The dollar can defend its global reserve role against EU and China

There is no alternative even if the US government grows tired of the downsides

Megan Greene


It is not likely that King Dollar will be dethroned


There are many reasons why the US dollar may be poised to lose its status as the world’s reserve currency. Not the least of these are efforts by the EU and China to make it happen. But, with apologies to Jean-Claude Juncker and Xi Jinping, Tina tells us it’s not going to happen anytime soon.

Tina is the old Margaret Thatcher dictum: “there is no alternative”. The phrase had been in vogue among equity traders (before October’s pullback) given weak returns in other asset classes, but it applies just as well to the dollar these days.

This has been a portentous year for the dollar. Its global share of central bank reserves fell to a five-year low of 62.3 per cent in the second quarter, even as the trade-weighted dollar index surged. Overall foreign holdings of US Treasury debt fell to 41 per cent, the lowest in 15 years. China began trading oil futures in renminbi, challenging the supremacy of the petrodollar. Germany, France, the UK and Russia suggested circumventing the dollar with a new payments mechanism to allow continued trade with Iran while avoiding US sanctions.

There are some obvious ongoing risks too. The US owes baby boomers entitlements it cannot afford and yet the government is on a spending spree, drastically increasing national debt. The Federal Reserve is shrinking its balance sheet, reducing dollar liquidity. The administration’s trade conflicts increase motivation for other countries to reduce their dependency on the US financial system and its currency.

And yet, I am not worried that King Dollar will be dethroned. For all its faults, Tina protects it. Mr Juncker, the European Commission president, pushed a more prominent global role for the euro in his State of the European Union speech in September. Yet while the euro accounted for the second-largest share of global central bank reserves by mid-2018, its share was only around one-third that of the dollar. It will be difficult for investors to put their trust in the euro as long as there are doubts about the eurozone’s survival, most recently prompted by the Italian government flouting fiscal rules. 
 
 
For all the talk of an insurgent China, its currency is hardly poised to take over. The renminbi accounted for a paltry 1.84 per cent of global central bank reserves in mid-2018. This could change as the Belt and Road Initiative expands — it would be easier for all countries in the project to use the same currency. But the renminbi has a long way to go. It is not freely floating, monetary policy is unpredictable and China’s economy and financial system are not open.
 
The return of the US as a major oil producer further protects the dollar’s position. The world trades oil in dollars — $2tn of them in 2017, according to business intelligence firm IbisWorld.
 
Finally, the US dollar benefits from a network effect. Around 40 per cent of imports worldwide are invoiced in dollars, even though the US accounts for only about 10 per cent of global sales. Banks and businesses like to use dollars because other banks and businesses do.
 
Some have suggested the IMF’s special drawing rights could be a viable alternative. But the SDR is not a currency, it’s an accounting entry valued against a basket of currencies.
 
The “exorbitant privilege” of having the reserve currency allows the US to borrow beyond its means and on the cheap. Global demands for transacting in the currency support a healthy financial services industry. But demand for the dollar also pumps up its value, making American exports less competitive, cheapening imports and widening the trade deficit.
 
The current administration has made no bones about its dislike of trade deficits. But even if the US were to decide it did not want the responsibility of the global reserve currency, it may not be able to shirk it.




The writer is global chief economist atManulife Asset Management


Can American Democracy Come Back?

America’s ideals of freedom, democracy, and justice for all may never have been fully realized, but now they are under open attack. Democracy has become rule of, by, and for the few; and justice for all is available to all who are white and can afford it.

Joseph E. Stiglitz



NEW YORK – The United States has long held itself up as a bastion of democracy. It has promoted democracy around the world. It fought, at great cost, for democracy against fascism in Europe during World War II. Now the fight has come home.

America’s credentials as a democracy were always slightly blemished. The US was founded as a representative democracy, but only a small fraction of its citizens – mostly white male property owners – were eligible to vote. After the abolition of slavery, the white people of America’s South struggled for nearly a century to keep African-Americans from voting, using poll taxes and literacy tests, for example, to make casting a ballot inaccessible to the poor. Their voting rights were guaranteed nearly a half-century after the enfranchisement of women in 1920.

