The latest on the dollar’s international currency status
Jeffrey Frankel 06 December 2013
Except for the period 1992-2000, the dollar’s role as an international currency has been slowly declining since 1976. Since 2010, there has been another pause in this decline – somewhat surprising, given that the financial crisis began in the US, and given Congress’ recent flirtations with default. The dollar’s resilience as the world’s reserve currency is due to a lack of good alternatives – the euro has its own problems, and the yuan only accounts for 2.2% of forex transactions.
As most people know, the general trend in the dollar’s role as an international currency has been slowly downward since 1976. International use of the dollar as a currency in which to hold foreign-exchange reserves, to denominate financial transactions, to invoice trade, and to serve as a vehicle for foreign-exchange transactions is below where it was during the heyday of the Bretton Woods era (1945-1971). However, few are aware of what the most recent numbers show.
It is not hard to think of explanations for the downward trend:
euro, reserve currency, dollar, foreign exchange, yuan
Monetary policy in Latin America: Where are we going?
Christian Daude 10 December 2012
Latin American central banks are facing new challenges in the form of unprecedented levels of uncertainty and exchange rate appreciation pressures. This column, focusing on Brazil, Chile, Colombia, Peru and Mexico, argues that there is an overestimation of the potential output in several Latin American economies, a lack of an explicit policy direction from central banks, and lacklustre frameworks for macroprudential policy. Although inflation targeting has served countries in Latin America well, significant risks remain.
Inflation targeting has served countries in Latin America well . They have achieved macroeconomic stability by reducing inflation and the pass-through of external shocks such as oil price and exchange rate fluctuations (cf. Mishkin and Schmidt-Hebbel 2007).
Macroeconomic policy Monetary policy
inflation targeting, Latin America, Central Banks, foreign exchange, Brazil, Chile, Mexico, Colombia, Peru
The foreign exchange market: Not as liquid as you may think
Loriano Mancini, Angelo Ranaldo, Jan Wrampelmeyer 03 September 2012
The foreign exchange market facilitates international trade and investment and is central to the global financial system. Market participants, both public and private, commonly think of the foreign exchange market as highly liquid at all times. This column challenges this view by documenting significant declines in liquidity during the recent financial crisis.
With an estimated average daily trading volume of $4 trillion, the foreign exchange (Forex) market is by far the world’s largest market (Bank for International Settlements 2010). Due to this size, market participants commonly regard foreign exchange as highly liquid at all times – liquid in the sense that you can buy or sell very large sums quickly and without turning the price against yourself by much.
foreign exchange, Forex
Getting beyond carry trade: What makes a safe-haven currency?
Maurizio Michael Habib, Livio Stracca 30 January 2011
What makes a safe-haven currency? This column analyses a panel of 52 currencies in advanced and emerging countries over the past 25 years. It finds that safe-haven status is not determined by the interest rate spread, as emphasised in the carry trade literature, but by the net foreign asset position, which is an indicator of country risk and external vulnerability.
We all “know” that some currencies are safe havens in crisis times – take the Japanese yen or the Swiss franc. But do we know why? And does the dollar belong to this list?
carry trade, foreign exchange, currencies, safe haven currency
Carry on speculating on the volatility of foreign exchange
Pasquale Della Corte, Lucio Sarno, Ilias Tsiakas 26 January 2011
The carry trade in foreign currency has attracted considerable attention from academics and practitioners. This column presents evidence of a new carry trade strategy – this time speculating on the volatility of foreign exchange. This is done by buying or selling forward volatility agreements. It suggests that investors following the new carry trade can do extremely well – regardless of whether the value of these currencies go up or down.
The standard “carry trade” is a popular currency speculation strategy that invests in high-interest currencies by borrowing in low-interest currencies. This strategy works well if, for example, spot exchange rates are unpredictable. There is ample empirical evidence pointing in that direction or, in academic jargon, showing that exchange rates follow a random walk (Meese and Rogoff 1983). In this case, investors engaging in carry trading will on average earn the difference in interest rates without having to worry about movements in exchange rates.
