Ask not what the economy can do for insurers – ask what insurers can do for the economy

September 22, 2020

Anna Sweeney, Executive Director, Insurance Supervision Division at Bank of England in this speech brings back the famous JFK words: ask not what your country can do for you — ask what you can do for your country.

She highlights how despite the economic crisis, insurance sector is quite suited to help the economy:

I began these remarks by highlighting three things that insurers do for the wider economy:

  • Provide protection for significant financial losses;
  • Channel investment into a wide range of assets; and
  • Provide security of retirement income in the form of savings and annuities, facilitating stable demand for goods and services.

On the first, there is a critical role for insurers to adapt and ensure they are able to meet customers’ insurance needs, particularly during the transition out of the crisis and also into the longer term. Firms should take early steps to assess what this could mean for their current business models. It would be in no one’s
interests for the experience of the Covid-19 crisis and responsiveness of business interruption cover to reduce consumer confidence in the value provided by insurance for financial protection.

In the life insurance sector there is an opportunity for firms to leverage their position as long-term investors in a wide range of assets and productive investment, to support our economic recovery but this must not come at the expense of policyholder protection and the provision of secure retirement income. We would expect to preserve the current, adequate level of capital in the sector whilst seeking to reduce complexity and frictional costs within the regime.

A financially resilient, competitive and productive insurance sector not only ensures that individual policyholders are protected, but signals an industry that is able to support the recovery of the wider economy whilst maintaining high prudential standards.

Ontology and the History of Economic Thought: An Introduction

September 22, 2020

Paul A. Lewis, Mário da Graça Moura and Jochen Runde in this paper:

This paper is the introduction to a special issue of the Cambridge Journal of Economics on the topic of ontology and the history of economic thought. It explains what is meant by social ontology and why ontological issues should be taken seriously by historians of economic thought. It then goes on to introduce the contributions to the special issue.

The Making of Reston and Columbia towns

September 22, 2020

Emily Wavering Corcoran writes an interesting piece on how towns of Reston and Columbia were developed in the 1960s  with similar visions for inclusive, connected communities.

Reston and Columbia illustrate the economic complexities that exist within a large-scale planned community, and they share some commonalities that may have contributed to their relative success. These include the early establishment of core values, innovative zoning, and prioritization of profitability. Simon and Rouse’s clear and public core values defined standards by which all design and business decisions could be assessed and simultaneously attracted like-minded residents who helped make those values a deep-rooted part of the community culture.

Reston and Columbia were pioneers in mixed-use zoning; today, mixed-use zoning and transit-oriented development are priorities for many localities across the United States, particularly those seeking to increase density and provide accessible amenities. The examples set by Reston and Columbia — including their more recent and ongoing conversations about transit design and the appropriate mix of residential and commercial development — have helped inform the development of mixed-use zoning nationally.

Finally, Reston and Columbia indicate the importance of the “mix” in mixed-use development — Goudie in Reston and David Stebenne in Columbia both note that commercial development provided critical income to help maintain economic viability. Even with the changes that Reston and Columbia have seen over the decades, it seems clear that their conversations about community, diversity, quality of life, and economic viability may never be over — they will simply evolve.


Amul’s B2C and C2C marketing mantra: Buffalo to Consumer and Cow to Consumer!

September 21, 2020

In its Conversation Series Ahmedabad University had the privilege to hear Mr R.S. Sodhi, the Managing Director of Amul.

The conversation video is here. I wish the internet connectivity was a little better. But still Mr Sodhi made some really interesting observations and shared insights on what makes Amul tick.

The house was in splits when he said Amul’s marketing mantr was B2C and C2C: Buffalo to Consumer and Cow to Consumer!

Do people understand Fed’s new policy of Average Inflation Targeting?

September 21, 2020

Olivier Coibion, Yuriy Gorodnichenko, Edward S. Knotek II, Raphael Schoenle analyse the early impact of Fed’s new policy of  Average Inflation Targeting. As expected. not many people understand the difference between AIT and IT:

Using a daily survey of U.S. households, we study how the Federal Reserve’s announcement of its new strategy of average inflation targeting affected households’ expectations. Starting with the day of the announcement, there is a very small uptick in the minority of households reporting that they had heard news about monetary policy relative to prior to the announcement, but this effect fades within a few days.

Those hearing news about the announcement do not seem to have understood the announcement: they are no more likely to correctly identify the Fed’s new strategy than others, nor are their expectations different.

