Journal of Financial Economics

REF 119 Currencies and financial globalization

Jean-François Théodore, « JFT », n’était pas celui que l’on croyait. Pour ce qui était de l’Europe et de l’opéra, certes, l’apparence de la passion correspondait parfaitement à la réalité. Mais, pour tout le reste, Jean-François Théodore aimait à dérouter, ce qui se lisait pour ses proches dans son regard souvent mutin contrastant avec une gestuelle éminemment débonnaire. De ce contraste venaient probablement pour partie ses qualités unanimement reconnues de fin négociateur...

This paper examines the role of currencies at moments of geopolitical shifts and in particular the “Thucydides dilemma” in which a strong state whose power is perceived as declining might have incentives to use financial power to strike against a weaker but rapidly growing rival. The paper examines in turn the use of seigniorage, the advantages for public sector borrowing, the creation of financial assets (a tool that is no longer exclusively – or indeed even principally – in the hands of governments), the role of currency manipulation in export promotion, and finally the direct security relevance of currencies. Using the experience of the early 20^th century as a test case, the paper examines two alternative strategies for would-be or rising powers: the more costly and destructive one of creating a completely alternative financial world or the system-reinforcing option of developing a complementary financial order.

The widening US current account deficit in the 2000’s and the fact that the financial crisis started in the United-States suggested a further depreciation of the US currency. Seven years after the collapse of Lehman Brothers, the dollar has however reached a ten-year high in effective terms. While the most recent bout of appreciation is related to different positions in the business cycle, the overall strength of the dollar since the beginning of the financial crisis is also due to the safe haven status of the US currency. The dollar has indeed remained predominant in the international monetary system, as shown by the share of the dollar in foreign reserve holdings, international payments or debt issuance, in advanced countries as well as in emerging economies.

The outbreak of the global financial crisis and of the sovereign debt crisis has fuelled discussions as regards new initiatives that could be taken to strengthen economic governance in the euro area and complete Economic and Monetary Union (EMU). Since its introduction in 1999, the euro has been, and still is, the second most important international currency however. The position of the European Central Bank (ECB) vis-à-vis the internationalisation of the euro, i.e. to neither hinder, nor foster the euro’s use outside the euro area, is as old as the ECB itself. And more than 15 years after these discussions, it is striking to observe that a large number of arguments used then, in one direction or the other, remain up-to-date. But the outbreak of the global financial crisis and of the sovereign debt crisis has partly changed the terms of the debate. European authorities may contribute to buttress the euro’s international status indirectly by completing EMU. That this status would grow more important in the period ahead would hence be an indication of their success in completing EMU.

The Chinese exchange rate regime has much fluctuated since the removal of the dollar peg in July 2005. Theoretically, it can be viewed as an “upward crawling peg” relative to a basket of currencies whose precise composition is not revealed. Here we estimate the composition of this basket over different periods and show that times of fast appreciation match a declining dollar weight in the basket. The “crawling appreciation” was meant to answer trade partners’ complaints about an undervalued renminbi giving rise to distortion of competition. After ten years of this regime, the undervaluation has been completely wiped off. The Chinese central bank is still closely monitoring the forex market, although the authorized volatility has increased. After fighting against upward market pressures through accumulating huge amounts of dollar reserves, the central bank must now tackle downward pressures and capital outflows, which result in loss of forex reserves. In parallel, exchange rate controls have been softened in order to promote the utilization of the renminbi by non-residents, particularly for the settlement of international trade. The Chinese authorities would like to benefit from an international currency, although they want to control every step of the financial opening. The inclusion of the renminbi in the special drawing rights (SDR) of the International Monetary Fund (IMF), which has been debated for years, would show the international recognition of the internationalization process.

Two years on, the unprecedented quantitative easing launched by the Bank of Japan has provided mixed results. The reflating effect on the monetary and financial sphere has beaten the wildest expectations: decrease of the real interest rates by 90 bp, depreciation of the effective exchange rate by 30%, increase of the Nikkei index by 130% since November 2012. The inflation rate came back into positive territory by 2013 and inflation expectations have notched up to 1%-1.5%. As regards the real economy, the impact is much less impressive in spite of the return to full employment. More specifically, the softness of the response of exports to the fall of the yen exchange rate is a surprise, which contrary to the moderation of the corporates’ fixed investment and the households’ consumption cannot be explained by the remaining “deflationary spirit”. Those contrasting developments question how full the implementation of Abenomics (i.e. each of the « three arrows ») has been so far but also, more fundamentally, if the priority given to the management of inflation expectations is not drawing too much political capital.

This article reviews the steps that China has taken towards financial reform with particular attention to capital account liberalization and internationalizing the use of the Renminbi (RMB). After a slowdown in the reform momentum during the global financial crisis, there is a clear push towards reform, especially as regards RMB internationalization. During the same period, though, China’s debt has doubled reaching levels which are clearly above those of most emerging markets. This clearly increases the risks imbedded in financial reform and, in particular, capital account liberalization. At this juncture, though, China has no option but to press for reform since it will allow China to better allocate its savings notwithstanding the cost of accepting a higher equilibrium interest rate, especially for the borrowers.

