Showing posts with label de-dollarization. Show all posts

Sunday, September 8, 2024

Bretton Woods should heed the cries for fair play or go, how China can help reshape the global financial system

Is Bretton Woods fit for the 21st century?

America is financed by the rest of the world because of the hegemomic of the US dollar.

The world's largest economy has moved from a giver of global public goods to a taker of global resources.

Probably the best way to increase global funding is to raise the capital of the global multilateral development banks like the World Bank, Asia Development Bank, etc.

In July 1944, delegates from 44 countries gathered in a UN-sponsored conference in Bretton Woods, New Hampshire to decide on a post-World War II monetary and financial order.

In the closing speech of the gathering, then US Treasury secretary Henry Morgenthau concluded that the conference had succeeded in addressing the twin “economic evils – the competitive currency devaluation and destructive impediments to trade” that led to the war.

To prevent competitive devaluation, the Bretton Woods conference established the fixed but adjustable exchange rate system, which was based on the US dollar linked to gold and capital controls, securing funding from a newly created World Bank and the International Monetary Fund (IMF).

The global free trade mechanism was negotiated first through the General Agreement on Tariffs and Trade, which decades later became the World Trade Organization.

The Bretton Woods negotiations were led by the US chief delegate Harry Dexter White and the eminent British economist John Maynard Keynes. Keynes argued unsuccessfully for the creation of an new international currency called the bancor, whereas the United States preferred to use its own currency.

In 1944, the US had the largest share of world GDP and was a major creditor to economies suffering from the destruction of war. It is no surprise that the Bretton Woods order was largely US-led and designed.

This Bretton Woods structure lasted until 1971, when rising US fiscal and trade deficits led US President Richard Nixon to delink the US dollar from gold at the fixed price of US$35 to one ounce of gold.

After flexible exchange rates became the global norm, the US continued to be financed by the rest of the world because of the hegemonic position of the US dollar. It was protected by the might of the US military and its status as the strongest economy, including being the consumer of last resort.

Eighty years later, the US share of world GDP has been pared down to 26 per cent by current exchange rates but the US dollar remains as mighty as ever.

People walk past an image of US dollar bills outside a currency exchange bureau in downtown Nairobi, Kenya, on February 16. Photo: Reuters

Unfortunately, having the US dollar act as the global reserve currency is both a blessing and curse. The US is able to fund its fiscal and trade deficits easily because the rest of the world prefers to hold the US dollar.

But running protracted deficits means that the US net liability to the rest of the world is now US$21 trillion, or about 20 per cent of world GDP, with a gross sovereign debt of US$35 trillion, or roughly one third of world GDP. Fiscal debt cost is rising as interest expenses will rise from 3.4 per cent of GDP in financial year 2025 to 4.1 per cent by 2034.

The irony is that the world’s largest debtor absorbs more of the world’s natural and financial capital that encourages global consumption to drive growth. Since increased levels of consumption ultimately generates more carbon emissions, the current model is neither ecologically nor financially sustainable.

To address these global imbalances, the United Nations has suggested that a “just transition” requires US$2.4 trillion annually to fund clean energy and climate resilience. Where is this money going to come from?

What is climate finance, and why is it crucial to the global energy transition?

This is both a flow and a stock problem. The annual shortfall, or flow, can either be funded from an increase in taxation or a cut in spending. The stock issue is whether there is enough wealth to be taxed or used to fund the needed climate action.

There is growing momentum behind an initiative proposed by French economist Gabriel Zucman, in which a minimum wealth tax of 2 per cent would raise US$200-US$250 billion per year globally from 3,000 billionaires who currently pay little to no tax. Current evidence suggests ultra-high-net worth individuals have an observed pre-tax rate of return to wealth of 7.5 per cent on average per year during the last four decades, while the current effective tax rate is equivalent to roughly 0.3 per cent of their wealth.

Alternatively, the Austrian Institute for Economic Research thinks that a global financial transactions tax of 0.1 per cent could yield between US$238 billion and US$419 billion per year. Needless to say, the rich who control the electoral process in countries across the world will not allow such tax increases.

There are two big-ticket items in global fiscal spending which could be cut. The largest is subsidies on fossil fuels, which were US$7 trillion or 7.1 per cent of global GDP in 2022. On top of that, global military expenditure was US$2.4 trillion in 2023.

Perhaps the best way to increase global funding is to raise the capital of the global multilateral development banks such as the World Bank and Asian Development Bank. If the countries which control the special drawing rights of the IMF can apply their US$650 billion in 2021 to increase the bank’s capital by eight times the leverage, these multilateral development banks can increase their lending by about US$5 trillion.

However, doing so would require these countries to agree that this is a priority, which could be unlikely given the current global atmosphere leaning towards protectionism and isolationism.

In short, the 21st century requires multilateral cooperation in dealing with mutual existential challenges involving climate warming, social imbalances and serious polarisation. If the Bretton Woods framework does not serve the Global South because the established powers are unwilling to reform it, do not be surprised if a new set of institutions rise to replace it.

Andrew Sheng

Andrew Sheng is a former central banker and financial regulator, currently distinguished fellow at the Asia Global Institute, University of Hong Kong. He writes widely on Asian perspectives on

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French economist Marc Uzan on how China can help ...