When we provide randomly selected households with pertinent information about average inflation targeting, their expectations still do not change in a different way than when households are provided with information about traditional inflation targeting.

Fed surely has a big challenge to explain the difference to the general public…

What will CBDC with Chinese characteristics look like?

September 21, 2020

Herbert Poenisch of Zhejiang University in this piece writes how the Chinese CBDC is likely to be very different from CBDCs planned by other countries:

Different from other central banks, the PBoC wants to go all the way by adopting a retail CBDC, with commercial banks playing a crucial role. Four major commercial banks, together with the main telecom companies, have been involved in pilot projects, such as the digital currency electronic payments project in Shenzhen. To avoid disintermediation, banks will be CBDC agents, CBDC will be used to top up accounts at banks, make bank transfers as well as payments, bringing business to banks while competing with the two giants.

It is also expected that the aim is for CBDC to replace all money, not just cash. The most significant step would be eliminating private commercial bank money. Any claim will be a claim on the PBoC. It thus supplies the public with money as a public good. A Swiss referendum in June 2018, the sovereign money initiative, had the same purpose. However, it was voted down by the people, most likely as they did not understand its implications. In China, popular understanding will not be an impediment. In their e-wallets the public cannot distinguish between private and public money. Banks will be deprived of the power of money creation and become only agents for public money.

As agents, they can monitor accounts and collect data. This will give authorities total traceability, so called ‘controllable anonymity’. CBDC will be account based rather than tokenised. PBoC stated, in a contribution to a G30 report, that finality will occur before bank account settlement through real time gross settlement. If peer-to-peer transfers will be added, new technologies such as distributed ledger technology and blockchain have to be applied. Monitoring such transactions by the PBoC will be possible as it would operate the central ledger.

Reports have hailed Chinese CBDC as a way of preparing for US financial sanctions. Cross-border transaction cannot be conducted directly between different systems. There is a need for an intermediary. The PBoC can avoid this is by allowing foreign central banks access to the new CBDC, accepting local currencies within the swap agreements. A case by case approach would be too cumbersome, only an automatic process will ensure efficiency. However, allowing foreigners of various credit risk access to Chinese monetary policy is the same dilemma as weak Euro members having access to the ECB monetary policy.

China still must convince the world that its CBDC with Chinese characteristics is beneficial, given the uncertainties which cause other central banks to adopt a more cautious approach.


Eggs in One Basket: Security and Convenience of Digital Currencies

September 21, 2020

As I wrote this article, came across this paper by Charles Kahn, Francisco Rivadeneyra and Tsz-Nga Wong in this piece.

They look at this problem of storing digital currencies via passwords in different locations. What if this information is hacked and money stolen? Whose liability? They suggest how finance firms and tech firms offering financial services can provide the solutions against such a problem:

We have studied the trade-off between safety and convenience of storing balances in anonymous addresses. This type of aggregation is the foundation of all private digital currencies like Bitcoin. Security risks arise from hackers, focusing on banks and exchanges, and from thieves, attempting to steal private keys and account passwords from customers. The extent of loss depends the technological choices of banks and the effort of customers, giving rise of a moral hazard problem. With shared liability we find that in general customers will take too little care. Even when managing their balances individually and facing the entire risk of loss, customers will find some level of aggregation desirable, and so will prefer to use wallets, reuse addresses, and rely on password  aggregation program.

Our findings have implications for the design of central bank digital currencies and their ecosystem. If the central bank can establish similar liability rules for loss as with bank notes, customers will have the incentives to exert the appropriate level of care. Enforcing these rules, however, might not be as straightforward. Moreover, determining the liability in case of loss would be even more complicated if the design of the CBDC allows any individual or firm to hold the digital tokens.

If this is possible, we would expect customers to aggregate balances in accounts held at intermediaries like exchanges. This would give rise to deposits in unregulated entities which might be out of reach of domestic authorities. Designing a CBDC that is universally accessible but cannot be
held by certain firms is a technological challenge.

Our framework applies to any digital asset that functions as a bearer instrument. As institutional investors consider holding digital currencies, it would be relevant to analyse other protocols like multisignature and key sharding. Another avenue is to analyse the incentives of large technology companies considering issuing digital currencies, which could provide custody services and earn revenue from the online activity of their customers.


