In Part III of MacroVoices’s conversation about the twilight of the dollar’s dominance over the global financial system, Jeff Snider elaborates on a theory we initially referenced in our writeup on Pt. II: The notion that, as the supply of dollars to certain economies contracts, the greenback could see its relative value climb, even as it cedes its dominance over the financial system to the Chinese yuan, or a consortium of rival currencies.
Snider describes this phenomenon as a short squeeze: Because so many central banks predicate their monetary policy on the dollar, and because so many foreign governments and corporations need dollars to finance trade and pay down debts, the global economy is effectively net short dollars.
So, when the Federal Reserve stops the money presses and the supply of greenbacks becomes less pliable, certain parts of the financial system – Snider points to BRICS countries like Brazil and Russia as examples – will begin finding it increasingly expensive to roll over their funding, pushing the greenback higher, as Snider explains.
Yeah, I think a better terminology would be short squeeze. It’s sort of a dollar short squeeze. And, again, if we think about the Eurodollar development from things all the way back as – some things like banker’s acceptances – it’s essentially a short dollar system, where every participant in it is short the dollar.
They roll over funding every day, whether it be in repo or unsecured or in FX – or however it’s done – essentially everybody around the world needs dollars and therefore they’re short of them. So when the dollar supply becomes less malleable, less pliable, less dynamic, it becomes a problem for certain parts of the system being able to roll over their commitments.
And what happens when you have to roll over your commitment and it’s not as easy to do so, the price of it goes up. And, in terms of currencies, a short squeeze in the dollar means a rising dollar or a falling counterpart currency.
Some signs of this squeeze have already started to emerge, Snider argues. Back in 2014, the Russian Central Bank started auctioning Eurodollars and euros after the annexation of Crimea, when sanctions from both the European Union and US made it more difficult for Russian banks to obtain foreign currency. The RCB was effectively repositioning itself as the central distribution point for dollars in the Russian economy. Snider argues this is a symptom of being squeezed out of the dollar market.
Furthermore, while this phenomenon helped push the dollar higher, the Russian ruble devalued, eventually reaching an all-time low around 80 to the dollar in late 2014.
So I think a good place to start, to really kind of describe and put some real-world examples to this process, is Russia. One of the things about central banks going back for the last couple of years – and this was Ben Bernanke’s (supposed to be) his great legacy – was opening up central banks to be more transparent in how they conducted monetary policy.
And some central banks take that to heart. Some central banks don’t. In 2014, the Russians, for example – the central bank of the Russian Federation very explicitly and very publically started auctioning off Eurodollars and euros – which in this case would be euro-euros. The reason they did so was because Russian banks were having trouble securing dollar funding, primarily in the second half of 2014.
So, essentially, what the Russian central bank was doing was becoming a redistribution point for local Russian banks that were being shut out or couldn’t afford the terms of Eurodollar financing.
They were, in essence, being squeezed out of the dollar market. And as that was happening, of course, the Russian ruble started to devalue. Because, again, the price of participating in a short squeeze is you have to pay up for it. So the Russian ruble in the second half of 2014 and throughout 2015 and 2016 underwent severe crisis. The devaluation was severe because the dollar shortage had become severe for them.
And the Russians were not alone in this. Brazil’s central bank also had to resort to creative derivative strategies to help create a large enough supply of dollars for its domestic economy.
However, these strategies are unsustainable, as Brazil demonstrated. Almost immediately, the program was threatening to consume nearly all of Brazil’s foreign currency reserves.
They were not alone in that position. In fact, it became a widespread thing. You go to Brazil, for example. The Brazilian real (R$) had started devaluating all the way back in the 2011 dollar crisis. But that really came to a head in 2013. The Banco do Brazil, the Brazilian central bank, chose to deal with their dollar squeeze a little bit differently. Or a lot differently, really, than the central bank of Russia.
Rather than deplete their reserves, they decided they would go into, essentially, a dollar subsidy. They’re technically not swaps, but a lot of people think of them as dollar swaps.
