In Episode 12 of COVIDcast, Roland Rajah, Director of the International Economy Program, sat down with Brad Setser, Senior Fellow for International Economics, Council on Foreign Relations, to discuss the upheaval brought about by the pandemic in emerging economies and what this has revealed about the importance of the US dollar in the functioning of the global economy.
Rajah and Setser began by discussing the dramatic outflow of capital from emerging markets between March and April. Setser described this as “the most rapid withdrawal of foreign financing that anyone had seen since the global financial crisis”. Although markets have since stabilised largely due to the intervention of the Federal Reserve (the Fed), a number of economies remain very fragile. As Setser put it:
“So long as oil prices remain low, or tourism remains shutdown, or if you needed foreign financing to roll over your debt, foreign financing remains scarce … Even though the most important shock and the peak of market stress is past, some countries are living off buffers and borrowed time.”
Setser also noted that while the Fed had reacted creatively and forcefully, the International Monetary Fund had been left on the sidelines and had yet to offer a crisis facility that is attractive to the big emerging markets.
On the role of the US dollar as global reserve currency, Rajah questioned the ability of emerging markets to wean themselves off dollar dependence. Setser argued the US dollar remains the most used to denominate world trade and financial assets – “as long as that’s the case, in a crisis you’re going to need dollars”.
Despite China’s goal to establish the RMB as a global reserve, the crisis and the response of the Fed, including providing dollar swap lines, had reinforced the dominance of the US dollar.
The US dollar remains the most used to denominate world trade and financial assets – “as long as that’s the case, in a crisis you’re going to need dollars”.
Given this dominance, Rajah asked why the United States did not actively take advantage of the dollar as a powerful tool of attraction in its competition for influence with China, and whether it had been too selective in the countries to which it offered swap lines. Setser said “the Fed’s mandate doesn’t include providing political swap lines to gain political influence” yet also that “the United States hasn’t made full use of its financial power”. America could try to compete with China to provide financing for infrastructure as well as financing in times of crisis through the Treasury’s balance sheet, he said.
Rajah concluded by asking what emerging economies could and should do to get through the current crisis. He noted everyone needs to run large fiscal deficits, but, in the absence of outside help, emerging economies are turning to their own central banks in unconventional ways reminiscent of quantitative easing in advanced economies. Setser argued it was a balance of risks versus benefits, and that each country has a choice to make, “between a weaker currency and easier access to central bank financing for fiscal deficits”.
COVIDcast is a weekly pop-up podcast hosted by Lowy Institute experts to discuss the implications of Covid-19 for Australia, the Asia-Pacific region, and the world. Previous episodes are available on the Lowy Institute website. You can also subscribe to COVIDcast on Apple Podcasts, listen on SoundCloud, Spotify, Google podcasts or wherever you get your podcasts.