Leaders of the FRB, the ECB, and the Bank of England jointly expressed their dissatisfaction to the dollar peg that many Asian countries pursued. In the wake of global inflation, the peg is detrimental, the bankers say. Donald Kohn of the FRB described that overheated Asian economies increased the commodity demand, inviting the price hike. Flexible monetary policy would be beneficial to counter the inflation. Kohn only said ‘Asian economies’, but it is widely understood that he meant China and Saudi Arabia.
Federal Reserve exports inflation (Seeking Alpha)
Kohn speech hints at call to drop dollar peg (Financial Times)
Governor King of the BOE spoke at the Parliament, saying “a very important region to the world economy pegs to just one currency called the dollar. [because of the peg] This region has to increase the monetary supply [because US does so to counter the crisis], causing worldwide inflation”. A very important region, of course, means Asia.
Interest rates in dollar-pegged Asia not appropriate (FX Street)
France’s governor Noyer, who was also the vice-president of the ECB, criticised the overstretched monetary policies of the pegged Asian countries. Flexible exchange rate would help balance the global trade flow, by which the depreciated dollar would increase US exports and discourage Asian exports to the US.
To keep the peg, China and the Middle East has invested in the financial industry of the US, as well as supported US bonds. The series of public statements made by the Western central banks represent that the US now thinks the negative impact of the inflation outweighs the benefits of capital inflow from Asia. At the same time, by these statements, the US authorities have admitted that US’ increase of dollar supply was the cause of the worldwide inflation.
Trans-Atlantic cooperation at stake
This is not the first time when the Western governments put the pressure on China and the Gulf to stop their dollar peg. In 2006, the IMF and the G7 called for the appreciation of those currencies against the dollar, to balance the terms of trade. The IMF created ‘Five Poles Council’ (=US, EU, Japan, China, Saudi Arabia). Yet the abandoning of the peg was not materialised by the opposition by China and Saudi Arabia, supported by Japan. The second call for the peg stop was due to America’s crisis that requires lowering of the interest rate and inflation due to shaky dollar credibility which disables to raise the interest rate. While the Fed’s FOMC keeps the interest rate, the ECB tends to raise the rate to counter the inflation.
Eurozone inflation soars to new high (FT)
In comparison to US economy, the eurozone counterpart is not performing so badly. The ECB wants to raise the interest rate to fight inflation. The inflation rate of the eurozone in 2007-08 was 4%, twice larger than its inflation target. Unlike America’s FRB, the ECB abhors inflation more than anything, by the tradition it inherited from the Bundesbank.
US sees a shadow of the Bundesbank (FT)
If the interest rate variance widens between the US and the Eurozone, the dollar will be sold for the purchase of the euro. The credibility of the dollar will be thus weakened further. Amidst the crash of the housing market, the US authorities are thought to continue its oversupply of the dollar. This is exactly the reverse of the dollar-euro interest rate variance in the 1990s, that threatened the nascent euro. Now investors perceive the euro as a more solid currency.
Morgan Stanley warns of catastrophic event as ECB fights Federal Reserve (Telegraph)
This is not advantageous to Europe. In Asia, many countries peg their currencies to the dollar – such that euro appreciation against the dollar automatically means expensive euro against the Asian monies. Europe wants Asia to stop the dollar peg.
Germany and Japan for the 1970s, China and GCC for the 2000s
China left its official dollar peg in 2005, and yuan has shifted to the peg to a currency basket of the dollar, euro, yen, and pound sterling. Yet the Chinese authorities still keep their flexible peg, by which they control the exchange fluctuation range against the dollar. The Gulf States (GCC6) plans to launch a common currency in 2010 while keeping the dollar peg. The US pressures both China and GCC6 to leave the peg, but they are reluctant. For them, currency management is easier while they free-ride on the US hegemony. Nonetheless, times are against the peggers. Depression in the US, financial crises, dollar credibility, worldwide inflation; they are all negative incentives to keep the peg. If they indeed leave the peg, they will no longer have to have a large amount of foreign reserves made of dollars cash and treasury bills. In the long run, such will devalue the dollar and US bonds. The US somehow needs to make sure that they won’t sell the dollar.
In the 1970s when Nixon left the gold standard, many thought West Germany and Japan would take over the economic hegemony. High level ‘Three Poles Committee’ was created to discuss this inevitable. However, the Germans and the Japanese didn’t wish sudden power shift to their camp. The old axis states of the WWII were well aware of the consequence of such an adventurism. The US took advantage of their unwillingness, and instead created the G5, in which Germany and Japan would collectively intervene to support the dollar.
In the 2000s, similarly, neither China nor the GCC wish to acquire sudden economic hegemony. But unlike Germany or Japan, they are not US allies, nor have they general pacifist tendencies in their societies. They also maintain good relations with anti-US states ie Iran and Venezuela. Will they take a big step to claim the position of world financial centre at some point?
Can they manage international currencies?
Saudi Arabia in the 1970s used to simply waste out the petrol revenue for … nothing. Petrol exporters these days invest in infrastructures and the sovereign wealth funds (SWFs). Iran’s Ahmadinejad also advocates the GCC common currency, albeit that it shifts from the dollar peg to the currency basket. He wants the crude oil to be denominated in the GCC currency, instead of the dollar.
The GCC has never managed its own currency. In the 1970s, before the dollar peg, they used the Indian rupee which was pegged to the pound. Some see that the GCC lacks an ability to form and manage its own currency. Yet it has a huge revenue base from the petrol. If it can somehow obtain techniques to manage the currency, it will be able to launch a strong common currency and leave the dollar peg. The Chinese, likewise, did not have an expertise on foreign exchange. But thanks to knowledge transfer from Goldman Sachs and the FRB, they improved their macroeconomic management ability. Like the Chinese, the Arabs have the traditional excellence in trade and commerce. They can do it too.
The monetary map of the world will shift from the current dollar dominance to a multipolar one, involving the five major currencies.