Open questions | French economist Marc Uzan on how China can help reshape the global financial system

With the US-led financial consensus at a crossroads, economist Marc Uzan says China has role to play in systemic reform
French economist Marc Uzan is executive director and founder of the Reinventing Bretton Woods Committee, a non-profit organisation established in 1994 to address issues related to the world’s financial architecture. He has been working closely with central banks and finance ministries around the world, as well as international organisations such as the International Monetary Fund and the Group of 20, to bring stakeholders together to attempt to fix the system.
In this latest interview in the Open Questions series, Uzan reflects on the decades of change since the paradigmatic Bretton Woods conference in 1944, and the role China and other emerging economies will play in the global financial system during an era of heightened unilateralism and confrontation. This interview first appeared in SCMP Plus. For other interviews in the Open Questions series, click here.
As suggested by the name of your organisation, the Reinventing Bretton Woods Committee, why did you think that the Bretton Woods system should be restructured back in 1994? Can it be?
This question brought a multitude of thoughts about the objectives of the 44 nations whose representatives gathered at Bretton Woods, New Hampshire, in the summer of 1944 to establish a new economic order.
The world has changed considerably since then. Instead of a system of fixed exchange rates among major currencies, we now have a mixed system with major floating currency areas but fixed rates among smaller countries. At that time, we had capital controls, and now we are a global financial market. And from a small group of 44 countries that became the founding members of the International Monetary Fund (IMF) and Worl

U.S. debt just hit $35 trillion. Is it putting the global economy at

risk ...

This nation’s gross cumulative debt has hit $35 trillion — a number so large, the International Monetary Fund warns that it’s putting the entire global economy at risk.

https://www.marketplace.org/2024/08/13/u-s-debt-just-hit-35-trillion-is-it-putting-the-global-economy-at-risk/

The National Debt is now more than $35 trillion. What does that mean?

Will US debt ceiling deadlock push capital to yuan market?

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Thursday, May 11, 2023

Will US debt ceiling deadlock push capital to yuan market?

Illustration: Carlos Latuff

Expert: The role of the U.S. dollar declines

The US Government is BROKE | The 2023 Debt Ceiling

Every few years, there is a bipartisan political farce over the debt ceiling negotiations in the US. It may look like a routine political drama, but quantitative change can lead to a qualitative difference, especially at a time when a global de-dollarization trend is gaining momentum, that is to say, the US trick of raising the debt limit to mitigate its default risk may now be very close to pushing the US treasuries to a dangerous tipping point.

The de-dollarization caused by the US debt crisis and the abuse of the dollar hegemony created unprecedented opportunities for the yuan internationalization, with more and more countries expressing willingness to settle trade in the yuan, but China must proceed with caution.

With the US on track to default without a debt ceiling increase, US President Joe Biden's talks with House of Representatives Speaker Kevin McCarthy on Tuesday failed to make any meaningful progress, with political divides remaining between the two parties, Reuters reported. Biden even told the media that he has been looking at the 14th Amendment as a way to unilaterally work around the debt ceiling, though it will not be a viable short-term solution.

The political stalemate over raising the debt limit has already led to US Treasury Secretary Janet Yellen warning of an "economic catastrophe" if the US fails to meet all government payment obligations, which could happen "potentially as early as June 1."

So far, most people still believe that the two parties will eventually reach a deal to avoid an ugly sovereign default before the deadline, just like what happened every time in the past debt ceiling struggles.

But unlike in the past, a new question has been raised in the market, that is, are the US treasuries still highly liquid? The US dollar's credit is the cornerstone of US treasuries. Because the dollar is an international settlement currency and US treasuries have stable yields and are highly liquid, countries are willing to hold US debt, making the US the world's largest debtor.

Yet, things may be different now with countries accelerating their de-dollarization efforts. The past year saw growing number of countries and regions such as India, Brazil, and the EU trying to establish new settlement systems for their trade.

Under the influence of the de-dollarization wave, some countries have reduced their holdings of US treasuries. Japan, the world's largest holder of US debts, slashed its holdings by $224.5 billion and China by $173.2 billion in 2022.

Moreover, the US' unlimited expansion of the size of its debt has also upset the market with the risks in the US treasuries. According to Yellen's testimony in a congressional hearing in March, gross federal debt would swell to $51 trillion after a decade. The scale and speed of the debt expansion means the US is getting increasingly closer to a real explosion of a debt crisis.

Also, the root cause of the US banking crisis this year is the holding of a large number of US treasuries assets, which shrank significantly in value as interest rates continued to climb. That could be a warning to various governments and precipitated them to speed up the pace of de-dollarization. Since the collapse of the Silicon Valley Bank, international investors stepped up sell-off of treasuries, and prices of all kinds of safe-haven assets like gold have surged.

Of course, de-dollarization is likely to be a long-term process, but once it started, the US treasuries could lose its aura quickly, especially as the US government repeatedly raises debt ceiling or faces risk of default. In other words, as the world realizes that the US cannot and does not have the willingness to control or reduce the size of its debt, the credibility of the US debt as a safe-haven asset is collapsing rapidly.

It should be noted that amid the de-dollarization trend, the yuan internationalization has made a series of positive new developments and breakthroughs. The yuan's international status as a trading currency has been significantly improved recently.

To ensure future development of the yuan internationalization, China needs to ensure liquidity and maintain exchange rate stability. Thus, China's financial markets as well as the yuan's onshore and offshore markets need more preparation to adapt to the new needs.