"Sell The Dollar": Think Price, Not Flows

The “sell the dollar” trade is coming up in the chatter I see. I think that economists love making international trade and finance more complicated than it should be, but that is partly a side effect of needing to publish new articles on a continuous basis. My simplistic input on this topic is that people need to stop thinking about “global rebalancing” in terms of flows, price changes can do the job.

My guess is that the focus on flows draws from the experience of developing markets, with countries with less developed financial sectors. If a handful of rich people directly control most of the assets in a country, it is a lot easier to generate catastrophic herding behaviour. When financial assets are in the hands of professional investors, there is a more diffuse response, as many professional investors are liability matchers that have the capacity to go against the herd.

USD No Longer A Reserve Currency (And Why That Doesn't Matter)

There are two potential definitions of “reserve currency.” The first is quantitative and weak: do other countries hold official foreign exchange reserves in that currency? The second is qualitative and stronger: is the currency at the centre of global financial markets while other countries peg their currency to the reserve currency, necessitating large holdings of official reserves? That is, the stronger definition implies that the reserve status affects economic behaviour beyond a basic fixed income portfolio allocation decision.

Comments On "The Mar-A-Lago Accord"

In an attempt to find an explanation for the erratic policy of the Trump administration, people are pointing to the so-called “Mar-a-Lago Accord.” (This short explainer by Torsten Sløk offers one summary.) Although one could imagine that this policy mix is what some members of the White House want, we run into the classic “you can’t get there from here” problem. To the extent the plan would work, it relies upon the world being one of simplified economic models, and the goodwill of other countries.

Primer: Currency Risks For Banks

Yet another unedited section from my banking primer manuscript. My feeling is that this section is packing in too much information, and might be trimmed. The technical appendix may be too technical, but I will look at that later.

Although the major banks have global operations and currency trading is a massive financial market, this book largely ignores the complications created by banks operating in multiple currencies. The first reason is that the author has no useful experience in that area. The second is that currency risk is not a significant source of risk for well-managed banks. If a sensible bank is operating in two currencies, it is best understood as two banks operating in one currency, with one bank acting as parent. (From a regulatory perspective, the fact that the home base is in a different jurisdiction matters, but this text is not delving deep enough into details for that to be a concern.)

Currency risk is defined as the risk of generating losses based on changes to the exchange rate between two currencies (i.e., the price of a currency in terms of another). Currency risk is not the risk associated with a bank relying on transferring funding from one currency to another. This cross-currency financing risk was a major factor in the 2008 Financial Crisis, but it is not “currency risk” as it understood from a risk management perspective. This distinction matters because there is considerable folklore about banks running currency risks, and the people spreading that folklore make the mistake of treating the cross-currency financing risk as being a currency risk.

Japanese Yen

The rapid decline of the Japanese yen — recently stabilised by a (presumed) round of intervention — has brought forth the usual “currency crisis” discussion from the usual suspects (people you do not want to listen to for macro views). I cannot say that I am following Japan closely right now (I used to in the now distant past…), so I will just make a few generic points.

• 1The yen is a floating currency, and no sector in Japan borrows in foreign currencies to any large extent. Historical currency crises are artefacts of managed exchange rate schemes or foreign borrowing.
• Although I would prefer a more timely data source, the chart above from the IMF World Economic Outlook database shows Japan’s current account surplus. The Japanese private (and public) sector have accumulated a large amount of financial claims on the rest of the world. A drop in the value of the yen increases the value of those foreign currency assets. Sooner or later, if the yen gets stupidly cheap, repatriation looks interesting for Japanese savers.
• Pretty much everyone wildly over-estimates the effect of exchange rate movements on domestic inflation. The price level in Japan (as measured by the CPI) has barely budged since the mid-1990s, while the yen has done any number of wacky things over that period.
• Could Japanese government bond yields rise? Sure, why not? The problem with JGB doom stories is that most of those Japanese savers with foreign currency assets have implicit/explicit actuarial liabilities denominated in Japanese yen. Higher JGB yields are exactly what they want to see.
• Although I am in no great position to understand why Japan intervened, the most likely reason was that they disliked how disorderly the previous decline was. Nobody in the private sector wants to catch a falling knife. But once the intervention takes out some of the weaker hands, it acts as a signal for other actors to start buying yen, creating a two-way market again.

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(c) Brian Romanchuk 2024

Currencies And Inflation

This is a sub-section that I forgot to include in my previous article that discussed inflation and financial assets. This is for a section of my manuscript that replaced two problematic sections. I kept this new section as lightweight and brief as possible; I might add more content later.

Currency trading is somewhat unusual in that the price reflects what is happening in two different currency zones. If we want to discuss how currencies relate to inflation, we should keep in mind that we should be talking about the inflation rate in the two currencies. For example, if the inflation rate in Canada is 2% and the inflation rate in the United States is also 2%, the effect of inflation on the Canada-U.S. exchange rate should cancel out.

Stop Trying To Make BRICS Happen

BRICS was a brilliant bit of sell side marketing, but it has taken a life of its own. One needs to stop projecting fantasies onto the global financial system, and accept that its form follows function.

The extreme dominance of the share of global GDP after World War II by the United States was a historical accident, and so the relative rise of other economic powers was inevitable. Meanwhile, the eagerness of the United States to use sanctions as a foreign policy tool is going to create incentives to develop mechanisms to do an end run around those sanctions. Nevertheless, the geopolitical system is far more stable than is commonly described. (I will enter a geopolitical tangent later in this article to justify that claim.)

