Financial Markets Professional and Author
Financial Markets Professional and Author
John Maynard Keynes once observed that “There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency.” As the spectre of higher inflation looks set to become more than transient, policymakers should beware.
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* First published in International Policy Digest (8 December 2021)
Photo credit: John Lyman; MJgraphics
By James A. FokAssets tied to environmental, social and governance (ESG) benchmarks are projected to grow to more than US$53trn by 2025, or one-third of global assets under management. This is a welcome development. By harnessing society’s resources, markets can be a powerful driver of progress and innovation.
However, markets alone cannot address some of the most important challenges we confront today. Governments must also play their part.
The economist Paul Samuelson argued that modern markets are ‘micro efficient’ but ‘macro inefficient’. What he meant was that it is easier to spot price anomalies in an individual security and eliminate them than to do so for the market as a whole. But Samuelson's dictum is perhaps true on more levels.
Continue reading at IFR Asia...
* First published in IFR Asia (30 September 2021)
Photo by Feri & Tasos on Unsplash
By James A. FokMarket participants long anticipating the launch of southbound Bond Connect may have felt a little deflated when the programme was finally announced. Initial quotas for Chinese investors to buy offshore bonds have been set at a very modest US$78bn annually, and US$3.1bn daily.
Nevertheless, China’s approach to capital markets internationalisation has always been gradual. The quotas will be raised over time, and longer-term opportunities will arise from the programme.
Some US$33trn of Chinese private wealth is held in low-yielding bank deposits, far exceeding investment in domestic stock and bond markets. Given the country’s rapidly aging demographic profile, Chinese policymakers need to raise savers’ allocations to higher-return assets to reduce the government’s future social welfare burden. China’s own markets are not yet deep enough to absorb so much capital, so the eventual scale of Chinese portfolio investment in global bond markets could be very sizable.
* First published in IFR Asia (24 September 2021)
Photo by Chester Ho on Unsplash
By James A. FokThis month marked the 50th anniversary since Richard Nixon suspended the US dollar’s convertibility to gold, effectively putting an end to the Bretton Woods System that had underpinned international currency stability since the end of World War 2. That system had fixed the exchange rates of all currencies to the dollar, which in turn was fixed to gold. Nixon’s move unleashed unprecedented volatility in global currency markets.
Currency volatility was a godsend to the financial services industry. Suddenly, there was huge demand for hedging foreign exchange risks, and speculators jumped at the opportunity to profit from currency swings. This spurred the development of an enormous market in financial derivatives, which has grown continuously since. However, the impact on other sectors and the wider economy has been decidedly mixed.
Nixon’s Treasury Secretary, John Connally, famously told a meeting of G-10 finance ministers: “The dollar is our currency, but it’s your problem.” Certainly, the dollar’s role in financial markets has created problems for many emerging markets, whose governments and businesses need to borrow in the US currency. Periodic bouts of dollar volatility caused a wave of emerging market financial crises across Asia and Latin America. However, it might be argued that the dollar has now become an even bigger problem for the US.
Bretton Woods’ demise did not end the dollar’s centrality in the global monetary system. It continued to serve as the key reference in foreign exchange markets. If anything, the growth of financial derivatives referencing the greenback further cemented the dollar’s global role. Therefore, while Nixon’s move to a free-floating currency saw a brief downward adjustment in the dollar’s exchange rate, demand for the US currency to support activity in global financial markets has led to a persistent structural overvaluation of the dollar. This has contributed to reduced US export competitiveness, for which American workers have paid a high price.
In the wake of the Asian financial crisis, many countries built up large dollar reserves to insulate themselves from capital markets volatility. This further compounded problems for US industry and indirectly contributed to the subprime mortgage crisis (along with a host of regulatory and policy failings, admittedly).
The dollar’s role has become something of a quagmire for America. On the one hand, it has been a source of considerable international influence and enabled the US government to access plentiful cheap funding; on the other, it has undermined American manufacturing competitiveness and required the Federal Reserve to step in to support global market liquidity in times of crisis. This has denied America the benefit of a critical exchange rate rebalancing mechanism in response to faster productivity growth in other countries and has been a significant source of rising wealth inequality.
The cracks in the dollar-centric global monetary system are starting to show. The March 2020 dislocation in US Treasury markets was a warning sign, highlighting the strains in the market for US government financing. The surge in the popularity and value of cryptocurrencies is another clear symptom. A disorderly unravelling of the dollar’s international role would pose huge risks, extending well beyond the realm of financial markets.