Venture Capitalists and COVID-19

September 21, 2020

New NBER WP by Paul Gompers, Will Gornall, Steven N. Kaplan, Ilya A. Strebulaev:

We survey over 1,000 institutional and corporate venture capitalists (VCs) at more than 900 different firms to learn how their decisions and investments have been affected by the COVID-19 pandemic. We compare their survey answers to those provided by a large sample of VCs in early 2016 and analyzed in Gompers, Gornall, Kaplan, and Strebulaev (2020). VCs have slowed their investment pace (71% of normal) and expect to invest at 81% of their normal pace over the coming year. Not surprisingly, they have devoted more time to guiding the portfolio companies through the pandemic. VCs report that 52% of their portfolio companies are positively affected or unaffected by the pandemic; 38% are negatively affected; and 10% are severely negatively affected. Overall, they expect the pandemic to have a small negative effect on their fund IRRs (-1.6%) and MOICs (-0.07). Surprisingly, we find little change in the allocation of their time to helping portfolio companies relative to looking for new investments. In general, we find only modest differences between institutional and corporate VCs.


Indian Banks: A Time to Reform?

September 21, 2020

Raghuram Rajan and Viral Acharya in a new paper list reforms needed for banking sector. The paper is written as Festschrift for Isher Judge Ahluwalia

This paper examines what holds Indian banking back and suggests a variety of implementable reforms that could allow banking activity to grow significantly without the periodic boom-bust cycles it has been subject to. Apart from regulatory and market reforms, we propose reforms to bank governance and ownership, especially for public sector banks. With the current enormous strains on government finances, there may be a window of opportunity in which these reforms may be possible since the status quo is untenable.

Recommendations in temporal sequence:

  • Dealing with Bad Loans
  • Improving the Performance of Public Sector Banks
  • Alternatives for Ownership Structure of Public Sector Banks
  • Making Better Loans
  • Strengthening Risk Management at banks
  • Creating Greater Variety in Banking Structures


The changing language of finance

September 21, 2020

My new piece in Moneycontrol. I reflect on how technology lingo is making inroads into finance lingo. You just cant escape not following and understanding technology terms anymore.

Financial organisations have always welcomed new technologies as they are in the business of exchanging information. Now, in addition to the benefits from using technology, they will have to learn how to talk in technological terms.



Reason for decline in inflation in last 40 years: Monetary policy or Asia joining world economy production?

September 18, 2020

William White (Former BIS chief economist and DG of Bank of Canada) says we need to ask five questions on world economy:

Fostering a sustainable recovery, in spite of such preconditions, requires answering five questions. First, what public policies have led us to the current unsustainable state of affairs – what I call ‘policy preconditions’ – and should be avoided in the future? Second, what future shocks threaten sustainable growth? Third, what would a more sustainable global economy look like? Fourth, what policies are required to get ‘there from here’? Fifth, how do we – to use John Kenneth Galbraith’s phrase – choose between the ‘unpalatable’ and the ‘disastrous’?

My analysis emphasises the importance of monetary and fiscal policies in both shaping the recent path, and conditioning the future. However, interactions over time between the global economic system and the surrounding political and environmental framework are also crucially important. These interactions imply the need for policies with a much longer-term focus than hitherto. As well, it requires global political leaders able to rise to the challenge of choosing the ‘unpalatable’ over the ‘disastrous’.

Lord Meghnad Desai responds to the piece:

My view on the last 40 years differs from White’s. The great moderation arose out of the stagflation of the 1970s and the monetarist counter attack on Keynesian policies. Lowering inflation became the goal of monetary policy. However, when prices started to come down, it was not due to policy. It was because after the decade’s oil shocks, capital moved away from the North Atlantic shores to Asia. Manufacturing prices, on which Keynesians once blamed inflation (wage rigidity, high mark-ups, monopoly capital, among others) dropped as production moved to China.

White shows that monetary easing was the principal anti-recession tool. When QE was introduced, low interest rates, along with central bank asset purchases, took over.

Despite large amounts of money in circulation, inflation did not rise. The Asian labour force carried on supplying manufactured goods at a flat rate. QE put more wealth in the hands of the asset-rich and exacerbated already rising income inequality. Fiscal policy was still tethered to lowering the debt-to-income ratio in the UK and European Union generally. The consequence was excess savings by the asset-rich. This has now led to negative interest rates. It is as if financial markets are no longer alarmed by debt to income ratios. They are in search of good yields, which are hard to find.

