Time for mighty US dollar to own up liquidity demand

Credit: www.uscurrency.gov

An institutional arrangement is needed for provision of dollar liquidity to prevent bank balance sheets going into disarray

Yes, the US dollar continues to have its exorbitant privilege. But, it has to own up growing demand for dollar liquidity from the whole of the planet.

The exorbitant privilege of the dollar continues unchallenged. As per the Composition of the Foreign Exchange Reserves (COFER Report) of the International Monetary Fund (IMF), dollar has a share of 59.5% in the foreign exchange reserves held by Central Banks.

Much of the world trade particularly in key commodities like oil continues to be quoted in dollars. Most of the invoicing of trade in the global economy is done in dollars, 96.3% in Americas and 74% in Asia Pacific. The only place where the euro dominates is in Europe.

The big talk about Indian rupee-denominated masala bonds and Chinese renminbi-denominated dim sum bonds apart, as per data of Federal Reserve Board, 63.9% of the total foreign currency debt issuance is denominated in dollars.

Read: G7 corporate tax accord, a ray of hope for cash-strapped nations (June 8, 2021)

According to the2019 Triennial Survey of Foreign Exchange of Bank for International Settlements, the share of the dollar in one side of the transactions is as high as 88%, next being euro at 32%. The total here adds up to 200%.

None of these figures from international financial statistics point to any serious challenge to the dollar in the near future. But the United States has to own up responsibility with respect to provision of dollar liquidity in uncertain times, particularly so in the contemporary economy.

Currently, the dollar credit outside United States to the non-financial corporations is at a stock of $13 trillion, as per the Bank for International Settlements. Of this, the emerging market and developing economies account for $4.2 trillion.

There has a been a large increase in the share of funds mobilized by non-financial corporations through the issuance of bonds rather than through loans in the post-global financial crisis period.

It would also be important to take note of the special mention in the Financial Stability Report 2021 of the Federal Reserve which draws attention, inter alia, to the Treasury market problem in March 2020.

Data from US Treasury international Capital reveal that foreigners hold as of now $7 trillion of the US Treasury securities, which is 30% of the total.

Different foreign official investors like Central Banks were net sellers of Treasury securities in March 2020 of $400 billion, resulting in the US Federal Reserve being forced to intervene as a buyer of Treasury securities to stabilize the market.

It had not just stepped in as a buyer of Treasury securities as a market maker to prop up its price, but also had taken to the unprecedented step of extending repo borrowing facilities to the Central Banks against the US Treasuries held. In the period after the global financial crisis, there was “flight to safety” to the safe haven of Treasury securities.

But with the eruption of the Covid-19 pandemic and the huge portfolio outflows which it triggered from many of the emerging market economies from January 2020, the developing country central banks had to do a lot of firefighting. To prevent their exchange rates from large depreciation, many of them were forced to resort to the selling of Treasury securities.

Read: Is India counting on U.S. firms from China for economic revival? (May 14, 2020)

In this context, facility for central banks towards repo borrowing against US Treasury holdings was introduced, this is an unprecedented development.

And, this is over and above the foreign currency swap arrangements announced by the Fed Reserve with major central banks like the European Central Bank (ECB), Bank of Japan (BOJ), Bank of England (BOE) and Swiss National Bank (SNB).

Further, this swap facility was extended to a set of developing countries also, dependent on the risks which they could entail to the US economy as well as to the global economy.

While this facility has been extended to Brazil, Mexico, Singapore, Korea and Poland, it belies logic as to why countries like India and China having a large stock of private dollar debt have been excluded from this swap line option. Nonetheless, the repo facility option provides for a big access to the window of dollar liquidity.

One crisis after another keeps coming. The dotcom boom was followed by the bust. The real estate boom and the financial innovations which accompanied it was followed by the global financial crisis. Making things worse has been the Covid-19 pandemic.

The recent crisis triggered by the Russian attack on Ukraine and the rise in the price of oil is posing another new risk.

Needless to say, an institutional arrangement for the provision of dollar liquidity is to be put in place. Else, it would put the balance sheets of Japanese and Canadian banks to disarray.

To be sure, the dollar lending of these banks has been far higher than the dollar liabilities that they are thriving through the forex swap and its associated rollover.

Read: Lesson from Lehmann Brothers: a bubble-led growth could harm US economy (September 19, 2018)

And, for all those non-financial corporations in the Emerging Market and Developing Economies (EMDEs) who have collective debt stock of $4.2 trillion, won’t they need a window of dollar liquidity?

Shouldn’t there be a more robust arrangement linking Central Banks to facilitate the same? With the oil prices rising, the advanced country central banks have yet another reason to reverse the process of bond purchases done as part of the unconventional monetary policies.

The year 2022 is going to be a litmus test for the United States as to how it’s going to assure access to dollar liquidity, even when reversal of bond purchases are going to be initiated.

(Krishnakumar S teaches economics at Sri Venkateswara College, University of Delhi)

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