China, in particular, has much at stake. This is not just due to its $1.1 trillion in US Treasury holdings, but also because it is now highly integrated with the global economy through the channels of trade and, increasingly, financial markets. Further, China’s international commerce continues to be primarily settled in dollars. The impact of a shaky dollar on US and, indeed, global trade and finance is therefore likely to have serious repercussions for China.
As the second largest economy in the world, China is uniquely positioned to expand the international role of its currency to help rebalance the global monetary system. Increasing the amount of trade and investment around the world settled in renminbi could also have considerable benefits for China. Nevertheless, while Chinese policymakers have been gradually expanding the international use of their currency, notably in financial markets through the Stock and Bond Connect programmes via Hong Kong, they have been wary about promoting the renminbi as a usurper to the dollar’s role. This is evidenced by former PBOC Governor Zhou Xiaochuan’s call in 2009 to promote greater use of the IMF’s Special Drawing Rights (rather than the renminbi), which was echoed by his successor Yi Gang in mid-2020.
Like Britain at the end of World War 2, the US cannot go on absorbing the world’s financial imbalances. Notwithstanding today’s tense geopolitical backdrop, it is in both China and America’s self-interest to find a solution to this dollar problem. Policymakers on both sides should therefore work together proactively to reform the global monetary system.
* First published on LinkedIn (17 August 2021)
Image by Moab Republic, courtesy of Shutterstock
By James A. FokIt appears that central bankers have finally met their match in COVID-19. As governments have reluctantly grasped the baton and released an unprecedented wave of fiscal stimulus, many of us are now wondering: what next?
The bill for years of quantitative easing and fiscal profligacy will ultimately have to be paid. The US government deficit had already been budgeted to exceed USD 1 trillion in 2020;1 with the loss of economic activity and further fiscal stimulus stemming from COVID-19, that number will well exceed USD 3 trillion.
In anticipation of further debasement of fiat currencies, gold has surged, while cryptocurrencies such as bitcoin have been claiming a larger audience. Both of these options, however, have serious shortcomings as currencies for global trade and investment.
Has the renminbi’s time now come?
It took two World Wars for the dollar to dislodge sterling as the pre-eminent global currency. Even if the twin shocks of the global financial crisis and COVID-19 can be seen as economically equivalent, it would be naive to think that the emergence of an alternative is down to economics alone. Matters of convertibility; openness and depth of capital markets; legal system; regulation; soft power influence; and even military capacity all come into play. China would also have to be willing.
There are good reasons for China to shy away from this role for its currency. While the dollar’s status has allowed the US to fund its vast fiscal deficits at extremely low rates, this has come at the expense of control of its foreign exchange rate. For a government that derives political legitimacy from its ability to deliver stability and consistent economic growth,2 this would be a huge risk – as highlighted by Japan’s experience following the breakdown of Bretton Woods.
In addition, China’s closed capital account affords the Chinese government significant influence over both access to China’s market and the flow of its citizens’ capital. These are huge levers of geo-economic power in China’s international policy.
Nevertheless, China faces some tough realities. China today finds itself in a similar position to the US in the 1970s; its ageing demographics and shift away from an export-led economy mean it faces steepening current account and fiscal deficits for the foreseeable future. Unless it can expand international demand for its sovereign debt, continued growth in Chinese prosperity is by no means assured.
Full renminbi convertibility would certainly help expand this demand, but the deck remains stacked against China. The international regulatory framework governing global financial institutions still assigns much greater risk weightings to Chinese securities, making them much more capital intensive to hold. Illiquidity exacerbates this problem, since Chinese securities are not widely accepted as collateral in international markets. Even if international investors are willing to buy more Chinese credit, therefore, they will demand substantially higher interest rates.
Why would the West be willing to facilitate renminbi’s rise?
China’s vast domestic pool of capital would
be one huge attraction. With its citizens’ bank deposits sitting at USD 28 trillion,3 China represents the largest untapped pool of capital in the world. As China’s recently minted middle classes turn to the capital markets to generate the returns to support their post-retirement lifestyles, China’s own markets will struggle to absorb this and international businesses are eager to access this renminbi funding.
Facilitating such “portfolio” flows would also be
far more palatable for countries receiving Chinese investment. Hitherto, the vast majority of Chinese outbound capital flows have taken the form of foreign direct investment by China’s (largely state- controlled) corporate sector, which raises concerns, including the level of state influence, technology transfer and the export of local jobs. Thousands of “Mrs Wangs” each buying a few shares in overseas- listed companies should raise no such concerns.