In the meantime, the technological revolution has almost eliminated the threat of inflation. Central banks are desperate to raise inflation rates back up to their target levels. In the days of hard monetarism, the idea of a central banker hoping for higher inflation was beyond the realms of fantasy. The world’s five largest publicly listed companies deal in data – not steel, cars or oil. It is a Schumpetarian process of creative destruction. While the old economy is in severe recession, data companies are making large profits.

The first question that arises is whether the burden of debt will hinder economic recovery, or whether the modern ‘magic money tree’ really exists. Economists wait to see if and when interest rates turn positive, especially real interest rates. The real economy will change as global supply chains are redesigned to mitigate the risk of future disruption and adjust to US-China decoupling.


Kraken cryptocurrency exchange of US: gets a banking licence!

September 18, 2020

All kinds of things happening. One expected digital currencies/exchanges to replace central banks and banks.  However, crypto exchanges seem to be applying for a bank charter instead.

Kraken, one of the oldest and largest crypto exchanges has received a bank charter:

We are thrilled to announce that the State of Wyoming has approved Kraken’s application to form the world’s first Special Purpose Depository Institution (SPDI), tentatively called Kraken Financial.

Headquartered in Cheyenne, Wyoming, Kraken Financial is the first digital asset company in U.S. history to receive a bank charter recognized under federal and state law, and will be the first regulated, U.S. bank to provide comprehensive deposit-taking, custody and fiduciary services for digital assets.

From paying bills and receiving salaries in cryptocurrency to incorporating digital assets into investment and trading portfolios, Kraken Financial will enable Kraken clients in the U.S. to bank seamlessly between digital assets and national currencies.

This new institution will be regulated in largely the same manner as other U.S. banks.


Why did it apply for a bank charter? To push for payments in cryptos:

 Why did Kraken decide to apply for an SPDI charter?

Kraken’s vision is to become the world’s trusted bridge between the crypto economy of the future and today’s existing financial ecosystem.

An SPDI bank charter permits Kraken to build this bridge in-house. With the charter in place, we can operate a fully independent bank that will reduce our reliance on third-party financial institutions and even help launch a new wave of innovative products for our users. A bank fully dedicated to the interests of our users is, without a doubt, the best way to deliver on this vision.

Wyoming’s approach to regulation is unique among programs anywhere in the world, its careful tailoring balancing the interests of digital asset innovators and their clients.

Though many regulators talk about fostering innovation, Wyoming is the only state to actually build out this vision in a concrete, commercially viable way.

This is more like a narrow bank with deposits backed by 100% reserves in guess what? Fiat money!

4. How is an SPDI different from a traditional commercial bank? Is it regulated differently?

There are several different kinds of banks. A traditional community bank exists to serve its local community through safeguarding customer deposits and lending those deposits to meet the credit needs of its neighbors and small businesses.

Other kinds of banks, called “custody banks” provide services that are more focused on asset custody and providing a safe, trusted gateway for customers to conduct transactions in regulated securities and commodities markets. Custody banks are among the largest U.S. banks.

The SPDI is a custody bank in the same way, but for digital assets like virtual currency. Both custody banks and community banks, however, are still ‘banks’ under federal and state law because they conduct deposit-taking activity.

Kraken Financial, as a bank, is required by Wyoming law to maintain 100% reserves of its deposits of fiat currency at all times. If every client were to demand withdrawals of their fiat at the same moment, Kraken Financial would be able to fulfill each withdrawal immediately without regard to how many loans we had outstanding.

This is the advantage of the SPDI charter, because the FDIC generally only insures deposits up to $250,000. For this reason, deposits will not be required to be insured by the FDIC.

Kraken Financial will be regulated in largely the same manner as other U.S. banks by the Wyoming Division of Banking. The Division is currently finishing development of the first regulatory manual for banks and digital assets, building on the standards in Wyoming and federal law.

  Lot more on the blog post

Vaccine finance and epidemics: An ounce of prevention is worth a pound of cure

September 18, 2020

David Bloom, Daniel Cadarette and Daniel Tortorice in this IMF piece:

Taken together, epidemic threats pose a huge risk to humanity and human progress. Vaccines represent one of the most valuable tools at our disposal for managing that risk.

