The Dollar Is Even More Important Than You Know

Some official financial statistics don’t account for the use of foreign-exchange derivatives to create synthetic greenbacks

By Mike Bird

The growth of foreign-exchange swaps leaves more of what is effectively dollar debt hiding off balance sheets. Photo: Andrew Harrer/Bloomberg News

The share of the Japanese yen in global currency reserves hit a multidecade high last year.

Paradoxically, that may be a symptom of the world’s ravenous appetite for U.S. dollars.

According to International Monetary Fund data released at the end of the year, yen-denominated reserves reached 5.6% of the world’s total in the third quarter of 2019, the highest amount since the late 1990s.

But part of the reason for the uptick in holdings isn’t that investors have fallen in love with Japan. There is effectively money lying at the side of the road for investors who want to swap those yen into dollars.

An instrument called a cross-currency basis swap lets an investor holding a Japanese government bond swap the yen-denominated interest and principal for a dollar-denominated interest and principal received by their counterparty.

Simply put, buying short-term Japanese government debt and swapping it into dollars has provided greater returns than buying U.S. Treasurys of equivalent maturity.

Before the financial crisis, these persistent opportunities rarely existed: A U.S. Treasury bond would yield the same amount as a Japanese government bond swapped into U.S. dollars, as supply and demand changed the prices of the swaps.

But tighter regulations on bank balance sheets postcrisis have changed that, limiting the ability of financiers to arbitrage away the difference. The most common trade is in short-term bonds because the maturity of swaps is typically short too.

Unsurprisingly, foreign investors have piled into short-term Japanese government bonds.

Bills issued with a maturity of one year or less have shrunk as a portion of Japan’s overall debt, but the share owned by foreigners has risen from about 5% at the turn of the century to more than two-thirds today.

Most central banks don’t break down their holdings of foreign-exchange derivatives. But Goldman Sachs analysts note that the Reserve Bank of Australia does: It records 40.36 billion Australian dollars (US$28.04 billion) in yen-denominated assets, as of June 2019.

After accounting for its derivative holdings, its net yen exposure falls to just A$2.61 billion, while its U.S. dollar exposure more than doubles.

So though the data suggests that the yen’s share of global reserves is growing, and the U.S. dollar share has declined, it’s more difficult to tell for sure what’s happening. It’s likely that much of the accumulation of yen reserves masks synthetic U.S. dollar holdings.

The growth in foreign ownership of short-term Japanese debt is a particularly obvious form of financial engineering, but it isn’t the only source of yield pickups. Investors who really want dollars can construct a higher-yielding asset by pairing many European bonds with a cross-currency basis swap too.

The use of outright foreign-exchange forwards and swaps for dollars has ballooned in the past decade. The notional amount outstanding has risen 64% since its pre-financial crisis peak, to about $53 trillion in the first half of 2019.

The growth of foreign-exchange swaps leaves more of what is effectively dollar debt hiding off balance sheets around the world.

So when you hear about the potential decline of the greenback in international finance, remember the share that’s hidden in plain sight.

Can Latin America Avoid Another Lost Decade?

As Latin America enters the 2020s, it must take steps to ensure that the next five years are not lost. Yes, the international context will make a difference. But the region’s governments have it within their power to improve economic performance significantly.

José Antonio Ocampo

ocampo36_blackdovfx Getty Images_latinamericamap

BOGOTÁ – In the 1980s, Latin America endured a debt crisis so severe that the entire decade was “lost” to poor economic performance. Since then, other economies – most notably, Japan – have endured their own “lost decades.”

But, today, it is again Latin America that is facing difficulties. In fact, it has already lost five years.

Latin America has suffered through a half-decade of anemic growth for the second time since the 1980s, and its lowest-performing quinquennium since World War II.

In the region’s previous lost half-decade, after the 1997 East Asian crisis, annual GDP growth averaged 1.2%.

