Discover more from American Economy Daily
Non-Bank Financial Intermediaries Could Bring Down the System
Dollar Dominance In Question.
Here is what we will be getting into today:
Dollar Dominance Challenged
Non-Bank Global Risk
Singapore Central Bank Stops Rate Hikes
Let's Dive In!
Geopolitical Tensions Between US and China Threaten Dollar and Euro Dominance
Geopolitical tensions between the US and China could lead to a 5% increase in inflation and threaten the dominance of the dollar and euro, according to Christine Lagarde, President of the European Central Bank. Speaking at a Council on Foreign Relations event in New York, Lagarde warned that disruption to global supply chains could hit critical sectors such as the electric-car industry. Policymakers at last week's annual meetings of the IMF and World Bank also expressed fears that rising political tensions could disrupt trade, weaken growth and push up inflation. Lagarde suggested that some countries could reduce their dependence on the dollar and euro, citing anecdotal evidence of increased usage of the Chinese renminbi or the Indian rupee in cross-border trade, and greater stocks of gold being used as an alternative reserve asset. Developing countries trading more with China are inclined to increase their holdings of renminbi as reserves, she added. China's growing global influence through diplomatic efforts with Brazil, Saudi Arabia, and Iran is causing concern in Washington. Meanwhile, the US has tried to isolate Russia economically and diplomatically since the Ukraine war. However, major economies such as China, India, and Brazil have continued trading with Russia, creating new problems for the rest of the world, including food and energy price impacts and a message about the potential danger of holding assets in dollars.
As a result, some countries are looking to do less trade in dollars and are encouraged by Beijing to use the yuan for bilateral trade. Brazil's President, Luiz Inácio Lula da Silva, has called on developing countries to work towards replacing the US dollar with their own currencies in international trade. This supports Beijing's efforts to end the dominance of the dollar in global commerce. Lula's call to shed dollar dependence aligns with Beijing's increasing efforts to promote the use of the renminbi in settlement of cross-border commodities trades.
China and Brazil's growing economic relationship has led to efforts to promote greater use of their respective currencies in bilateral trade. Brazil will face a substantial challenge in the near term in its attempt to spurn the US currency. The dollar is crucial to global commodities markets and benchmarks, which encourages top Brazilian miners such as Vale to keep most transactions dollar-denominated.
In response to these global economic challenges, Lagarde has called for greater policy cohesion through countries co-operating to tackle problems. She suggests that if countries worked together to secure supply chains or diversify energy production, they could create a virtuous circle of lower volatility, lower inflation, higher investment, and higher growth. It remains to be seen whether countries will heed this call for cooperation or continue to pursue their own interests in a changing global landscape.
The Growing Risk of Non-Bank Financial Intermediaries
The global financial system is facing significant challenges, with the potential for further financial stress in North America and Europe. The collapse of Silicon Valley Bank (SVB) illustrates how the central banks' inflation and financial stability objectives can be in conflict. The long period of super-low interest rates since the great financial crisis of 2007-09 introduced fragilities into the financial system while creating asset bubbles, ultimately undermining financial stability.
Non-bank financial intermediaries (NBFIs), also known as shadow banks, have grown rapidly since the global financial crisis and now account for almost 50% of international financial assets. These NBFIs lie outside the scope of bank regulation because they do not take deposits, making them a significant source of risk amid tight monetary policy and shrinking liquidity. Regulators need to get a handle on non-banks quickly, particularly if high inflation persists and rates need to go higher. The Financial Stability Board needs to play a stronger role in providing remedies and ensuring they are actually implemented.
The global financial crisis of 2008/09 led to radical financial regulatory reforms to prevent institutions that were too big to fail, but recent events have shown that the safety net has been distended again, with both big and medium-sized institutions being found to matter. Since the global financial crisis, the world economy has been hit by two enormous shocks, first Covid and then the cost of living, which were cushioned by monetary and fiscal measures of unprecedented scale and scope.