Reserve Currency Blues

The “Demise of the Dollar” is a long-running story in hard money circles, and has gotten a recent push by the growth of transactions in the Chinese yuan in international transactions. Although it seems likely that the yuan will grow in importance, this is largely a nothingburger from the perspective of the United States.

Emerging market investor Paul McNamara was recently interviewed by Tracy Alloway and Joe Weisenthal on this topic. His views are better thought out than mine, but I just want to chime in from the perspective of a developed market govvies analyst.

Currencies And Geopolitics

Zoltan Pozsar is back with his stories about “Bretton Woods III” and the petro-yuan. (The original report is presumably for bank clients, but I found this summary by ER Valasco.) Although developing countries trading with China might take these developments seriously, from the perspective of the developed economies, how third parties arrange their affairs has limited domestic impact.

Currency Swap Comments From The BIS

Claudio Borio, Robert McCauley, and Patrick McGuire solved the problem about what I will write about this week by publishing “Dollar debt in FX swaps and forwards: huge, missing and growing” as part of the Bank of International Settlements’ quarterly review (https://www.bis.org/publ/qtrpdf/r_qt2212h.htm). One can interpret the text as a plea for more data, which is reasonable enough. However, the lurid headlines and commentary that the article has attracted elsewhere is somewhat missing the point. I am not attempting to discuss that article in depth, rather offering my interpretation of the underlying issues.

Currency Regime Shift Effects Over-Rated

I have seen a fair amount of chatter about currency regime shifts. Although such an event may be happening, there is no particular reason to get too excited about it from the perspective of the developed countries.

The figure above shows foreign official holdings of Treasuries as a percentage of Federal Government Debt — using the Fed Flow of Funds (Z.15) report. We can see why there was a great deal of excitement about “China buying all the U.S. bonds!” going into the 2008 crisis, but we can also note that this series has moved around a lot over time (mainly the result of mercantilist policies of Asian countries). However, the downdraft in foreign reserve holdings over the past decade certainly did not result in a Treasury bear market.

Is MMT Only Applicable To The U.S.?

One common line of criticism relates to what is termed open economy considerations – can the foreign sector create constraints on fiscal policy that are not apparent in closed economy models? One simplistic variation of this is the argument that “MMT only applies to the United States,” that is, only a global hegemon that issues the reserve currency can afford to ignore the external sector.

(Note: this is an unedited excerpt from my MMT primer manuscript.)

The Currency Market Is A Market. Act Accordingly.

One recurrent line of discussion I have seen over the years are assertions or questions about currency values that follow this format: if some particular economic event happens, then the currency will rise (or fall). This seems to be the result of "all else equal" logic, but it is highly misleading. Foreign exchange markets are markets, and prices (exchange rates) should not be expected to follow simple rules. Otherwise, all foreign exchange traders would end up with above average profits, and we would have discovered a private sector magic money tree.

Why Cross-Currency Bond Yield Spreads Do Not Matter

I have been running into cross-market yield comparisons in the news flow in recent weeks. For example, the raw U.S. Treasury/German bund yield spread often comes up in valuation discussions.The simple rule of thumb is that one should never make such cross-currency yield comparisons; they only matter if the currency value is being pegged. Since I do not have a handy source for euro-denominated bond yields, I will use the Canada-U.S. comparison.

Bitcoin Valuation Part II(b): What Might Work

This article concludes my series on Bitcoin valuation techniques. There appear to be three broad techniques that are not entirely psychological. The first would rely on the use of the crypto currency as an intermediary; it needs to have a large enough market capitalisation for transfers through the currency to work. The second relies on the portfolio allocation decisions of the large holders: at what point does it become irresistible to allocate towards other assets? Finally, there is the slim possibility that it is possible to hire labour or buy commodities at a fixed bitcoin price, allowing purchasing power parity (arbitrage) to work.

Bitcoin Valuation Part II(a): What Might Work

We need to distinguish between a fair value and what price an instrument trades at. Economic and financial theory is almost invariably about the first part, and the second is not viewed as respectable. However, Bitcoin as an instrument is an excellent example how observed prices are actually determined by the actions of human beings, and not mathematical models. If we wanted to have a more formal approach, we need to look at the valuation of Bitcoin on a macro basis, and not arguments about the valuation of one Bitcoin on the margin.

Bitcoin Valuation Part I: The Wrong Answers

The rise of Bitcoin (and other crypto-currencies) appears that it will have a negative net effect for most law-abiding citizens, but it has provided us with a rather wonderful teaching opportunity. It underlines the weaknesses of existing analytical techniques. (I discussed Bitcoin in a previous article, but I used it to take a sideswipe at DSGE models, and I didn't bother giving the correct answer.)

Due to article length, this article will discuss incorrect valuation techniques. Part II will give the correct methodology.... 

Modelling A Gold Standard

Although the topic of the Gold Standard often comes up in economic discussions, their actual operation is less well understood. This article explains how a theoretical model of a Gold Standard works, as implemented by stock-flow consistent (SFC) models. This is a unedited draft of a section of an upcoming book that describes how to use the Python sfc_models framework.

Growth Limits (Again)

The "limits to growth" debate is continuing. Ramanan has written a good article discussing the role of the external constraint in this debate. I agree with what he says, but I am less troubled by the fact that it is not heavily discussed by others.

Monetary Disorder: Some Views From France

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