In 1980-1985 – the worst five years of the debt crisis – average growth amounted to 0.7%. Over the last five years, it reached a mere 0.4%.

This is partly the result of an unfavorable global environment, reflected in Latin America’s deteriorating terms of trade since 2014, the virtual stagnation of international trade overall, and two years of renewed financial turbulence in emerging economies.

But other developing regions have faced the same external headwinds, and every one of them has outperformed Latin America, not only in the last five years, but since 1990 – a period during which annual GDP growth in the region averaged just 2.7%.

Clearly, long-term domestic and regional factors are also contributing to Latin America’s underperformance. They have economic origins, but also reflect political crises and complex political transitions in several countries.

Nowhere are these political challenges more apparent than in Venezuela, which, despite having the world’s largest proven oil reserves, is in economic free fall. Since 2014, Venezuela’s GDP has contracted by more than 60% – one of the sharpest economic contractions in history for a country not at war.

Recent international sanctions have exacerbated Venezuela’s economic travails. But the problems began long ago, and have been fueled by the sharp political polarization and catastrophic economic policies of President Nicolás Maduro, the late Hugo Chávez’s handpicked successor.

Excluding Venezuela, Latin America’s average GDP growth rises, but only to 1% per year – still worse than the region’s last lost half-decade. This partly reflects the fact that the region’s largest economy, Brazil, experienced its deepest recession since WWII in 2015-2016, and has been recovering very slowly.

In Mexico, Latin America’s second-largest economy, President Andrés Manuel López Obrador (widely known as AMLO) pledged, upon taking office in December 2018, to achieve 4% annual GDP growth. Instead, the economy has stagnated, and even slipped into recession in the first half of 2019. Concerns about AMLO’s economic management have contributed to this outcome.

Elsewhere, Argentina has struggled with domestic macroeconomic imbalances, in addition to global financial turbulence and, more recently, concerns about the return of a Peronist government. Political turmoil in Ecuador, and more recently in Bolivia and Chile, has also undermined economic performance.

But Latin America’s economic problems began long before the current wave of economic and political instability. Latin America achieved faster growth – a 5.5% average annual rate – in the 30 years that preceded the lost decade of the 1980s, when state-led industrialization was the order of the day, than in the 30 years that followed it.

The economic orthodoxy that took hold three decades ago derided the state-led approach and urged Latin American countries to undertake market reforms that, so far, have failed to fulfill their promise.

On the contrary, countries’ dismantling of their industrial policies – together with the repercussions of the debt crisis, the “Dutch disease” effects of the commodity-price super-cycle after 2003, and rising competition from China – led to premature de-industrialization.

Specifically, manufacturing’s share of GDP has been declining fairly consistently since the 1980s, to the point that current levels are similar to those in the 1950s. While a shift away from manufacturing is a natural upshot of economic development, it began in Latin America at much lower income levels than in the developed countries, making it far more difficult for the region to escape the “middle-income trap.”

Though Chinese demand for Latin American commodity exports has boomed over the last decade, it remains insufficient to offset manufacturing losses.

Undermining Latin America’s prospects further are its low levels of investment in research and development: about 0.7% of GDP, on average.

That is about one-third of what China (2.1%) and the OECD countries (2.6%) spend.

In Latin America, only Brazil invests more than 1% of GDP in R&D.

During the Fourth Industrial Revolution, no economy can compete, let alone rise from middle- to high-income status, without a strong capacity for innovation.

Latin America’s lost half-decade has had severe social consequences. From 2002 to 2014, poverty declined rapidly in the region, and inequality – which had risen during the 1980s and 1990s – was on a downward trend. Since then, progress on inequality has stalled – income distribution has remained relatively constant since 2010-2011 – and poverty has increased.

As Latin America enters the 2020s, it must take steps to ensure that the next five years are not lost. Yes, the international context will make a difference. But the region’s governments have it within their power to improve economic performance significantly.

