A dicey dollar could yet revive Keynes’s Bancor currency plan

Note4Students

From UPSC perspective, the following things are important :

Prelims level : Not much

Mains level : Paper 3-Bancor

The direct question in the exam from this article is not expected. Nevertheless, it is important to get a general understanding of the important role dollar plays in the world economy and the reasons for any viable alternative to it.

Context

  • The dollar fell in July to a two-year low against the euro.
  • When the covid-19 pandemic went global in March, the dollar strengthened on the back of safe-haven flows into US Treasury bonds.

What the depreciation of dollar indicate?

  • The dollar’s subsequent depreciation reflects the changing prospects of the US and European economies.
  • Some observers point instead to the agreement by European leaders to issue €750 billion ($884 billion) of European Union (EU) bonds.
  • With the spread of covid-19 investors expect the Fed to keep interest rates low for longer.
  • In the eurozone, the virus is under better control, and data from purchasing managers’ surveys are surprising on the upside.
  • This improving outlook doesn’t mean that the European Central Bank (ECB) will start raising its policy rate in the near future.
  • Interest rates determine the exchange rates as per the “interest parity” theory.

Factors responsible for holding currency

  • 1) Normally, investors hold a currency when the issuer’s policies are sound and stable.
  • 2) Banks and firms hold a currency when it is useful for invoicing and settling trade with the issuing country.
  • But President Donald Trump’s administration has done more than any in living memory to disrupt US trade.
  • 3) Governments, for their part, hold and use the currencies of their alliance partners.

Resilience of dollar

  • The most striking takeaway from recent experience is the dollar’s resilience.
  •  US policy has been risky and erratic.
  •  But President Donald Trump’s administration has done more than any in living memory to disrupt US trade.
  • Under Trump, the US today is no longer the reliable alliance partner it once was.
  • Despite all this, countries continue to hold the dollar.
  • The currency’s international role has not diminished significantly.
  • It has declined only along select dimensions—its share in central banks’ foreign-exchange reserves, for example—and even there, only marginally.

No alternative

  • The euro is not an alternative to the dollar.
  • The stock of safe euro assets remains segmented along national lines.
  • Nor is the renminbi a viable alternative.
  • Given heightened tensions with China, no Western government will encourage its residents to depend on the People’s Bank of China for liquidity.

Conclusion

The only solution to this conundrum is more resources for the International Monetary Fund, so that it can supply countries in a crisis with the dollars that a future Fed fails to provide. This, of course, is the solution that John Maynard Keynes offered in 1944, albeit by another name-Bancor.

Subscribe
Notify of
0 Comments
Inline Feedbacks
View all comments