving carefully, slowly,
deliberately, and I think theywill continue to do that. They're
following the Fed's early 20thcentury playbook in promoting use
of the renminbi for tradesettlements first and assuming that
(54:25):
that will spill over into useof the currency in financial transactions
over time. So a majority ofChina's own imports and exports are
now invoiced and settled inthe country's own currency. Financial
transactions still much lessso. But that's the way dollar internationalization
(54:46):
work in the first half of the20th century as well. So I think
it's a sound strategy. Itwon't transform renminbi into a leading
international currencyovernight, however, and we're seeing.
And hearing more and morecalls for digital currencies, even
(55:06):
from official circles. SoChristine Lagarde at the last press
conference has Precib kind ofcalling on the Commission to make
further progress on Savingsand Investment Union, but also I
think plans for a digitaleuro. I mean, how does that alter
the landscape, if any? If youhave a digital renminbi, a digital
(55:29):
euro, talk of kind of banks inthe US issuing a joint stablecoin,
I mean, where does that fitinto the whole debate about reserve
currencies?
Well, I think for the euroarea or the United States, it doesn't
make a great big difference.Our financial markets and financial
(55:51):
transactions are alreadyheavily digital and fedwire is now
24 7. In other words, we haveexisting digital payments technologies
and a central bank digitalcurrency might lower costs and increase
speed on the margin. But Idon't think that would be transformative.
(56:15):
What would be transformativein terms of payments would be if
China and some of itspartners, allied countries, if you
will, create a common platformthat would render their central bank
digital currencies directlyinterchangeable for one another so
(56:37):
they wouldn't have to gothrough Swift and the dollar and
the US correspondent bankingsystem when making payments. So the
fact of the matter is thistechnology already exists. It's called
Project Enbridge. It's beenunderway for three or four years
(56:59):
originally with coordinationfrom the bank for International Settlements.
The BIS is now withdrawnbecause the US observed that this
kind of platform could also beused as a backdoor for payments for
countries like Russia. But thecode for Project Enbridge was written
in the Digital institute ofthe PBoC. The PBoC and the Saudi,
(57:25):
UAE, Thai central banks andthe Hong Kong Monetary Authority
are the five partners in thisexperiment. They're doing actual
transactions using it already.So the problem question is how many
countries might participate?Would they be happy with a system
(57:48):
dominated by the PBoC? Couldthe level of transactions be significantly
scaled up from its currentrelatively low level? But that's
the context in which I thinkCBDCs could make a first order difference
for the structure of theglobal system.
And we're talking about apayment clearance system as opposed
(58:12):
to currencies wouldn't be tiedin any sense, but just they would
all use the common platform.
Right. They could all run on asingle private permission blockchain.
That's basically what ProjectEnbridge is.
Yeah. Just one final questionon this whole topic, which is, you
know, we had during thefinancial crisis the extension of
(58:32):
these dollar swap lines,which, you know, were seen to really
embed the dollar even more asthe anchor to the system, you know,
and to facilitate thattransmission of liquidity in times
of stress. And I think theywere further extended in Covid. I
mean, there was always aquestion whether they would remain.
You know, they kind of came inunder the radar in some sense without
(58:56):
kind of requiring anypolitical approval. Would they be
at risk, do you think, in anyscenario? And do their existence
still kind of give the dollarthat stronghold in the international
system?
I think their existence iscritically important. Dollar swap
lines enable foreign centralbanks to get their hands on dollars
(59:18):
when they need them. And thatin turn allows foreign central banks
to be more accommodating oftheir local banks and firms when
the latter borrow dollars andneed dollars and use dollars in their
own transactions. So the swaplines are important for cementing
the dollar's global role. Ithink the Fed fully understands that
(59:43):
and appreciates the value ofthese swap lines. But that's a little
bit like saying the U.S.defense Department appreciates the
value of NATO. One can imaginea U.S. president who says, if we're
going to give you these swaplines, you have to give us something
in return, and I'm going tosuspend the swap lines or force the
(01:00:05):
Fed somehow to suspend theswap lines until you give us that
other thing in advance. So CEAChair Steven Mehran has this famous
white paper from Novembersaying the US can't keep on providing
(01:00:25):
global public goods freely tothe rest of the world. We can't afford
it, he asserts, and I suspecthe would view swaplines as a global
public good that the US isfreely giving away where it should
be, charging a user fee.
Interesting. Well, I thinkthis could be a topic we're hinting
(01:00:48):
at, could come on the radar atsome point, but there's been so much
to touch. Thanks very much fortaking the time. So, as you can hear,
we're at a critical junction,certainly in terms of the outlook
for U.S. treasuries and thedollar. So stay tuned and follow
Barry's work for more. But fornow, from all of us here on Top Traders
(01:01:12):
Unplugged, thanks for tuningin and we'll be back again soon.
Thanks for listening to TopTraders Unplugged.
If you feel you learntsomething of value from today's episode,
the best way to stay updatedis to go on over to itunes and subscribe
to the show so that you'll besure to get all the new episodes
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