Foreign Exchange Trading and the Dollar

The new Bank for International Settlements (BIS) Triennial Central Bank Survey was published last month. The Foreign exchange turnover is down for the first time since they started in 1996. As the press release says: "Trading in FX markets averaged $5.1 trillion per day in April 2016. This is down from $5.4 trillion in April 2013." The figure below shows the main results.

Not surprisingly the dollar remained the key vehicle currency, being on one side of around 88% of all trades, while the euro has continued to slide down approximately from 39% in 2010 to 31% now. Also, while the yuan or renminbi is now the most actively traded developing country currency, the rise in the share in global foreign exchange turnover is from 2.2% to 4%.

PS: For those interested here there is an old paper, but I think still relevant, on the dollar after the crisis, and why there should be no fear about its dominant position.

Desperately seeking the natural rate of interest

The Economist Free Exchange (FE) blog gets into the debate of where is the elusive natural rate of interest. I've already discussed Krugman's views (see here and here) that the natural rate of interest is negative, and that's why we need fiscal policy, something that he refers to as the Liquidity Trap. FE suggests that William White, formerly from the Bank of International Settlements (BIS) and now from the Organization for Economic Cooperation and Development (OECD), believes that the natural rate is higher than the monetary rate.

According to FE White believes that: "the Wicksellian natural rate must be high and monetary policy too loose because low rates have encouraged all sorts of yield-chasing behavior." If one reads White's paper, we find that he says more precisely the following:

"Moreover, given this particular way of thinking and noting that the financial rate is now constrained by the ZLB [zero lower bound interest rate], this gap can only be redressed by raising the natural rate to encourage investment."

In other words, he believes that central banks, like the Fed, can move the natural rate, by affecting savings behavior presumably associated with inflationary expectations. This would lead to a monetary rate that is lower than the natural rate and increased investment. This is actually the same story that Krugman has favored, which I suggested is an inflationary expectations confidence fairy.

Interestingly enough, still according to FE, DeLong, who seems to be on the same page with Krugman, has responded to White, if FE's description is correct, suggesting that there is little that the Fed can do about the natural rate, and is stuck with a very low monetary rate for a while.

Mind you, the search for the holy grail of the natural rate is futile anyway (yep capital debates; it's been a while). And no act of the Fed will lead to more inflationary expectations and higher spending. And because of the Tea Party, and also fiscal hawks in the Democratic Party, there is no hope for fiscal stimulus. This FE post shows the incredible confusion of the mainstream.

PS: In this post FE also tells us that the natural rate of unemployment is 5.5%. Oh well.

The position of the dollar was enhanced by the crisis

The BIS Triennial Central Bank Survey shows that over the last three years the position of the dollar as key currency has become more dominant. The figure below shows the turnover by currency and currency pairs.

You can see that the dollar was on one side of the operation 87% of the time, compared to 84.9% three years ago. The euro has lost some ground. Also, the average daily turnover in foreign exchange markets in April was around US$ 5.3 trillion.

Global Monetarism Strikes Back



Olivier Blanchard, the chief economist at the International Monetary Fund (IMF) announced in a triumphalist tone that “earlier fears of a double-dip recession—which we did not share—have not materialized” and defended the need for “fiscal consolidation that is neither too fast, which could kill growth, nor too slow, which would kill credibility.” For Blanchard fiscal expansion has done its job, since “private demand has, for the most part, taken the baton.” The risks are associated to the higher prices of commodities and inflation. The Bank of International Settlements (BIS) has added to the IMF’s view that inflation is the main risk on an otherwise recovering world economy. In their recent Annual Report they argue that: “spread of inflation dangers from major emerging market economies to the advanced economies bolsters the conclusion that policy rates should rise globally.” That is, add monetary contraction to the policy mix.

Read the rest of the entry here.

Basel III and the BIS

Two news from Basel this Monday. None good. First, in their just released Annual Report, the Bank of International Settlements (BIS) complements the IMF's demands for fiscal contraction, with their own calls for monetary contraction.  In their view:

"Inflation risks have been driven up by the combination of dwindling economic slack and increases in the prices of food, energy and other commodities. The spread of inflation dangers from major emerging market economies to the advanced economies bolsters the conclusion that policy rates should rise globally. At the same time, some countries must weigh the need to tighten with vulnerabilities linked to still-distorted balance sheets and lingering financial sector fragility. But once central banks start lifting rates, they may need to do so more quickly than in past tightening episodes."

It is bad enough not to have sufficient fiscal stimulus in the developed world, but to export the behavior of the ECB to other central banks would be a terrible idea.  In this case, they think that developing countries are exporting inflation, and developed countries should act swiftly.

In part, the misguided recommendation of the BIS follows from an incorrect view of what caused the crisis.  For them low rates of interest now will create new risks in the financial system.  Yet, the crisis was not the result of low rates of interest, but a consequence of deregulation.

And that leads to the second news.  The Basel Committee on Banking Supervision has added a surcharge of extra capital (on top of the Basel III ones) requirements between 1 and 2.5% of the value of risk adjusted assets for large banks (here; subscription required).  I'm sure people more qualified will discuss the nitty gritty details of this proposal, but from my point of view the problem is that this perpetuates large institutions, and avoids the old New Deal commitment to break them up and separate the speculative activities from the financing of productive activities.  There is no reversing of the so-called "revenge of the rentiers."