They can foster re-industrialization (including by pursuing greater regional economic integration, thereby supporting intra-regional trade in manufactured goods) and invest in science and technology.

Together with active social policies, such growth-enhancing measures can enable Latin America to regain its economic footing and lay the foundations for a better future for its people.

José Antonio Ocampo is a board member of Banco de la República, Colombia’s central bank, a professor at Columbia University, and Chair of the UN’s Committee for Development Policy. He was Minister of Finance of Colombia and United Nations Under-Secretary-General for Economic and Social Affairs. He is the author of Resetting the International Monetary (Non)System, and co-author (with Luis Bértola) of The Economic Development of Latin America since Independence.

 The horrible housing blunder

The West’s biggest economic policy mistake

Its obsession with home ownership undermines growth, fairness and public faith in capitalism


Economies can suffer both sudden crashes and chronic diseases. Housing markets in the rich world have caused both types of problem. A trillion dollars of dud mortgages blew up the financial system in 2007-08. But just as pernicious is the creeping dysfunction that housing has created over decades: vibrant cities without space to grow; ageing homeowners sitting in half-empty homes who are keen to protect their view; and a generation of young people who cannot easily afford to rent or buy and think capitalism has let them down.

As our special report this week explains, much of the blame lies with warped housing policies that date back to the second world war and which are intertwined with an infatuation with home ownership. They have caused one of the rich world’s most serious and longest-running economic failures. A fresh architecture is urgently needed.

At the root of that failure is a lack of building, especially near the thriving cities in which jobs are plentiful. From Sydney to Sydenham, fiddly regulations protect an elite of existing homeowners and prevent developers from building the skyscrapers and flats that the modern economy demands.

The resulting high rents and house prices make it hard for workers to move to where the most productive jobs are, and have slowed growth. Overall housing costs in America absorb 11% of GDP, up from 8% in the 1970s. If just three big cities—New York, San Francisco and San Jose—relaxed planning rules, America’s GDP could be 4% higher.

That is an enormous prize.

As well as being merely inefficient, housing markets are deeply unfair. Over a period of decades, falling interest rates have compounded inadequate supply and led to a surge in prices.

In America the frenzy is concentrated in thriving cities; in other rich countries average national prices have soared, especially in English-speaking countries where punting on property is a national sport.

The financial crisis did not kill off the trend. In Britain inflation-adjusted house prices are roughly equal to their pre-crisis peak, while real wages are no higher. In Australia, despite recent falls, prices remain 20% higher than in 2008. In Canada they are up by half.

The soaring cost of housing has created gaping inequalities and inflamed both generational and geographical divides. In 1990 a generation of baby-boomers, with a median age of 35, owned a third of America’s real estate by value.

In 2019 a similarly sized cohort of millennials, aged 31, owned just 4%. Young people’s view that housing is out of reach—unless you have rich parents—helps explain their drift towards “millennial socialism”.

And homeowners of all ages who are trapped in declining places resent the windfall housing gains enjoyed in and around successful cities.

In Britain areas with stagnant housing markets were more likely to vote for Brexit in 2016, even after accounting for differences in income and demography.

You might think fear and envy about housing is part of the human condition. In fact, the property pathology has its roots in a shift in public policy in the 1950s towards promoting home ownership. Since then governments have used subsidies, tax breaks and sales of public housing to encourage owner-occupation over renting. Politicians on the right have seen home ownership as a way to win votes by encouraging responsible citizenship. Those on the left see housing as a conduit for redistribution and for nudging poorer households to build wealth.

These arguments are overstated. It is hard to show whether property ownership makes better citizens. If you ignore leverage, it is usually better to own shares than to own homes. And the cult of owner-occupation has huge costs. Those who own homes often become nimbys who resist development in an effort to protect their investments.

Data-crunching by The Economist suggests that the number of new houses constructed per person in the rich world has fallen by half since the 1960s. Because supply is constrained and the system is skewed towards ownership, most people feel they risk being left behind if they rent.

