My past three columns argued that financial markets were at risk from the potentially negative implications of US policy on global growth. But the focus was on trade policy. I underappreciated the risk to settled monetary orthodoxy that could yet come from this administration.
The dollar is the global reserve currency, the currency by which states save. Central banks worldwide use their dollar holdings, typically held in US Treasury instruments, to secure the value of their country’s currencies. The dollar is the world’s indexing currency, the currency in which others are quoted and by which every asset is valued.
US Treasury yields are the dollar funding rates, and hence the foundational rates for valuation of all other assets. Global finance and trade are organised around the US monetary system. To the extent that it influences US monetary policy, what happens at the White House will be hugely consequential for the rest of us.
Financial markets are rioting again this week as markets digest US President Donald Trump’s threats to fire Federal Reserve chair Jerome Powell. Like other presidents, Trump would like lower rates and high growth. However, unlike with other US presidents, including the previous Trump administration, the man now inhabiting 1600 Pennsylvania Avenue is less restrained than any US president in recent memory.
Markets have taken him seriously. Even if Powell remains in his position the president’s threats have undermined US monetary policy credibility. Powell’s term ends in May next year, and Trump will have an opportunity to appoint a federal open market committee of his own choosing.
We are habituated to splitting economies into hierarchical groups. At the top end of the scale are developed economies. These countries’ currencies are referred to as “hard” and exhibit low volatility. Their interest rates are low, consistent with historically lower inflation and policy risk.
Next are developing countries. Their currencies are more volatile and their interest rates high yield. Bringing up the rear are what financial markets people refer to as frontier markets. These typically have high currency volatility and their interest rates also tend to be high.
At the top of the classification pile is the country with the hardest of all hard currencies, the US. This status now appears at risk, as policymaking out of the US has become less orthodox and institutions less secure. As with the UK and its fiscal crisis, we are reminded that our rules of thumb can and do change.
These classifications of countries into developed and developing assume developed economies have some institutional stability and policy credibility. But these were always tenuous assumptions, as explored in Peter Kent’s recent article (“How the lines between emerging and developed markets have blurred”, April 7).
Economics professor Refet Gürkaynak made the point at a SA Reserve Bank conference that the classification of countries into developed and emerging is useless to the extent that it determines policy space. Countries were best divided into those implementing smart policies and those implementing dumb policies, he said. Hyperinflation followed Turkish President Recep Tayyip Erdogan’s assault on monetary policy credibility.
The dollar will depreciate and US bond yields will rise if Trump does the same in the US. Not-so-smart policies tend to produce predictable results. The Turkish lira is not the global reserve currency. The dollar has lost 11% against a broad-based basket of currencies since Trump’s inauguration and the start of his frenzy of executive orders in January.
The global financial system works on the assumption that the US will largely pursue smart economic policies. But global investors and sovereigns cannot quickly, easily and cheaply replace the dollar monetary system. Hopefully sanity will prevail sooner rather than later in the US.
• Lijane is global markets strategist at Standard Bank CIB.
Would you like to comment on this article?
Sign up (it's quick and free) or sign in now.
Please read our Comment Policy before commenting.