Global Governance in a Non-G-Zero World

Marc To Market's picture

There is an intellectual fashion that has been inspired by the past decade in which there has been some convergence between the GDP per capita of emerging markets and those of the developed countries.  After diverging from 1950 to around 2000,  the out-performance of emerging markets over the past decade has nearly unwound growing disparity of second half of the twentieth century.

 

It may have inspired the idea that the world is flat or flattening, a la Thomas Friedman, or that power is so dispersed now that it makes sense to talk about a G-Zero world a la Ian Bremmer.

 

Some have seen this as a rise of the rest, such as Alice Amsden and Fareed Zakaria.  Others have written countless tracts about what they posit as America's decline.  My book, Making Sense of the Dollar (2009), was an early response to the wave of declinists; ultimately suggesting that the US dollar and the evolutionary expansion strategy, based on direct investment rather than an export-oriented approach, would prove more durable than many of America's friends and enemies may suspect. 

 

While the jury may still be out, there has an important development in Q4 13 that speaks to global governance issues and the financial architecture in the post-crisis period.  Without much fanfare, though covered by the business press of the day, at the end of October, six countries agreed to convert their swap line to standing arrangement.  This seemingly technical move is significant.  It replaces what was temporary with permanence (as permanent as these things are). 

 

The Federal Reserve and the central banks of England, euro area, Japan, Switzerland and the Canada had agreed about six years ago to initiate these swap lines that ultimately had to do making dollar funding available to foreign financial institutions, via the central banks, minimizing the risk on the part of the US.  The swaps are bilateral in the sense that allow the Federal Reserve to access those respective foreign currencies, if needed (here is a link to a video from the Federal Reserve explaining why the swap lines are beneficial for America).

 

These swap lines were set to expire in February.  They were deemed highly successful in reassuring investors of access to liquidity in these currencies.  Rather than simply roll them over (extend the duration), these swap lines have become a permanent feature in the post-crisis international financial architecture.    When first established, the swap lines were thought of, and legally were, temporary.  In 2010 Bernanke defended the temporary nature of the agreements, not wanting financial institutions to come to rely on them.   

 

What has changed the thinking?  Of all that which may motivate officials, cynics may suspect fear is at work.  Maybe Europeans officials are afraid of the results of coming stress tests of systemically important banks in Europe.  Maybe Fed officials were anticipating capital outflows as it prepared to announce tapering.  

 

As intriguing as that reasoning may be, it seems to misunderstand the role of the swaps in general and the role of dollar in particular.   Recall that prior to the crisis, the dollar was used to fund the purchases of other assets.  While the media would some times get infatuated with the yen-carry trade, the edifice of the post-tech boom finance was constructed on dollar funding. This was especially true of European financial institutions.    The crisis brought this mismatch to the surface.  

 

The swap lines were arranged primarily to provide access to dollar funding, without which a greater financial crisis would likely have ensued. Rather than the Federal Reserve provide it and take on potentially high counter-party risk, the swap lines were arranged with foreign central banks, who in turn offered them to their members.    

 

That the lines became reciprocal was largely a symbolic gesture and symbols are important. It allowed the European, Japanese and Canadians to deflect criticism of relying on the Americans and it gave American policy makers the ability to claim reciprocity.  But make not mistake about it, the swap lines for first and foremost about making dollars, not SDRs, not gold, or euros, or sterling available.  

 

That these lines become permanent shows that policy makers have begun thinking about post-crisis global governance.   The swap lines strengthen the investment climate by assuring investors to a permanent dollar liquidity backstop, without a world government.   

 

China was not included, though the Bank of England Governor and Chairman of the Financial Stability Board Mark Carney did suggest that it could be invited to join.   Indeed, it is not only China's absence that is notable, but this is primarily a G7 creation, not G20.  

 

China does have numerous bilateral swap lines including with the Bank of England, the European Central Bank and the Swiss National Bank.    It does not have swap lines with the US, Japan or Canada.   Although many observers have cited the bilateral swap lines as evidence of the internationalization of the renminbi, they have not been utilized.  Neither have the bulk of the other bilateral swap lines.  Outside of dollars swap lines being used, the only other noteworthy activity was with the Swiss franc.  At its peak the ECB auctioned around $170 bln of francs, acquired in the swap line with the SNB.  

 

Lastly, we note that the agreement to make the swap lines a standby agreement was signed at the end of October.  Bernanke's replacement at the head of the Fed was still not secure.  Yet the swap lines did not expire until February.  Waiting for the new Fed Chairperson to make this official would have arguably been helpful in solidifying the central bank's new leadership and more clearly demarcate the beginning of a new era that is neither flat not leaderless.