22 April 2011
A World Without A Monetary Superpower
On April 18, 2011, one of the Big 2 major credit raters, Standard & Poor's revised its "outlook" on its long-term rating for U.S. Treasury debt from stable to negative.
This news was left in the provinces visited mostly by financial-news wonks, while sleeping air-traffic controllers and a continuing civil war in Libya (and the pseudo-campaign of possible Presidential hopeful Donald Trump) continued to get headlines. Syill, the S&P announcement was yet another straw in a wind that had been blowing for some time already -- the emergence of a world in which there will be no hegemonic economic/financial superpower.
Our business in this chapter is an examination of the consequences of a truly multi-polar financial world.
Note that El-Erian, in the blog entry to which I've just linked, refers to the "risk free" standard as one of the "global public goods" that US hegemony provides. What he means to ask is:
how will anyone make use of the Black-Scholes formula if the US Treasury gets an S&P downgrade? Any use of the formula requires a value for “r,” the risk-free rate of return. My understanding is that T-bills have provided a proxy for r.
I raised this issue in the comments section of one of Felix Salmon's blog posts. Another commenter responded, "Observe option prices, assume put-call parity, and back out r."
But back to S&P. Along with the words of caution, it re-affirmed AAA sovereign credit rating for the US. Why would it do both of those things? As Einstein noted, everything is relative, and the US can only really be measured against the handful of other countries that have the coveted AAA rating. Yet in that company, it has earned its downgrade: "Even in our optimistic scenario we believe the US's fiscal profile would be less robust that those of other AAA rated sovereigns by 2013."
On a related front, Robert Zoellick, president of the World Bank Group (2007-), one-time U.S. Trade Representative (2001 - 2005), one-time Goldman Sachs managing director (2006-07), spoke in November 2010 about the need to “look beyond Bretton Woods.”
Actually, we've all been "beyond" Bretton Woods for about 40 years now. What I take it Zoellick means is that the diplomats and international finance bigwigs to whom he was addressing himself should look to fix the free-float of all-against-all that replaced it, and that they shuld seek to do so by moving forward not back.
We're building on chapter 6 especially here. Will not repeat its historical lessons. Let's focus, instead, on what Zoellick meant by this.
He seems to have in mind especially a sort of G2, an accord between the US and China to share a leadership position. "The U.S. and China could agree on specific, mutually reinforcing steps to boost growth," then to create "wide bands for exchange rates" and finally to work out a new series of market-opening trade agreements. The reference to the G2 agreement on exchange rates suggests that there could be a shared numéraire role. A numéraire is the currency-of-currencies, the one (or two?) that may be said to back the others.
I have to dissent from RZ here, the idea of 2 currencies sharing that role, especially when they are the currencies of countries so different, seems to me unworkable. Explain why.
RZ also says this: "The system should also consider employing gold as an international reference point of market expectations about inflation, deflation and future currency values. Although textbooks may view gold as the old money, markets are using gold as an alternative monetary asset today."
One or more major currencies links or re-links itself to gold, and then floats freely re: the other. Competing to acquire the status of numéraire.
Or, forgetting RZ, the US could take unilateral action in another direction, without the stigma of gold but perhaps with the same benefits. Repeal the special legal tender status of the dollar domestically, allow competing currencies. The winning currency within the US market will be in a sound position for export.
Knowledge is warranted belief -- it is the body of belief that we build up because, while living in this world, we've developed good reasons for believing it. What we know, then, is what works -- and it is, necessarily, what has worked for us, each of us individually, as a first approximation. For my other blog, on the struggles for control in the corporate suites, see www.proxypartisans.blogspot.com.