The U.S.: Inept Diplomacy, Indispensable Currency
by Joseph Joyce
The U.S.: Inept Diplomacy, Indispensable Currency
The announcements by several European governments that they would join the new Asian Infrastructure Investment Bank (AIIB) have been widely seen as indicators of the declining position of the U.S. The AIIB had been proposed by China for the purpose of funding much-needed infrastructure projects in Asian countries. The U.S. had discouraged other governments from joining, ostensibly on the grounds that the new institution would overlap with the World Bank and the Asian Development Bank. But the real reason seemed to be a concern that the Chinese would have a regional forum to wield power.
The New York Times held both the Congress and President Obama responsible for mishandling the issue. The U.S. claimed it sought to ensure better governance in the new institution, but gave no signal of being willing to work with the Chinese and others to make the AIIB an effective agency. The continuing refusal of Congress to approve reforms in the IMF’s governance structure gives the Chinese and other emerging markets ample cause to look elsewhere. The Economist put it starkly: “China has won, gaining the support of American allies not just in Asia but in Europe, and leaving America looking churlish and ineffectual.”
And yet: the same issue of The Economist stated that “In the world of economics, one policy maker towers above all others…,”, and named Federal Reserve Chair Janet Yellen as holder of that position due to the sheer size of the U.S. economy. The influence of the U.S. in financial flows extends far outside national borders. A study by Robert N.McCauley, Patrick McGuire and Vladyslav Sushko of the Bank for International Settlements estimated that the amount of dollar-denominated credit received by non-financial borrowers outside the U.S. totaled $9 trillion by mid-2014. Over two-thirds of the credit originated outside the U.S., with about $3.7 trillion coming from banks and $2.7 from bond investors. The report’s authors found that dollar credit extended to non-U.S. borrowers grew much more rapidly than did credit within the U.S. during the post-global financial crisis period.
Almost half of this amount went to borrowers in emerging markets, particularly China ($1.1 trillion), Brazil ($300 billion), and India ($125 billion). In the case of Brazil, most of the funds were raised through the issuance of bonds, while bank lending accounted for the largest proportion of credit received by borrowers in China. Much of this credit was routed through the subsidiaries of firms outside their home countries, and balance of payments data would not capture these flows.
The study’s authors attributed the rise in borrowing in emerging markets to their higher interest rates. Consequently, any rise in U.S. interest rates will have global repercussions. The growth in dollar-denominated credit outside the U.S. should slow. But there may be other, less constructive consequences. Borrowers will face higher funding costs, and loans or bonds that looked safe at one interest rate may be less so at another. This situation is worsened by an appreciating dollar if the earnings of the borrowers are not also denominated in dollars. The rise in the value of the dollar has already prompted reassessments of financial fragility outside the U.S.
All this puts U.S. monetary policymakers in a delicate position. Ms. Yellen has made it clear that the Fed is in no hurry to raise interest rates. The Federal Reserve wants to see what happens to prices and wages as well as unemployment before it moves. The appreciation of the dollar pushes that date further into the future by keeping inflation rates depressed while cutting into the profitability of U.S. firms. While the impact of higher rates on credit markets outside the U.S. most likely has a relatively low place on the Fed’s list of concerns, Fed policymakers certainly are aware of the potential for collateral damage.
All this demonstrates the discrepancy between the diplomatic and financial power of the U.S. On the one hand, the U.S. must deal with countries that are eager to claim their places in global governance. The dominance of the U.S. and other G7 nations in international institutions is a relic of a world that came to an end with the global financial crisis. On the other hand, the dollar is still the predominant international currency, and will hold that place for many years to come. The use of the renminbi is slowly growing but it will be a long time before it can serve as an alternative to the dollar. Consequently, the actions of the Federal Reserve may have more international repercussions than those of U.S. policymakers unable to cope with the shifting landscape of financial diplomacy.
cross posted with Capital Ebbs and Flows
Yup, the dollar is king, and will be for some time to come. A blessing or a burden?
External debt by all countries comes to $73 trillion. The vast majority of that is in dollars.
World GDP was recently 87T. US GDP was 20% of total. What this means is that a significant portion of world GDP runs on the dollar.
At some point this is going to cause a headache. Too many $s around outside the US controlled system.
The NYT may be being even-handed for once between GOP-dominated Congress and Dem executive, but this outcome is overwhelmingly due to the failure of the Congress to act on the proposed reforms for the stupidest and most parochial reasons. Obama was put in a bad spot thanks to this and almost any reaction would look bad, although I supose that berating other nations for joining it comes across as indeed churlish and silly.
Interesting article.
Inept diplomacy because all we listen to in econ matters are supply side monetarists who are clueless about accounting identities and how they constrain policy choices.
Seems to me that one takeaway from all this is that most of the econ/finance talking heads on CNBC and Faux Business are having a hard time with all their contradictory ideas.
All the fear mongering about our policies crashing our currency over the last 6 years have amounted to nothing, in fact our currency is strengthening…. which is now being lamented. Gosh its rough being a know nothing talking head on a RW business channel.
“The NYT may be being even-handed for once between GOP-dominated Congress and Dem executive, but this outcome is overwhelmingly due to the failure of the Congress to act on the proposed reforms for the stupidest and most parochial reasons. Obama was put in a bad spot thanks to this and almost any reaction would look bad, although I suppose that berating other nations for joining it comes across as indeed churlish and silly.”
I agree with this assessment. I have written about the myopic Congressional refusal to approve the IMF reforms at https://blogs.wellesley.edu/jjoyce/2014/01/19/the-spirit-of-versailles/
I was, however, baffled by the public criticism of Prime Minister Cameron for announcing that the UK would join the AIIB. It did nothing but draw attention to the fact that our allies were not going along with us.