As a result politicians focus on subsidising marginal buyers, as Britain has done in recent years. That channels cash to the middle classes and further boosts prices. And it fuels the build-up of mortgage debt that makes crises more likely.

It does not have to be this way. Not everywhere is afflicted with every part of the housing curse. Tokyo has no property shortage; between 2013 and 2017 it put up 728,000 dwellings—more than England did—without destroying quality of life. The number of rough sleepers has dropped by 80% in the past 20 years.

Switzerland gives local governments fiscal incentives to allow housing development—one reason why there is almost twice as much home-building per person as in America. New Zealand recoups some of homeowners’ windfall gains through land and property taxes based on valuations that are frequently updated.

Most important, in a few places the rate of home ownership is low and no one bats an eyelid. It is just 50% in Germany, which has a rental sector that encourages long-term tenancies and provides clear and enforceable rights for renters. With ample supply and few tax breaks or subsidies for owner-occupiers, home ownership is far less alluring and the political clout of nimbys is muted.

Despite strong recent growth in some cities, Germany’s real house prices are, on average, no higher than they were in 1980.

A home run

Is it possible to escape the home-ownership fetish?

Few governments today can ignore the anger over housing shortages and intergenerational unfairness. Some have responded with bad ideas like rent controls or even more mortgage subsidies. Yet there has been some progress.

America has capped its tax break for mortgage-interest payments.

Britain has banned murky upfront fees from rental contracts and curbed risky mortgage lending.

A fledgling yimby—“yes in my backyard”—movement has sprung up in many successful cities to promote construction. Those, like this newspaper, who want popular support for free markets to endure should hope that such movements succeed.

Far from shoring up capitalism, housing policies have made the system unsafe, inefficient and unfair. Time to tear down this rotten edifice and build a new housing market that works.

Dystopia Is Arriving in Stages

Science fiction has a warning about developing mind-reading technology without any proper framework for how to control it. It should be heded.

Alexander Friedman

afriedman17_Matjaz Slanic Getty Images_brainwavesmindreaddata

NEW YORK – It is commonly believed that the future of humanity will one day be threatened by the rise of artificial intelligence (AI), perhaps embodied in malevolent robots.

Yet as we enter the third decade of the millennium, it is not the singularity we should fear, but rather a much older enemy: ourselves.

Think less The Terminator, more Minority Report.

We are rapidly developing literal mind-reading technology without any framework for how to control it.

Imagine, for a moment, if human beings had evolved to be able to read each other’s minds.

How would that have gone for us?

To answer this question, consider your own internal dialogues. It is safe to assume that every one of us has had thoughts that would be shocking even (or especially) to those closest to us. How would those who might not wish us well have reacted to being able to hear what emotional rants go through our heads from time to time?

Would they have had the judgment to let them pass, recognizing them as just flashes of emotion? Or would some have responded opportunistically, taking advantage of thoughts we would otherwise not wish to betray?

Evolution did not enable us to read minds because that power might have ended our existence as a species. Instead, as our ancient ancestors organized into groups for protection, most of us learned what could be said and what was best left unspoken.

Over time, this became a highly evolved human trait that enabled societies to form, cities to rise, and even hundreds of stressed out people to be jammed into a flying tube, usually without attacking their seat-mates. It forms a core part of what we now call EQ, or emotional intelligence.

And yet technology is now beginning to threaten this necessary evolutionary adaptation in a fundamental way.

The first stage has taken place in social media. Facebook underscored this trajectory, when Russian manipulation of the platform affected the United States’ presidential election in 2016.

And Twitter, which empowers a user to dash off a passing thought or emotion that might then be shared with millions, amplifies this trend.

Imagine how North Korean leaders struggled to interpret President Donald Trump’s tweet of nuclear “fire and fury.”

Was it a real threat from a new and erratic US leader, or just a spur-of-the-moment exhalation, a mental flash without a filter that would best be ignored?

