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Jay Hao: Reconstructing Global Monetary System in an Imbalanced World
On March 23, as the COVID-19 pandemic continued to intensify across the globe and the financial markets continued to plummet, the US Federal Reserve swiftly introduced a new policy to the world’s surprise – Quantitative Easing Infinity (aka QE infinity) to provide market liquidity. Is this an effective measure? It does enhance the interbank liquidity as the Fed stated in its recent statement that it will include commercial mortgage-backed securities in its buying. This changes the role of the Central Bank from the “last lender” to the “last buyer”. So, theoretically, banks can issue as many mortgage loans as they wish and leave the risks to the Fed, solving the problem of lending for banks, as well as reducing financing costs and easing the debt repayment pressure of many firms.
But the question is, is QE Infinity the cure for this crisis? We all know that the root of this drop was the market panic caused by the worsening of the pandemic and the plunge in oil prices. As the novel coronavirus continues to worsen, global production activities have come to a halt, resulting in a sluggish economy and increasing company bankruptcies every day. The economic shutdown is the crux of the current downturn. Injecting liquidity to the market via QE infinity is like giving more nutrition to a critically ill patient – it won’t work solely. Even if liquidity is enhanced, factories still won’t be able to resume production and the panic in the market won’t disappear. Instead, the government should implement more proactive measures to control the spread of the coronavirus and support economic activities in order to restore the confidence of the market.
Last week, I pointed out that the Fed’s QE is not only a seigniorage to the world, but also a relief of its own debt repayment pressure – and now they have even gone more extremely to QE infinity. Here, it begs a question: How does the Fed make other countries to pay for the crisis of its own country?
Since the collapse of the Bretton Woods System and the Jamaica Accords were established in the 1970s, the US dollar is no longer pegged to gold and its value becomes free-floating, but the dominance of the dollar didn’t stop. Since the 1980s, the dollar has been circulating around the world like this:
- 1.From developed countries into developing countries: In order to promote domestic economic growth, developing countries have to vigorously develop their export industries and export large quantities of goods to developed countries due to insufficient domestic consumption.
2.From developing countries back to developed countries: The name of developing countries’ export game is lowering their exchange rates to maintain the price advantage of their own commodities. For this reason, central banks of the developing countries have to intervene in the exchange rate by buying a large amount of government bonds issued by developed countries to maintain favorable exchange rates, and the dollar flows back to the developed countries.
3.As developing countries buy U.S. treasury bonds, the dollar flows back to developed countries. Then, developed countries can use the funds to purchase goods from developing countries again.
To help you better understand the above, take a look at this example. A farmer sold his hard-earned food to a landlord, and the landlord paid him with a Benjamin note, which actually costs 10 cents, as $100. The farmer then used the note to buy a low-interest bond from the landlord. After that, the landlord took that $100 note to buy food from the farmer.
This is a kind of intangible exploitation – developed countries can pay unreasonably low costs to buy commodities produced by the developing countries at the expense of the citizens’ health and environment of the latter. Worse still, developing countries face a more challenging problem - the devaluation of the dollar. As long as the Fed can print money with their so-called monetary policy tools, developing countries couldn’t but have to face the risk of shrinking foreign exchange assets. Just like the example above, although farmers bought $100 bond from the landlord, one year later, with $100, they might only be able to buy half a bag of rice instead of one bag.
Be that as it may, under this monetary system, developed countries also face serious challenges. As the developing countries can enjoy a comparative advantage with better product quality at low costs, it weakens the competitiveness of developed countries, leading to a decline in their manufacturing industry. As a result, lots of domestic workers in the United States lost their jobs in recent years. That’s where the infamous "Rust Belt" comes in. On the other hand, this situation benefited the financial service industry. In particular, companies in Wall Street has made a lot of money in the process of globalization.
The failure of the global monetary system caused imbalances across economies worldwide, inequality in distribution, and the rise of "deglobalization" and populism. Therefore, it comes with no surprise to see Donald Trump take the presidency and the European right-wing forces emerging, which is intertwined with profound economic reasons.
Facing such an imbalanced world, how can we transform the current global monetary system?
The root problem of the fragile monetary system lies in the hegemony of one sovereign currency over others. To beat that, we need to consider a new monetary system, a super-sovereign currency. In fact, the idea of super-sovereign currency has been around for a long time. In the 1940s, John Maynard Keynes proposed a conceptual super-sovereign currency named “Bancor”. After the financial crisis in 2008, some proposed the IMF's Special Drawing Rights (SDR). However, in the current global political and economic context, it is difficult to establish a global super-sovereign currency system through international cooperation.
Nevertheless, we see the potential in cryptocurrency. At present, Bitcoin possesses the characteristics of a super-sovereign currency. Although it is difficult to become a world currency due to its price volatility, we see some hope from Facebook's stablecoin project, Libra.
Libra is pegged to a basket of currencies. In that sense, it is more like the SDR. Its application scenarios made it capable of serving the core function of a super-sovereign currency. More importantly, Libra is issued based on the currency board system with 100% reserve guaranteed. Therefore, Libra is unlikely to see inflation due to oversupply.
Libra is a good attempt for the world to move towards a super-sovereign currency system. Despite the hurdles ahead, I look forward to seeing more cryptocurrencies like Libra to bring us surprises and hopes.
Disclaimer: This material should not be taken as the basis for making investment decisions, nor be construed as a recommendation to engage in investment transactions. Trading digital assets involves significant risk and can result in the loss of your invested capital. You should ensure that you fully understand the risk involved and take into consideration your level of experience, investment objectives and seek independent financial advice if necessary.
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