Many recognize that the overwhelming dominance of the dollar comes at a cost. Dollar supremacy has created a huge concentration risk, and the ripple effects of periodic dollar volatility can have devastating consequences for emerging markets forced to borrow in the greenback. Moreover, dominant positions in any market generally lead to abuses: a greater balance in the mix of currencies for trade and global finance would help reduce such risks.
A major driver of the dollar’s rise to dominance was the US’s role as the largest oil importer. That mantle has since passed to China, while the shale oil revolution has restored the United States’ status as a major oil exporter. The uncomfortable truth is that stability in the Middle East today is far more economically important to China than to the US, which may appreciate being able to reduce some of its foreign commitments. In return, China would seek to pay for its energy imports in its own currency, while exporters would need a deeper international pool of renminbi assets to deploy the proceeds.
The practical challenges for China in allowing its citizens to partake in international capital markets lie in being able to moderate the pace of flow to avoid global economic disruption from a “big bang” event; ensuring appropriate levels of transparency to prevent large-scale tax evasion; and avoiding exposure to foreign financial sanctions. The Stock and Bond Connect programmes pursued with Hong Kong have largely addressed the first two challenges. The third remains unresolved; Chinese outbound portfolio flows today would be wholly dependent on a Western-controlled global custody network, leaving it heavily exposed to the type of financial sanctions that have been applied to Russia and Iran.
Notwithstanding the mutual interests at stake, frameworks of trust need to underpin any such changes, and this appears to be in short supply. Nevertheless, with the right regulatory framework and financial market infrastructure, these challenges can be overcome. While Hong Kong’s image has no doubt been tarnished by the events of the past year, its role as a bridge between China and international markets looks set to endure, and may yet prove highly valuable in the renminbi’s evolution.
The question of whether the renminbi will eventually “usurp” the dollar is, perhaps, the wrong question. The more important and immediate question is the greater international role for China’s currency and capital markets, commensurate with its economic success and status. Properly managed, this could bring a better economic and geopolitical balance to the world.
As COVID-19 draws growing speculation about globalization’s retrenchment, we should all hope that China is willing to engage, for this is not just about economics: increased financial and economic integration is our greatest guarantee of international peace.
* Co-authored with Cheah Cheng Hye. First published in the World Economic Forum Insight Report: China Asset Management at an Inflection Point (July 2020)
By James A. FokWhatever you may think about Davos, it is truly amazing what a spectrum of different ideas across a wide range of different fields you are exposed to at the annual World Economic Forum gathering. This year did not disappoint in this regard.
Relating to HKEX’s business, I attended a host of presentations and discussions relating to financial markets, technology, sustainable metals sourcing, China, corporate governance and geopolitics. In addition, there were a large number of meetings with business partners and customers, out of which we have a good few interesting follow-ups. Relating to more personal interests, I also had the opportunity to attend some fascinating sessions on healthcare, education and social mobility.
One noticeable shift from last year was that, on a number of social issues such as climate change and inequality, the tone has shifted from one of genteel persuasion to one of indignant frustration, and even anger. Perhaps this should not have been surprising, as it simply reflects the sentiment on the streets around the world – that we can no longer afford to wait to address many pressing global issues.
What was surprising, however, was that even in a setting such as Davos, progress is often impeded by a polarization of viewpoints and a lack of willingness to compromise. A case in point was at a workshop on social mobility, where there was widespread agreement that more had to be done to improve in areas such as access to educational opportunities for those from less advantaged backgrounds, but where some in the group argued vehemently against increased taxation that might be required to pay for it.
In any disagreement, there are always at least two sides to an argument and the best path to resolution tends to require an acknowledgment of the validity of different perspectives. It’s a little like trying to lose weight – even if you start to exercise, you are unlikely to see any real results unless you also control your diet. To help raise up those at the bottom of society, it is likely that those at the top will need to exercise some restraint. On climate issues, there is little doubt that humans will have to adjust their consumption habits, but it’s probably not realistic to expect people to give up air travel or beef overnight – a combination of lifestyle adjustments and new technologies will need to play a part.
The world has some big problems to solve. In order to do so, there will need to be more give and take.
First published at https://hkexindavos.com/2020/lesson-from-davos-you-cant-out-exercise-a-bad-diet/
Photo by Damian Markutt on Unsplash
By James A. Fok