Back in the days of the bipolar superpower world, the iconic US-Soviet hotline phone was installed as a way to clarify each side’s intentions, lest through some misunderstanding the world might otherwise disappear beneath a nuclear mushroom cloud.

Today, in our much more complicated multipolar and asymmetric-threat-driven world, social media offers all who are willing a giant, unedited megaphone. Social media has become a tool that can undermine democracy; and yet it is mere child’s play compared to what is now barreling our way.

Companies ranging from start-ups to multinational conglomerates have recently announced startling innovations that enable mind reading.

Elon Musk’s company Neuralink is seeking approval for human trials of a device implanted in users’ brains to read their minds.

Nissan has developed “Brain-to-Vehicle” technology that enables a car to read instructions from a driver’s mind.

Facebook has funded scientists that use brainwaves to decode speech.

A recent paper in the science journal Nature explains how AI can create speech by analyzing brain signals.

Researchers at Columbia University have developed technology that can analyze brain activity to determine what a user wants and vocalize those desires via a synthesizer.

Clearly, these kinds of advances can offer real benefits, including helping those suffering from paralysis or neurological disorders.

Early examples of neuroprosthetics, such as cochlear implants, which enable a deaf person to hear, or promising devices that could allow the blind to see, are already in use.

But there are also darker potential applications, like enabling advertisers to micro-hone their offerings to individuals’ unspoken desires, or employers to spy on their workers, or police to monitor citizens’ possible criminal intent on a vast scale, akin to the way London residents today are tracked on CCTV.

An early warning is ToTok, one of the most downloaded social-media apps, which, it was recently revealed, the United Arab Emirates government had been using to spy on users. And what happens if mind-reading devices are hacked? It is difficult to imagine a more relevant area of data privacy than that which exists in the human brain.

Musk believes that brain interfaces will be necessary for humans to keep up with AI.

This brings us back to Philip K. Dick’s science fiction horror story “The Minority Report” (the basis of the 2002 film).

Consider the myriad of thorny ethical, legal, and social-order implications of a policeman stopping a crime before it takes place because he or she could “assess” an individual’s likely intent by reading their brainwaves.

When is a crime committed? When the thought takes place? When actions begin that manifest the thought in reality? When the gun is pointed? When the trigger finger tightens?

A principal challenge of technological innovation is that it usually takes society a long time to catch up, understand the broader implications of how the new technology can be used and abused, and provide appropriate legal and regulatory frameworks to regulate its conduct.

In the second decade of this millennium, social media moved from a tool to connect to a platform with immense power to spread lies and manipulate elections.

Society is now grappling with how to harness the best of this innovation, while mitigating its potential for abuse.

Perhaps, before we have even figured that out, the third decade of the millennium will confront us with far more consequential technological challenges.

Alexander Friedman, an investor, is a former Chief Executive Officer of GAM Investments, Chief Investment Officer of UBS, Chief Financial Officer of the Bill & Melinda Gates Foundation, and White House Fellow.

Trump Hopes Trade Deals Will Boost Growth. Experts Don’t Agree.

Trump administration officials say the “Phase 1” deal signed Wednesday will promote growth. Many economic forecasters are less optimistic.

By Jim Tankersley

President Trump signed a limited trade agreement with China at the White House on Wednesday.Credit...Pete Marovich for The New York Times

WASHINGTON — Cabinet secretaries and White House officials have predicted that President Trump’s initial trade agreement with China and his revised accord with Mexico and Canada — slated for final passage this week — will deliver twin jolts to the economy.

But outside forecasters, including some economists who have welcomed the China agreement in particular, have predicted much more modest gains — and, in some cases, no gains at all.

“We now have U.S.M.C.A.; that’s going to pass the Senate this week,” Treasury Secretary Steven Mnuchin said Wednesday on CNBC, referring to the United States-Mexico-Canada Agreement. “We have China Phase 1, there is a deal with Japan, a deal with Korea. These are all going to have significant positive effects on the 2020 economy.”