Providing insurance or safety nets to mitigate risks in the financial system can have unintended consequences by altering the behavior of market participants, potentially creating new risks. The mounting evidence suggests that we may be reaching a critical point where the costs of such measures could outweigh their benefits.
The shift from quantitative easing to quantitative tightening and sharply increased interest rates has imposed a gigantic stress test on both the financial system and the wider economy. The combined debt of households, companies, and governments in relation to gross domestic product has risen to levels never before seen in peacetime. Stress testing on non-bank financial markets risks needs to be a norm, and central banks will need to be prepared to provide appropriate liquidity support if incidents of systemic stress arise.
Covid-19 and geopolitical friction are forcing companies to restructure supply lines, increasing resilience but reducing efficiency. The supply of workers has been hit by deaths and long Covid, and the global supply of workers is in sharp decline, pushing up wage costs everywhere. For mortgage borrowers, the continuing high level of inflation is reducing the real value of mortgage debt. If financial stability concerns cause the Bank of England to stretch out the period over which it brings inflation back to its 2 per cent target, the real burden of debt will be further eroded.
It is time to reconfigure our safety nets, in finance and beyond, and reinvigorate capitalism in anticipation of the next big crisis. Increasing capital requirements when the economy is doing poorly is conducive to recession because it reduces banks' lending capacity. Technology is supplanting traditional banking, and policymakers must reduce gaps in data, including on NBFIs liquidity and leverage. The most obvious scope for sharp repricing relates to market expectations about inflation. To mitigate risks and promote financial stability, it is crucial that national and international regulators shed more light on the shadow banking sector, and private investors should be cautious about investing in banks as returns are poor, and even well-run banks can be destroyed by a systemic panic.
Singapore's Central Bank Leaves Monetary Policy Unchanged Amid Concerns About Growth Outlook.
Singapore's central bank, the Monetary Authority of Singapore (MAS), surprised economists by leaving its monetary policy settings unchanged. This decision reflects the city-state's concerns about its growth outlook, as economic growth for the first quarter missed expectations. Singapore's economy is expected to have expanded at a slower pace in the first quarter of 2023, according to a Reuters poll of 19 economists. Preliminary data due on April 14 is forecast to show gross domestic product (GDP) expanded by 0.6% in January-March from a year ago, compared to 2.1% YoY growth in Q4 2022. The city-state's manufacturing sector has contracted for five consecutive months due to the slowdown in demand for semiconductors globally, along with non-oil domestic exports.
The MAS had tightened monetary policy five times in a row from October 2021, including two off-cycle tightening moves last year in January and July. However, with concerns about global growth overshadowing worries about persistently high inflation, the central bank has decided to leave its monetary policy settings unchanged. The MAS is expected to face a delicate balancing act as it seeks to contain persistent inflation while shoring up weakening growth. The core inflation rate, the central bank's preferred price measure, rose to 5.5% in January and February on a year-on-year basis and is at its highest since November 2008. The MAS manages policy by letting the local dollar rise or fall against the currencies of its main trading partners within the S$NEER.
Singapore now joins economies such as Australia, India, South Korea, and Canada that have recently paused sustained policy tightening campaigns as fresh concerns about global growth overshadow worries about persistently high inflation. The MAS's decision not to tighten monetary policy reflects these concerns about global growth and Singapore's own growth outlook.
For more analysis on these topics, check out these articles:
Thanks For Reading!
If you find value in this newsletter and want to make sure you don't miss any important updates, you should definitely consider subscribing. By subscribing, you'll be the first to know about new articles and special offers.
We also offer a paid service which will give a breakdown of every source we cover that will be sent out almost daily.
Our Wednesday newsletter will always be free, but to make sure YOU are not missing anything be sure to sign up for our paid subscription.
If you have any newsletters you wish to see in our lineup, please reach out and let us know. We will continually look to incorporate more sources to our weekly wrap-up.
Thanks for reading American Economy Daily! Subscribe now to receive new posts and support our work.