Frontiers of economic research International finance
carry trade, speculation, foreign exchange, investing
The $4 trillion question: What explains FX growth since the 2007 survey?
Dagfinn Rime, Michael R King 23 December 2010
Daily average foreign exchange market turnover reached $4 trillion in April 2010, 20% higher than in 2007. This column describes how recent growth is largely due to the increased trading activity of “other financial institutions”, which include high-frequency traders, banks trading as clients of the biggest dealers, and online trading by retail investors.
In April this year, 53 central banks and monetary authorities participated in the eighth Triennial Central Bank Survey of Foreign Exchange and Derivatives Market Activity (BIS 2010). The 2010 Triennial shows a 20% increase in global foreign exchange (FX) market activity over the past three years, bringing average daily turnover to $4 trillion (Table 1 and Figure 1, left panel).
Financial markets International finance
Lessons for the foreign exchange market from the global financial crisis
Michael Melvin, Mark P. Taylor 06 November 2009
The timing of the subprime crisis that became the global crisis is well known. Its impact on the foreign exchange markets has been much less discussed. This column fills that void. Its findings suggest that foreign exchange portfolio managers could have protected their portfolio by an appropriate risk control strategy using market stress indicators.
The timing of the subprime crisis, which became the global crisis, is well known; see, for example, New York Fed (2009). The impact on the foreign exchange markets has been much less discussed.
Exchange rates International finance
global crisis, foreign exchange, FX markets
Can we understand the recent moves of the euro-dollar exchange rate?
Anton Brender, Emile Gagna, Florence Pisani 21 July 2009
The crisis has broken the close correlation between differences in expected interest rates and the euro-dollar exchange rate. This column attributes that to the sharp increase in risk aversion triggered by the collapse of Lehman Brothers. It argues that fluctuations in risk aversion explain the path followed by the euro-dollar exchange rate since the beginning of the financial crisis.
Trying to forecast foreign exchange rates is challenging. Understanding their past behaviour is not much easier. In this respect, the bumpy road followed by the dollar against the euro during the last two years seems to be no exception. Nonetheless, a look at Figure 1 gives some interesting clues. It compares the rate of the euro in dollars and the difference in 3-month rates on the two currencies expected at a one year rolling horizon. Until last year, the two variables appear to have been strongly correlated. This should not be a complete surprise.
euro, dollar, foreign exchange, risk aversion
Why foreign exchange transactions did not freeze up during the global financial crisis: The role of the CLS Bank
Richard M. Levich 10 July 2009
How can markets prevent counterparty failure from cascading into broad financial turmoil? This column looks at the seven-year-old clearing and settlement bank that handles 60% of foreign exchange transactions. The institution’s effective mitigation of counterparty risk throughout the financial crisis may be a model for a centralised derivatives trading exchange.
Administration officials have once again put the need for new trading systems for complex derivatives on the front burner. Officials are right to be concerned, as many new financial products represent contracts between two counterparties – banks, brokerage houses, insurance companies, and hedge funds, among others – without the benefit of a centralised exchange or clearinghouse. These bilateral deals develop in a “shadow banking system.” When institution A trades with B and institution A’s credit standing takes a hit, there is a direct impact on institution B.
Financial markets International finance
foreign exchange, Clearinghouse, settlement bank, CLS Bank
Policymakers must prevent financial institutions from becoming too connected to fail
Jorge A. Chan-Lau, Marco A. Espinosa-Vega, Kay Giesecke, Juan Solé 02 May 2009
The current financial crisis has underscored the problem of institutions that are too connected to be allowed to fail. This column suggests new methodologies that could form the basis for policies and regulation to address the too-connected-to-fail problem.
How should governments handle large and complex financial institutions that are “too big to fail” and “too connected to fail”?
foreign exchange reserves, IMF, currency crisis, Too big to fail, too connected to fail, foreign exchange, exchange rate