He and other officials have good reason to hope: Mr. Trump is up for re-election, and the economy appears to have grown by just over 2 percent in 2019, a dip from 2018 and well short of the administration’s forecasts of growth above 3 percent for the year.

The administration has yet to publish an official 2020 growth forecast. Mr. Mnuchin said on Sunday that he expected the economy to grow between 2.5 percent and 3 percent this year, though he cautioned that growth could fall to the lower end of that range because of troubles at the aerospace giant Boeing.

Other forecasts were less optimistic. The World Bank said last week that it expected the United States economy to grow by 1.8 percent this year. The first phase of the China trade deals and the U.S.M.C.A. are not expected to have much of an impact on the more pessimistic predictions.

“I have not changed my forecast as of yet and don’t expect to materially,” said Rubeela Farooqi, chief United States economist for High Frequency Economics. She expects the nation’s economy to grow by 1.8 percent this year.

The China agreement, she said, “is a step in the right direction, but tariffs remain in place, and I’m not sure they will be rolled back imminently.”

The Phase 1 agreement could affect American growth in two ways, and administration officials are counting on both to deliver.

First, the deal calls for China to begin purchasing what the administration says will be $200 billion worth of American crops and other exported goods and services. Those purchases should increase exports from the United States to China, which, all else being equal, would promote growth.

Second, and perhaps more important, administration officials appear to be counting on the agreement to revive business investment in the United States, which has fallen in recent quarters after surging in the first half of 2018. The uncertainty that Mr. Trump and the Chinese sowed as they imposed escalating tariffs on each other’s imports was largely to blame for that sluggishness, many companies and economists have said.

The bullish case for the China agreement is that it will ease that uncertainty. Some economists say the U.S.M.C.A. could do the same. For months, administration officials have touted a study by the United States International Trade Commission that predicted that the North American trade deal could raise growth by 0.35 percent, largely by reducing uncertainty over trade in digital services.

Andrew Hunter, senior United States economist at Capital Economics, backed that assessment on Tuesday. “The gap that opened up last year between investment and corporate profits suggests that tariff uncertainty has caused firms to delay” investment plans, he wrote in a research note. He added, “With the U.S.M.C.A. deal signed and the threat of further tariffs on Chinese goods seemingly off the table, that drag should now be fading.”

Many economists have praised the agreements for reducing uncertainty, but few have raised their growth forecasts because of them. That is in part because they say the deals still leave a large number of tariffs in place — particularly those against China, but also on some steel, aluminum, solar panels and washing machines imported from other countries.

They also noted that Mr. Trump had waged his trade wars on fronts well beyond North America and China. New trade battles loom this year, including one between the United States and France over a French push to impose a new tax that hits American tech giants like Google and Amazon.

Mary Lovely, a senior fellow at the Peterson Institute for International Economics, said the Phase 1 agreement was “good news for the U.S. and the world economy.” But, she said, “there remains considerable uncertainly for businesses using China as a platform for products destined for the U.S. market, and we will continue to see the impact of this in slower investment and higher business costs.”

Lewis Alexander, chief United States economist at Nomura, revised his 2020 growth forecast up by 0.1 percentage points in late fall to reflect the suspension of a new round of tariffs that had been set to take effect in December. He said he did not expect a material gain in business investment because of the deals.

Several economists expressed optimism that a “Phase 2” deal with China that rolls back more tariffs — coupled with a long stretch of trade peace on other fronts — could deliver more benefits to the economy. But administration officials appear to have ruled out such a deal before November.

“Yes, there is some upside risk to our outlook if things go better than we expect,” Mr. Alexander said. “But in general the direct effects of tariff changes are not large, and to really change the tone, a lot of things about the U.S.-China relationship would have to be settled in a way that seemed durable. It’s hard to see how that could be achieved in an election year.”