Democracies rightly constrain majority domination, which is why they enshrine certain basic rights that cannot be denied. But in the US, this has been turned on its head. The minority is dominating the majority, with little regard for their political and economic rights. A majority of Americans want gun control, an increase in the minimum wage, guaranteed access to health insurance, and better regulation of the banks that brought on the 2008 crisis. Yet all of these goals seem unattainable.

Part of the reason for that is rooted in the US Constitution. Two of the three presidents elected in this century assumed office despite having lost the popular vote. Were it not for the Electoral College, included in the Constitution at the insistence of the less populous slave states, Al Gore would have become president in 2000, and Hillary Clinton in 2016.

But the Republican Party’s reliance on voter suppression, gerrymandering, and similar efforts at electoral manipulation have also contributed to ensuring that the will of the majority is thwarted. The party’s approach is perhaps understandable: after all, shifting demographics have put the Republicans at an electoral disadvantage. A majority of Americans will soon be nonwhite, and a twenty-first-century world and economy cannot be reconciled with a male-dominated society. And the urban areas where the majority of Americans live, whether in the North or the South, have learned the value of diversity.

Voters in these areas of growth and dynamism have also seen the role that government can and must play to bring about shared prosperity. They have abandoned the shibboleths of the past, sometimes almost overnight. In a democratic society, therefore, the only way a minority – whether it’s large corporations trying to exploit workers and consumers, banks trying to exploit borrowers, or those mired in the past trying to recreate a bygone world – can retain their economic and political dominance is by undermining democracy itself.

That strategy includes many tactics. Aside from supporting selective immigration, Republican officials have sought to prevent likely Democratic voters from registering. Many Republican-controlled states have instituted burdensome identification requirements at polling stations. And some local governments have purged such voters from electoral rolls, reduced the number of polling stations, or shortened their hours of operation.

It’s striking how difficult America makes it to vote, to exercise the basic right of citizenship. The US is one of the few democracies to hold elections on a workday, rather than a Sunday, obviously making it more difficult for working people to vote. This contrasts with other democracies, like Australia, where citizens are required to vote, or with some states, like Oregon, which have made it easier to vote through mail-in ballots.

Moreover, a system of mass incarceration that continues to target African-Americans has historically served a triple function. Aside from providing cheap labor and driving down wages (even today, as Columbia University’s Michael Poyker points out, some 5% of America’s industrial output is produced by inmates), this system was designed to deny those convicted of a crime the right to vote.

When all else fails, Republicans seek to tie elected governments’ hands, in part by packing the federal courts with judges who can be counted on to strike down policies that their donors and supporters oppose. Important recent books, such as Duke University historian Nancy MacLean’s Democracy in Chains and University of Oregon political scientist Gordon Lafer’s The One Percent Solution, trace the intellectual origins and organizational mechanisms of the Republicans’ assault on democracy.

America’s ideals of freedom, democracy, and justice for all may never have been fully realized, but now they are under open attack. Democracy has become rule of, by, and for the few; and justice for all is available to all who are white and can afford it.

Of course, this is not just an American problem. All over the world, strongmen with little commitment to democracy have taken power: Recep Tayyip Erdoğan in Turkey, Viktor Orbán in Hungary, Jarosław Kaczyński in Poland, and now Jair Bolsonaro in Brazil. Some, looking at the past, say that this, too, will pass. Think of all the nasty dictators in the 1930s. Think of those, like Salazar in Portugal and Franco in Spain, who survived into the post-World War II era. They are all gone now.

A moment’s reflection, though, should remind us of those dictatorships’ human toll. And Americans must confront the fact that their president, Donald Trump, has been aiding and abetting today’s crop of budding despots.

That is only one of the many reasons why it is so important this year to have a Democratic Congress that can provide a check against Trump’s authoritarian tendencies, and to elect state and local officials who will restore the vote to all those entitled to it. Democracy is under attack, and we all have an obligation to do what we can – wherever we are – to save it.


Joseph E. Stiglitz, a Nobel laureate in economics, is University Professor at Columbia University and Chief Economist at the Roosevelt Institute. His most recent book is Globalization and Its Discontents Revisited: Anti-Globalization in the Era of Trump.


