The Breakdown - Dollar Decline and the Paralysis of Conventional Monetary Policy

Episode Date: November 15, 2020

On this week’s edition of Long Reads Sunday, NLW reads former IMF chief and current Harvard economist Kenneth Rogoff’s latest Op-Ed, “The Calm Before the Exchange Rate Storm” in Project Syndicate.

Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. The breakdown is sponsored by crypto.com and nexo.io and produced and distributed by CoinDes. What's going on, guys? It is Sunday, November 15th, and that means it's time for Long Reads Sunday. And today's LRS gets at one of the... most fundamental questions in macroeconomics, which is currency competition. There is a great debate afoot on the role of the dollar in the world, what might be competing of today's currencies, but also whether an entirely new system is likely to emerge. How many times over the last few

months have you heard a call for an invocation of a new Breton Woods? This is a key, key question. The piece is called The Calm Before the Exchange Rate Storm, and it was written by Harvard professor and former IMF chief economist Kenneth Rogoff. It was published by Project Syndicate, which is an awesome op-ed-only publication. I highly encourage you to check it out. So let's read now, the calm before the exchange rate storm. Core dollar exchange rates have so far been surprisingly stable during the pandemic, most likely because major central bank's policy interest rates are effectively frozen at or near zero. But although the current stasis could last a while, it will not last forever. With alternative assets such as gold and Bitcoin thriving in the pandemic, some top economists

are predicting a sharp fall in the U.S. dollar. This could yet happen. But so far, despite inconsistent U.S. management of the pandemic, massive deficit spending for economic catastrophe relief and monetary easing that Federal Reserve Chair Jerome Powell says has crossed a lot of red lines, core dollar exchange rates have been eerily calm. Even the ongoing election drama has not had much impact. Traders and journalists may be getting worked up about the Greenback's daily travails, but for those of us who study longer-term exchange rate trends, their reactions to date amount to much ado about nothing. To be sure, the euro has appreciated by roughly 6% against the dollar so far in 2020. But that is peanuts compared to the world's gyrations that took place after the 2008 financial

crisis, when the dollar fluctuated between $1.58 and $1.7 to the euro. Similarly, the yen dollar exchange rate has hardly moved during the pandemic, but varied between 90 and 123 yen to the dollar in the Great Recession. And a broad dollar exchange rate index against all U.S. trading partners is currently sitting at roughly its mid-February level. Such stability is surprising, given that exchange rate volatility normally rises significantly during U.S. recessions. The muted response of core exchange rates has been one of the pandemic's major macroeconomic puzzles. Economists have known for decades that explaining currency movements is extremely difficult. Nevertheless, the overwhelming presumption is that in an environment of greater global macroeconomic

uncertainty than most of us have ever seen in our lifetimes, exchange rates should be shifting wildly. But even as a second wave of COVID-19 has stunned Europe, the euro has only fallen by a few percent, a drop in the bucket in terms of asset price volatility. Fiscal stimulus talks in the United States are on one day off the next. And although America's election uncertainty is moving towards resolution, more huge policy battles lie ahead. So far, though, any exchange rate response has been relatively small. This episode is brought to you by Crypto.com, the crypto super app that lets you buy, earn, spend crypto all in one place and earn up to 8.5% per year on your Bitcoin. Download the

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And remember, it's your crypto, your credit, your choice. Get started at nexo.io. Nobody knows for sure what might be keeping currency movements in check. Possible explanations include common shocks, generous Fed provision of dollar swap lines, and massive government fiscal responses around the world. But the most plausible reason is the paralysis of conventional monetary policy. All major central bank's policy interest rates are at or near the effective lower bound around zero, and leading forecasters believe they will remain there for many years, even in an optimistic growth scenario. If not for the near zero lower bound, most central banks would now be setting interest rates far below zero, say at minus three or four percent. This suggests that even as the

economy improves, it could be a long time before policymakers are willing to lift off from zero and raise rates into positive territory. Interest rates are hardly the only likely driver of exchange rates. Other factors, such as trade imbalances and risk, also are important. And of course, central banks are engaged in various quasi-fiscal activities such as quantitative easing. But with interest rates basically in a cryogenic freeze, perhaps the single biggest source of uncertainty is gone. In fact, core exchange rate volatility was declining long before the pandemic, especially as one central bank after another skirted the zero bound. COVID-19 has since entrenched these ultra-low interest rates. But the current stasis will not last forever. Controlling for relative inflation

rates, the real value of a broad dollar index has been trending up for almost a decade. And at some point will probably partially revert to the mean, as happened in the early 2000s. The second wave of the virus is currently hitting Europe harder than the U.S., but this pattern may soon reverse as winter sets in, particularly if America's post-election in Teregum paralyzes both health and macroeconomic policy. And although the U.S. still has enormous capacity to provide much-needed disaster relief to hard-hit workers and small businesses, the growing share of U.S. public and corporate debt in global markets suggests longer-term fragilities. Simply put, there is a fundamental inconsistency over the long run between an ever-rising

share of U.S. debt in world markets and an ever-falling share of U.S. output in the global economy. The International Monetary Fund expects the Chinese economy to be 10% larger at the end of 2021 than it was at the end of 2019. A parallel problem eventually led to the breakup of the post-war Bretton Wood system of fixed exchange rates, a decade after the Yale economist Robert Triffin first identified it in the early 1960s. In the short to medium term, the dollar could certainly rise more, especially if further waves of COVID-19 stress financial markets and trigger a flight to safety. The exchange rate uncertainty aside, the overwhelming likelihood is that the greenback will still be king in 2030. But it's worth remembering that economic traumas such as we are now experiencing

often proved to be painful turning points. So a few bits that I want to point out. One is this phrase the paralysis of conventional monetary policy. It feels to me like there is a sense among many observers that the hands of all of these central bankers are fundamentally tied, that in some ways we are all on a ship that we cannot keep in check and all that's left to do is see what happens and where the tide takes us. The second passage that I want to hone in on is this fundamental inconsistency over the long run between an ever-rising share of U.S. debt in world markets and an ever-falling share of U.S. output in the global economy. The tension between those two things, the inevitable inability to keep them reconciled is, I think, at the root of a lot of people's

long-term concern with the way that the U.S. has organized itself in the world right now. Lastly, it's interesting to me just how much the only assessment of what we know economically speaking right now, or rather what we know about the economy going forward, is almost nothing. We are in proverbial uncharted waters. Everyone is guessing at what might happen next, but no one actually knows, and the honest ones actually say so. You have some people who are just trying to preserve the system we have now, despite signs of cracking, but you also have. the emergence of intellectual alternatives like MMT and Bitcoin. This will be the great economic debate of the coming year, what the fundamental global economic system should be organized around, especially because it is unknowable. Along the way, I'm sure we're going to have a lot more conversations here, so I appreciate you listening, I appreciate you hanging out, I appreciate your

ratings and reviews to bring more people into the conversation as well. So I hope you're having a great weekend, and until tomorrow, be safe and take care of each other. Peace.