Despite the high societal value of vaccination against diseases of epidemic potential, aspects of vaccine economics create challenges for achieving socially optimal levels of vaccine R&D, production, and uptake. Because vaccine R&D and the knowledge it creates are global public goods and because administered doses of vaccine have substantial positive externalities, the market tends to undersupply them. We therefore need public intervention to support R&D, manufacture, financing, and delivery—likely in the form of collective financing and the regulation of existing institutions.

COVID-19 is highlighting the fragility of our current systems for vaccine development, manufacture, and delivery. The world would do well to strengthen its systems before the next emerging pathogen gets a foothold in the human reservoir.

One cannot still believe that we have underinvested in vaccine research only to come this complete halt of world economy and society.


Macroeconomic risks across the globe due to the Spanish Flu

September 18, 2020

Roberto A. De Santis, Wouter Van der Veken in this ECB Working paper look at global impact of Spanish Flu of 1918:

We characterise the distribution of expected GDP growth during the Great Influenza Pandemic (known also as Spanish Flu) using a non-linear method in a country panel setting. We show that there are non-negligible risks of large GDP losses with the 5% left tail of the distribution suggesting a drop in the typical country’s real per capita GDP equal to 29.1% in 1918, 10.9% in 1919 and 3.6% in 1920. Moreover, the fall in per capita GDP after the Spanish flu was on average particularly large in low-income countries. Particularly, the size of the GDP drop in the lower tail of the distributions is high for higher income countries and immense for lower income countries. As for the
United States, the estimated size of the recession in the lower tail of the distribution following the Spanish flu is not negligible.

More like K-shaped recovery in most economies…

50 years of Friedman’s article on social responsibility of business

September 17, 2020

On 13 Sep 1970, Milton Friedman in a NYT article wrote the infamous words:

..the doctrine of “social responsibility” taken seriously would extend the scope of the political mechanism to every human activity. It does not differ in philosophy from the most explicitly collective doctrine. It differs only by professing to believe that collectivist ends can be attained without collectivist means.

That is why, in my book Capitalism and Freedom, I have called it a “fundamentally subversive doctrine” in a free society, and have said that in such a society, “there is one and only one social responsibility of business–to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud.”

Obviously, several writers just cut short the lines to: “there is one and only one social responsibility of business–to use its resources and engage in activities designed to increase its profits”.

Mckinsey reflects on the 50th anniversary of the Friedman article:

It has now been 50 years since economist Milton Friedman asked and answered a fundamental question: What is the role of business in society?

Friedman’s stance was plain: “There is one and only one social responsibility of business—to use its resources and engage in activities designed to increase its profits.” That view has long influenced management thinking, corporate governance, and strategic moves. But more recently, many leaders have sought to expand that definition to consider all the stakeholders who stand to gain—or lose—from organizations’ decisions.

In 2019, Business Roundtable released a new “Statement on the purpose of a corporation,” signed by 181 CEOs who committed to lead their companies for the benefit of all stakeholders—customers, employees, suppliers, communities, and shareholders. The statement outlined a modern standard for corporate responsibility.

On the 50th anniversary of Friedman’s landmark definition, we look at how the conversation on corporate purpose has evolved.


How Croatia adopting Euro could impact Bosnia and Herzegovina..

September 17, 2020

Europe and its currency arrangements are always interesting to figure.

I had pointed how Croatia (and Bulgaria) is on its way to adopting Euro.  This transition might impact economy of Bosnia and Herzegovina.

Mr Senad Softić, Governor of the Central Bank of Bosnia and Herzegovina says they will be watching out:

How much will the adoption of the euro in Croatia, sooner or later, have an impact on Bosnia and Herzegovina, given the border connections and the turnover that still exists?We do not expect major challenges regarding the introduction of the euro in Croatia. On the contrary. The exchange rate regime in force in Croatia is a managed fluctuating exchange rate. The fact that Croatia is in ERM II means, among other things, that the CNB has successfully maintained the exchange rate of the kuna against the euro in a certain narrow spread.

Therefore, fluctuations in the exchange rate of the kuna against the euro, and consequently against the KM, were not strong. This means that foreign exchange risk in the financial system and the real sector, from this aspect, was not emphasized. With the introduction of the euro, foreign exchange risk in transactions with Croatia will become negligible, as long as the Currency Board regime is in place in BH, or until BH introduces the euro.

Therefore, when Croatia introduces the euro, the risks of doing business with Croatia will be lower because the foreign exchange risk of changes in the value of the kuna against the euro will be eliminated. Also, exchange operations (currency exchange operations) will be simpler because the same money will be used in 17 other countries.