The Illusion of a Russia-China Alliance

Neither country can solve the other’s top economic and strategic problems.

By George Friedman

 

China is holding a weeklong event called the China International Import Expo in Shanghai this week meant to encourage trade, sell China as an import market and send the message that the Chinese economy is open for business. China’s motivation for doing this is obvious: It’s a nation dependent on exports, and American tariffs have decreased demand for its goods. In his opening address, President Xi Jinping stressed that China was prepared to open its markets even further to international trade – with the United States and the rest of the world. His remarks were clearly directed at the U.S., as he looks toward his meeting with U.S. President Donald Trump at the G-20 meeting in Argentina later this month. But the conference has also raised questions about China’s relations with another country that’s experienced its own setbacks in U.S. relations: Russia. Russian Prime Minister Dmitry Medvedev said at the expo that Moscow and Beijing are now closer than ever, and the Chinese emphatically agreed. Indeed, there has been much talk of a Russo-Chinese alliance, and the Shanghai extravaganza is a good opportunity to look closer at what this could mean.
China and Russia both have serious economic problems that have been exacerbated by the United States. Russia’s problems derive from the decline in the price of oil, a resource on which the Russian economy is heavily dependent. The United States, along with the EU, has compounded Moscow’s economic woes by imposing sanctions following Russian incursions in Ukraine and meddling in the 2016 U.S. election. China’s problems derive, at least in part, from its dependency on exports. This year, the U.S. has imposed tariffs on more than $250 billion worth of Chinese imports, and according to Bloomberg, it’s preparing to announce new duties on all remaining Chinese imports by December if trade talks don’t go well.

On the surface, that Russia and China share a common, powerful adversary should be the foundation of a strong alliance. Both countries are significant military powers, and they ought to be able to support each other economically. But appearances can be deceptive.

On the economic front, developing stronger ties with each other wouldn’t fully solve any of their problems. Russia needs to sell raw materials, particularly oil, in massive amounts to keep its economy running. Between January and August 2018, crude oil accounted for 28.8 percent of Russia’s total exports and natural gas accounted for 10.9 percent, according to Russia’s statistics agency. China was its biggest oil importer at 22 percent, though it purchased only 1 percent of Russia’s natural gas exports. (As a whole, however, the European Union imported more Russian oil than China did.) Indeed, China is a big oil importer and overtook the U.S. as the world’s largest crude buyer in 2017, according to the U.S. Energy Information Administration. The problem, however, is that Chinese imports are limited by the lack of energy infrastructure between the two countries. Pipelines are costly and take a long time to build. China, therefore, might be able to ease a bit of Russia’s demand for oil consumers, but it can’t buy enough to keep prices high or ease the risk of further sanctions that could target its energy exports.

 




 


 

China, meanwhile, needs to find buyers for its manufactured goods. In 2017, exports made up nearly 20 percent of its gross domestic product, according to the World Bank. The United States is its largest market, accounting for 19 percent of its goods exports, according to the International Trade Centre. With U.S. tariffs cutting into these exports and intensified competition from other exporters, Beijing needs to find new buyers for its goods. But Russia is in no position to consume enough Chinese exports to make up for these losses – it purchased only 2 percent of China’s total exports in 2017. Neither country, therefore, can provide meaningful economic support to the other.

 


 

On the military front, it’s true that the two countries have increased cooperation in recent years. Since the end of the Cold War, China has been Russia’s largest arms purchaser, and according to Russian media, Beijing acquired a Russian-made S-400 air defense system in July of this year. In addition, Russia’s largest military exercises since the Cold War, held in September, were attended by thousands of Chinese troops. This had many speculating that the two countries were on the verge of forging a military alliance. The problem is that alliances are based on shared interests, and Russia and China have a history of mutual distrust. The two have clashed over border issues several times throughout the years and competed for influence in Asia throughout the Cold War.

They also have different strategic priorities. Russia is facing what it sees as intense pressure along its western frontier and, to a lesser extent, in the Middle East. China has little interest in expending its resources to protect Russia’s European buffer. They might share the world’s sixth-longest international border but deploying troops and resources to Russia’s west, where its major population centers are located, would be a logistical nightmare for China, to say the least. (Nor would Moscow welcome or be able to support such a deployment.)