While the concept of macroprudential policy has been extensively discussed, the issue of its coordination at the global level has barely been touched upon. Coordination is however key to warrant its effectiveness, maintain sound and fair competitive conditions between financial institutions or jurisdictions and avoid redundancies or conflicts of objectives between the different decision-making levels: national, regional, and global. This paper first presents the main rationales to think about macroprudential policies at the global level and second considers possible avenues to do so.

Global financial integration should, in theory, provide better portfolio diversification, international risk sharing and thus more efficient allocation of capital across the world. This financial integration has, in reality, facilitated the accumulation of global imbalances which, since the global crisis of 2007-2008, have contracted in terms of flows but have increased in terms of stock. These net external wealth imbalances reveal an asymmetric financial system and a new form of risk sharing where some countries act as insurer of last resort.

During the “global financial crisis”, the interactions, at a global level, between domestic financial systems appeared to be much more complex and crucial than thought previously. The meaning of the macroeconomic and microeconomic determinants of the gross financial flows or the precise nature of the liquidity “spillovers” call for a renewal of our view of the international monetary and financial system. This paper attempts to give an overview of these interactions by addressing successively the following three questions. What are their origins? What are the extent and diversity of their effects? How can the authorities react to these spillovers?

OECD countries’ monetary policies are faced with a new situation. First, inflation in OECD countries is becoming increasingly lower due to structural causes: decline in wage earners’ bargaining power in labour markets, prolonged decline in commodity prices. This has driven central banks, which have kept their former inflation targets, to conduct expansionary monetary policies. Second, monetary policies in OECD countries are less and less efficient in boosting activity and inflation, especially due to the continuous rise in debt ratios, which has eliminated the monetary policy credit channel. The combination of inflation that is structurally lower than central banks’ inflation target and the growing inefficiency of monetary policies is leading to a growing expansionary bias of monetary policies, with the associated risks: asset price bubbles, excessive liquidity flowing between different asset classes and currencies, and excessive variability of asset prices and exchange rates.

Very expansionary and non-conventional monetary policy in the advanced economies has suppressed bond market volatility and lowered yields. When this reverses, there may be an outsized impact on emerging market bonds. This paper considers the options open to central banks in the emerging markets – policy rate changes, forex intervention, changes in reserve requirements and interventionist bond market operations.

For emerging economies, the expected return to conventional monetary policies in the US, which will result in a rise in US interest rates and in a decrease in global liquidity, raises the question of the choice of the monetary regime for those countries that permits to ensure stable growth without financial instability in the post-crisis period. Monetary regime stands for the combination of monetary policy rules, of financial stability objectives and of the choice of exchange rate regime. After studying the monetary regime of the emerging countries in a context of unconventional monetary policies since the crisis, we focus on international spillovers caused by US monetary policy, before analyzing the different dilemmas or trilemmas between which central bankers from emerging countries will arbitrate to implement their monetary regime after the normalization.

This article aims at showing that, with limited institutional efforts, SDRs could be given a more prominent place within central bank international reserves and that such an evolution could generate a significant improvement in the functioning of the International Monetary System.

In contradiction with the ambitions laid out in the IMF Articles, SDRs have so far played a very limited role in international reserve composition. Yet, it proves to be a good instrument and using it more intensively could both facilitate the management of the global liquidity and alleviate the “Triffin dilemma”. However this would imply to make it more user- friendly and to transform it in a full-fledged market instrument, especially with the development of a specific market and the creation of a link between “Official” and “Private” SDRs. Even though such an evolution would necessitate no or a limited set of institutional arrangements, a good deal of political will would be required.

This paper is a survey of the literature that studies the end of bank secrecy in offshore financial centers. Research in this area can be read under two perspectives. On the one hand, the existence of the bank secrecy raises ethical issues like the respect of confidentiality, the equality of all before the taxation, tax evasion and the support for corrupted regimes. On the other hand, bank secrecy and its removal affect international tax competition among nation states and thus the incentives of exchange of information. A critical analysis of the existing contributions along these two strands enables us to understand better indirect and complex effects of the recent reforms on international competition for capital.

Since the beginning of the crisis of 2008, the credibility of central banks is again an important question. Indeed, in spite of their independence and the success of their monetary policy, based on price stability, they were not able to ensure financial stability. To restore it and save the banking systems, central banks and states, whose deficits strongly increased, had to conduct new joint actions.

The subject of this article is to show the unsuitable character of the monetarist literature devoted to the credibility of the central bank prior to the crisis and the inevitable dependence between monetary and fiscal policies questioning the independence of central banks which they seek to preserve by “disconnecting” the banking crisis and the sovereign debt, in particular in Europe. The observation of the results shows that the choices operated by central banks, essentially providing liquidity, only strengthen their credibility.