It is possible that in the medium term, the Croatian economy will become more integrated and turn to countries that have the euro. But I repeat, there should be no major challenges. The CBBH will monitor the developments very carefully and take measures in time, if necessary.


Similarities between Yap stone and Bitcoin

September 16, 2020

Jens Weidmann of Bundesbank in this speech points to similarities between Yap Stone and Bitcoin.

The history of money is a story of its gradual dematerialisation from tangible objects to intangible computer code. For example, there once was a time, on the Pacific island of Yap, when huge and heavy, often doughnut-shaped limestone discs were used as money. That is evidently a very tangible form of money, as you can see in places like the Bundesbank’s Money Museum where such a Yap stone is on display. Digital money, by contrast, is intangible. It exists only as binary code.

However, the stone money was a less impractical means of payment than you would imagine. Moreover, the similarities with crypto tokens based on distributed ledger technology (DLT) are so striking that some people wonder whether stone money might have inspired the invention of Bitcoin.[1]

One such similarity is that the creation of new stone discs was constrained. The limestone was carved on the Palauan archipelago, some 400 kilometres away, and shipped to Yap. This made it a very resource-intensive process, not unlike the mining of Bitcoin.

But the most striking similarity between stone money and crypto tokens is that both rely on a public, community ledger system. On Yap, villagers knew and memorised the transactions – much like a blockchain network. For this reason, it was not necessary to move the heavy stones. According to reports by locals, one large stone was still accepted as money even though it had fallen off a boat and sunk to the bottom of the ocean. So physical possession was not necessary, either. And both systems provide transparency about transactions, as well as security, without needing a centralised bank structure.

However, oral ledgers can quickly become overwhelmed if economic transactions are conducted outside a Pacific atoll or become highly frequent. Digital ledgers, by contrast, facilitate global transactions in large numbers. Of course, crypto tokens have shortcomings of their own. The high volatility of their value, in particular, limits their use as a payment medium.

So, both stone money and crypto tokens touch upon two key issues in the payments debate: First, how can consumers pay conveniently, safely and efficiently? And second, what role do we want the central bank to play?

He even points to a paper which discusses the similarities in more details.

What led to rise of hegemony of US Dollar?

September 16, 2020

Kathleen Tyson has a nice piece in OMFIF. Much of USD hegemony was not just based on the ambitions of Washington but driven by banks based in New York:

Speculation about the dollar’s hegemonic decline is premature. The global financial plumbing is relatively inflexible in the short term. It will not change quickly or inexpensively.

It took a century of New York banks’ financial activism and extensive global interbank innovation and collaboration to make the dollar a global hegemonic currency.

Dollarisation of the global economy was driven by mercantile ambitions from New York, not geo-strategic ambitions from Washington. New York banks expanded abroad with gold as the hegemonic asset for settlements, offering dollar finance only for trade. The dollar only became a hegemonic currency after the US revoked Bretton Woods dollar-for-gold convertibility in 1971.

It was New York banks that insisted on the need for a central bank and the plumbing for international settlements. The Federal Reserve was founded in 1913 against a backdrop of wider national suspicion and American isolationism, hence the 12 regional reserve banks and a strict domestic mandate. The McFadden Act in 1927 banned inter-state branching and mergers by American banks, forcing New York banks to look abroad for investment and expansion opportunities. Like the Fed, the Bank for International Settlements was conceived in New York to make settlements of gold and German war reparations more convenient. The first two presidents of the BIS were New York mercantile bankers. The Fed only joined the BIS as a member in 1994.

Importantly, many elements of the dollar hegemonic order were engineered to counter American policies. The rise of offshore Eurodollar bank deposits was spurred by American sanctions against China in 1949 and Russia in 1956, forcing these governments to hold dollar accounts at banks in Paris and London, respectively, to avoid expropriation or freezing of accounts in New York. Similarly, the Eurobond market started financing offshore dollar bonds in Europe in 1963 to avoid taxation in the US and European issuer nations.

Regulation played an important role in the growth of dollarised capital markets. Global banks concentrated in London to take advantage of regulatory liberalisations following the ‘big bang’ deregulation of markets in 1986, trading from screens instead of floors. By 1990, more than 90% of cross-border equities trading was booked in London. The 1988 Basel accords institutionalised minimum bank capital requirements, cementing global demand for US Treasuries as the most liquid counter-cyclical capital asset, but globalising markets for other high-quality liquid assets too. Harmonisation of securities laws and regulations in the 1990s spurred wider expansion of global bank operations.