China, on the other hand, faces a challenge from the United States in the South China Sea, where Beijing is trying to prevent any possible future blockade of its access to maritime shipping lanes by stationing military and naval assets on its artificial islands off its southeastern coast. The U.S. often conducts freedom of navigation operations in contested waters there to make the point that the Chinese buildup won’t prevent others from traveling freely through the region and to reassure its allies in Southeast Asia. The Chinese could undoubtedly use naval support there and in the Western Pacific, but the ability of the Russians to project significant naval power in these areas is limited. The Russians do have a naval base at Vladivostok, but it’s blocked from ready access to the Pacific by Japan, as well as U.S. air power. While a blockade of Vladivostok isn’t likely, any military action must take into account the worst-case scenario, and Vladivostok can easily become a trap for Russia’s fleet.

It might be far-fetched, but the only way the Russians and Chinese could coordinate to thwart their major threats would be through a simultaneous attack by Russia toward the west and by China on U.S. naval assets in the east. The problem is that whereas Europe is an army issue, the South China Sea is a naval issue. The U.S. could concentrate its naval forces against China without diverting land forces from Europe. But infinitely more important is the fact that, considering all their economic problems, neither China nor Russia intends to start a world war, which this certainly would do.

Though a Sino-Russian alliance would seem to be a logical counter to their common adversary, it’s just an illusion. All the warm gestures in Shanghai can’t hide the fact that Russia and China can’t help each other get out of their serious economic and strategic problems. It’s an alliance that works only on paper, at best.


Why Are 77% Of Global Assets In The Red In 2018? It's Simple

by: The Heisenberg



- Well, depending on how wide you want to cast your net, somewhere between 75% and 89% of global assets are negative this year.

- If you're looking to explain that rather unfortunate state of affairs, you might look at "cash".

- You might also consider that we hit "peak QE" flow in 2018.

- This really is not all that complicated.

 
As America goes to the polls and analysts begrudgingly churn out the obligatory deluge of midterm election projections, I thought I'd offer readers what I'm reasonably sure will be a welcome reprieve from the incessant flow of articles documenting how various asset classes have performed under historical instances of split government.
 
Over the weekend, in the comments on my most recent post for this platform, a couple of readers indirectly happened on the simplest (and by extension, the most elegant) explanation for this year's cross-asset malaise.
 
Back in September, in a post called "I Drink Your Milkshake", I noted that if you're looking for a straightforward reason to be wary of risk assets, you need only consult the following chart:
 
(Bloomberg)
 
 
Long story short, what that represents is risk-free, USD "cash" becoming some semblance of viable again as an alternative to risk assets. That is of course a function of Fed hikes (and expectations thereof). Those would be the same Fed hikes which have driven the dollar (UUP) inexorably higher this year, which has in turn put enormous pressure on emerging markets that have borrowed heavily in foreign currencies. Here's a five-year chart of the BBDXY:
 
(Bloomberg)
The point there is that Fed hikes (and expectations of developed market monetary policy normalization more generally) are reversing the nine-year-old global hunt for yield that pushed investors down the quality ladder and out the risk curve. The higher USD short rates go, the more acute that reversal is going to be as investors question the relative merits of staying put in risk assets as rates on riskless USD "cash" continue to rise.
 
This dynamic is exacerbated by the waning QE bid. For years, investors were warned that once the QE "flow" effect (i.e., the combined monthly bid from the big developed market central banks) starts to wane, risk assets would stumble. It's funny how controversial that contention was, given how self-evident it most assuredly is. When you have a price insensitive buyer armed with a printing press snapping up billions worth of assets (from govies, to corporate bonds to ETFs) every, single month, it stands to reason that when that flow subsides, prices for those assets will fall, if for no other reason than the fact that suddenly, more of the onus for absorbing supply will fall on price sensitive private investors.
 
There isn't a single thing that's complicated or controversial about that. In fact (and I tried pretty hard to emphasize this point last year), it's not as much a "bear" thesis as it is just a common sense assessment of the prevailing reality.
 