Without really getting into too much of the details, what the central bank essentially had to do was to subsidize Brazilian banks borrowing in the Eurodollar markets to make it cheaper so that they could borrow more on the Eurodollar market to bring dollars into Brazil.
And what happened was, in 2013 and especially 2014, they did so many of these swaps, or these synthetic swaps, that it threatened to use up all of Brazil’s reserves. I think at the worst part it was about $120 billion in non-deliverable swaps – compared to about, I think it was $380 billion in Brazilian reserves.
So as soon as they cut off the subsidy in late 2014, the Brazilian real, the bottom essentially fell out from it. Without the subsidy, there was no way for Brazilian banks to easily obtain dollars on the dollar market. And, of course, the short squeeze hit Brazil.
Still, central banks looking for an alternative to the dollar are bound to be disappointed, as the Chinese undoubtedly were, Snider said, when they tried to liquidate some of their dollar-denominated foreign reserves.
As Yusko pointed out in Pt. II – an analysis of the Eurodollar market’s role in supporting US dollar hegemony – shifts in international currency regimes happen gradually. By the time Nixon killed Bretton Woods, the infrastructure for the Eurodollar system and floating interest rates was already in place.
The Chinese are grappling with this problem. The dollar system isn’t working to their benefit, but any attempts to ditch the dollar inadvertently trigger an uncomfortable tightening in Chinese monetary conditions.
You know, the dollar is the basis of so many central banks. The monetary system in China is predicated on the dollar. And so selling down US Treasuries or US dollar balances has the effect of tightening Chinese money.
And that’s exactly what happened. Bank reserves in 2015 declined by some 3 trillion RMB, which is an enormous decline. So there was direct economic and financial consequences to that happening. Which is essentially the point. These countries are almost in the position of mutually-assured destruction here. They can’t just sell off their own dollar holdings, because that would undermine their own currency. It would undermine their own monetary system.
So I think that’s why we’re getting into Luke’s point, and to Mark’s point as well – the geopolitical concerns here is that, okay, the dollar system doesn’t work, but we’re stuck with it. So what the hell do we do? You kind of sympathize with their position, because it’s between a rock and a hard place.
My sympathy kind of ends, because they were certainly on board with all this while it seemed to be working. Up until August of 2007. So they kind of made a deal with the devil. And eventually the devil gets paid. And so the question is, how does the devil get paid? And in what form?
And so, from my perspective here, especially when we go through the Chinese stuff, is – what is their choice? They have to work almost behind the scenes to try to get something of a workable alternative. Because they don’t have an alternative today. They cannot go with today getting rid of the dollar. Can’t ditch the dollar today. I think they would want to.
After years of resisting a shift away from the dollar for fear of the consequences, how long until the Chinese just saw ‘screw it?’
Luke: Doesn’t that speak to the binary nature, in your opinion? Like, if there’s going to be a change, it’s going to have to be – just by virtue of the fact that how much this is not working and how far away we still appear to be from a solution, right? Like I think of those things and it’s like, we’re running out of gas in the plane and we’re nowhere near a landing strip, right?
So that doesn’t imply that we’re going to get to the landing strip. It implies that we’re going to fall straight down. No?
Jeff: Yeah, I agree. And I think that’s what scares me the most. Maybe the analogy’s a little different. To me the Chinese are increasingly desperate. You look at what they’ve done in ‘14–‘15–‘16–’17. They do increasingly desperate things. And it’s possible – to get to your point about a binary option here – they get to the point where they say screw it. You know what?
We’ve resisted de-dollarizing as best we can because we don’t think there’s an alternative. Let’s just do it.
Let’s just say tomorrow – I mean, because this isn’t working. We’re in a high-risk position. So why don’t we just say screw it. We’ve been waiting patiently for those idiots in America to get their house in order, for somebody to take control of the Eurodollar system and do something about it. It’s been ten years already, it’s clear that’s not going to happen, So let’s just start reevaluating everything we do in RMB.
As global banks’ dollar lending business has declined in Europe, it has grown in the emerging markets in Asia, based partly on the assumption that these economies would continue to grow at a rapid clip, and therefore, would maintain a high demand for dollars.
But banks are quickly realizing that they can’t take this for granted.