So Chinese should be mindful of these developments. Infact, Chinese Renminbi challenging USD hegemony will be a combination of policies and developments:

If the digital renminbi does gain critical mass as a global hegemonic currency, the US might provide the motivation. A ‘hard fork’ splitting the world’s financial and operational systems between the legacy dollar markets and digital renminbi markets could be triggered by more aggressive ‘America first’ policies on finance, trade, security and technology.

Sanctions have been used recently to target Chinese commercial rivals of US tech giants, stretching a national security rationale to the edge of credibility. Tariffs now target geostrategic allies as well as rivals.

The Dodd-Frank Act of 2010 stripped the Fed of power to make emergency loans to foreign banks and corporations, even though such loans stabilised global markets in the 2008 financial crisis. The Fed retains the power to make dollar swaps with peer central banks, but emergency swap lines have been extended to just nine central banks during the Covid-19 crisis.

Looser fiscal and monetary policies may also drive a shift toward renminbi claims and assets. The Fed has already monetised more than $3tn in new debt issued in 2020 as federal debt crests 100% of GDP. Last month it relaxed its long-held inflation target of 2%, despite a rapid depreciation by the dollar against other reserve currencies. Sterling was eclipsed in the global monetary order a century ago by Britain’s debts, loss of global empire, inflation, and civil unrest at home. The dollar may lose appeal if parallel US trends become entrenched.

At the start of this year, most dollar cash claims and dollar-denominated assets were owned by non-Americans. The dollar is a global currency. China’s influence in the world can grow with dollars for settlement now just as America’s influence grew with gold for settlement until 1971. The dollar will only lose its hegemonic status if Chinese policies make use of the renminbi more practical for foreign banks and investors, while American policies make continued use of the dollar impractical.

The emphasis is mine and is interesting: “China’s influence in the world can grow with dollars for settlement now just as America’s influence grew with gold for settlement until 1971.”

Lots of history in the article.


The shadow of fiscal dominance: Misconceptions, perceptions and perspectives

September 15, 2020

Isabel Schnabel of ECB in this speech defends ECB policies during the ongoing crisis in Europe since 2010:

the euro area is still far from being a fiscal union. And even if it were, there would still be the question, as in other advanced economies, of whether rising debt has jeopardised, or will jeopardise, monetary dominance and, as a result, central bank independence.

Indeed, some observers have taken the launch of the asset purchase programme (APP) and, more recently, the pandemic emergency purchase programme (PEPP) as a sign that the ECB has started monetising sovereign debt at the expense of its primary mandate of price stability.

They accuse the ECB of undermining fiscal discipline by keeping interest rates artificially low and of assuming powers that the European Treaties reserve for national governments.

Deviations from the capital key under the PEPP are interpreted as tailoring monetary policy towards the most highly indebted euro area countries, in order to ease their debt burden and avoid destabilising the currency union as a whole.

These claims are not new. Central bank independence was already coming under close scrutiny before the pandemic, not only in the euro area.[3]

I would like to structure my remarks in three parts.

The first part deals with the misconception that the ECB’s policies constitute a form of “financial repression”.

The second part discusses the disciplinary function of sovereign bond markets and provides evidence that it has not been lost in the wake of the ECB’s unconventional policies. I will also argue that market failures imply a role for central banks in stabilising government bond market in times of stress.

The third and final part opens up perspectives on the changed interactions between fiscal and monetary policy in a low-interest-rate environment and what it implies for the longer term.


Coin migration between Germany and other euro area countries

September 15, 2020

Matthias Uhl of Bundesbank has an interesting paper on coinage in Euroarea:

Euro coins have a common European side and an individual national side. Thanks to coin migration, coins bearing a panoply of national sides are in circulation throughout the euro area. In this paper, we model the mixing of coins circulating in the euro area countries and in particular the extent of coin migration in the euro area. A model calibration suggests that, for the coin denominations €2, €1, 50 cent and 20 cent roughly the same quantity of euro coins migrate from Germany to the rest of the euro area as vice versa. Accordingly, the relatively large quantities of coins issued by the Federal Republic of Germany are not materially explained by exports of coins to other euro area countries.


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