Well sure enough, we hit "peak QE" in 2018 and guess what? Through October 31, only 23% of global assets have managed positive returns in 2018. That’s according to BofAML, who looked at some 300 assets spanning equities, commodities, FX and credit. Long story short, that doesn't normally happen outside of recessions and debt crises.
 
(BofAML)
 
Did your favorite QE skeptic predict that? I'm guessing no.
 
Again, the simplest explanation for that is simply that the policies which ensured a voracious appetite for anything that offered any semblance of yield are being gradually rolled back.
 
Here's a two-sentence excerpt from the BofAML note which contains that chart:
We think it reflects a bigger picture theme: Namely that assets are now struggling to produce meaningfully positive returns in an era of less central bank liquidity. The “invisible hand” that once propped-up market prices is now significantly smaller.
That would have been precarious enough on its own, but in 2018, it's been exacerbated by the Fed, which is caught in a rather unfortunate loop. The Trump administration's fiscal and trade policies are dollar positive, at least in the short- to medium-term. Repatriation flows from the tax cuts and the outperformance of the American economy and U.S stock market have helped support the greenback.
 
At the same time, the inflationary nature of late-cycle fiscal stimulus as well as jitters about tariff-related price pressures, have forced the Fed to lean more hawkish than they otherwise might. The tighter the labor market gets, the more pronounced that tendency is likely to be.
 
That means the monetary policy divergence between the Fed and the rest of the world is wider than it might have been, providing still more support for the dollar.
 
And it gets better (or worse, depending on how you want to look at it). The Treasury has had to ramp up debt issuance in order to fund the tax cuts and spending. That supply deluge comes just as the Fed is pulling back from the Treasury market. Well, somebody has to buy all of that USD debt and with the Fed's support waning, more of the supply has to be absorbed by other investors. That, in turn, worsens the dollar liquidity shortage. Just ask the RBI’s Urjit Patel, who wrote the following in an Op-Ed for the Financial Times earlier this year:
Dollar funding of emerging market economies has been in turmoil for months now. Unlike previous turbulence, this episode cannot be attributed to the US Federal Reserve’s moves on interest rates, which have been rising steadily since December 2016 in a calibrated manner. 
The upheaval stems from the coincidence of two significant events: the Fed’s long-awaited moves to trim its balance sheet and a substantial increase in issuing US Treasuries to pay for tax cuts. Given the rapid rise in the size of the US deficit, the Fed must respond by slowing plans to shrink its balance sheet. If it does not, Treasuries will absorb such a large share of dollar liquidity that a crisis in the rest of the dollar bond markets is inevitable.
All of that helps to explain why suddenly nothing is working across assets. While you might not have seen the above chart from BofAML until now, you've probably seen the following set of visuals from Deutsche Bank, as they started making the rounds last week:
 
(Deutsche Bank)
 
 
In addition to the waning bid from QE and the gradual rollback of accommodative monetary policy more generally, it's important to note that the backdrop against which all of this is unfolding is profoundly different from that which persisted in 2017. I penned a lengthy piece on this for my site on Monday evening, so I won't rehash the whole thing here, but suffice to say the "Goldilocks" environment of synchronized global growth and well-anchored inflation has given way to what looks like the beginning of synchronized downturn with higher inflation (at least in the U.S.). That "Goldilocks" narrative was what ultimately underpinned the low vol. regime in 2017 which allowed for the proliferation of all the various carry trades and virtuous loops that kept cross-asset volatility suppressed.
 
Clearly, global trade frictions are serving to heighten fears about the trajectory of global growth and the prospect of tariffs is raising concerns about inflation, although as ever, there are structural disinflationary forces pushing in the opposite direction.
 
The overarching point here is that if you're looking for reasons why (almost) nothing is performing well in 2018, a simple explanation is that USD "cash" is rapidly becoming viable again and developed market central banks are buying less assets. Not much of a mystery, really.
 
The bad news is that it's difficult to postulate a scenario where those two bearish forces for risk assets don't continue largely unabated, short of a serious global slowdown which prompts central banks to rethink their normalization plans.

For now, I'll leave you with one last chart which shows you how the S&P typically performs when ISM is falling and CPI is rising.
 
(Goldman)