The world's dominant currency

Delivered on By Justin Pyvis

Good morning! Treasurer Josh Frydenberg warned that if Labor wins the election it will revert to its “natural instincts to tax more and to spend more”.

That may be true but we fail to see how another term with Josh at the helm of the Treasury would be much different?

The Morrison government threw the kitchen sink at the pandemic and has no plans to slow its deficit spending anytime soon.
The Morrison government threw the kitchen sink at the pandemic and has no plans to slow its deficit spending anytime soon. Source

Reading the tea leaves

Daily % change

AUD/USD

72.6

+2.3%

AUD/CNY

4.79

+2.1%

AU Bond

3.40

-0.4%

US Bond

2.92

-1.5%

ASX200

7,305

-0.2%

S&P500

4,300

+3.0%

Brent (bbl)

110.3

+5.0%

Gold (oz)

1,884

+0.8%

Iron ore (t)

142.9

-0.6%

Bitcoin

39,843

+5.5%

Ethereum

2,953

+6.1%

Note: Brent oil, gold bullion and iron ore prices are the second futures contract. Bond yields are 10-year Treasuries.

The US S&P500 surged late in the session to finish up 2.99%, after the US Federal Reserve raised rates by only the expected 50 basis points, the biggest rate hike since 2000.

But chair Jerome Powell’s dovish comments were the real kicker, stating that the board is not “actively considering” a 75 basis point hike down the road and that the current 50 basis point increases may only persist for the next two meetings.

Locally, the ASX200 edged down -0.16% with real estate again the biggest loser, falling -1.40% as investors come to grips with the prospect of rapidly rising interest rates, with economists at all four big banks now forecasting a cash rate above 1% by Melbourne Cup day (1 November).


Food for thought

"The dollar and the euro have emerged as the two leading currencies in accounting for international trade flows, with the role of the euro elevated by the fact that a large portion of international trade happens among European countries or involves one of the European countries."
"The dollar and the euro have emerged as the two leading currencies in accounting for international trade flows, with the role of the euro elevated by the fact that a large portion of international trade happens among European countries or involves one of the European countries." Source

What would it take for another currency, say the Chinese renminbi, to supplant the US dollar is the world’s dominant currency? According to Oleg Itskhoki, the most recent John Bates Clark medal winner – known as the “baby Nobel” because many winners go on to claim a Nobel – a lot depends on how the world evolves post-pandemic.

Itskhoki offers two scenarios, the first of which involves “greater globalisation of production and more intensive reliance on global value chains”, which would strengthen the US dollar’s “position as the dominant global currency”:

“Our results show that cross-border foreign direct investment — a proxy for global value chains — is associated with more US dollar currency invoicing. This would render exchange rates less relevant as determinants of relative prices and expenditure switching in the global supply chain.

The other scenario involves “fragmentation and localisation of production chains, which might happen in response to a global pandemic shock”, which would:

“…reverse this trend and speed up the transition to a multicurrency equilibrium, with more intensive regional trade and greater barriers to cross-regional trade.”

The big uncertainty is how China responds. For the Chinese renminbi to gain in prominence, Itskhoki argues that “a shift in the exchange rate anchoring policies of the major trade partners, such as China, could trigger a long-run shift in the equilibrium environment”:

“If China were to freely float its exchange rate, encouraging Chinese exporters to price more intensively in renminbi, then the equilibrium environment would change for exporting firms around the world. In particular, this would alter both the dynamics of prices in the input markets as well as the competitive environment in the output markets across many industries.”

But China floating its exchange rate – opening its capital account – would mark a significant departure from current policy. Doing so would mean the government could no longer intervene in currency markets while also suppressing interest rates to bail out struggling firms (e.g. inefficient state-owned enterprises or indebted property developers), without triggering potentially destabilising capital outflows.


Chewing the fat


Bits and bytes

💸 The value of new housing loan commitments rose 1.6% in March, driven by record new investor loan commitments and solid owner-occupier loan commitments, right as interest rates start to rise.

🛒 Aussie retail sales shot up 1.6% in March, hitting a new record level due to “Rising prices, combined with the continued easing of restrictions across the country.”

📈 Nobel prize winning economist Kenneth Rogoff warned that the Fed stopping at 2-3% “is really unlikely – I think they’re going to have to raise interest rates to 4% or 5% to bring inflation down to 2.5% or 3%… it’s clear that things are way out of control”.

📉 Macquarie’s global head of strategy, Viktor Shvets, said that “disinflationary outcomes are more likely into 2023 and 2024 rather than inflation”, as “Central banks are now tightening in inclement weather when there is no cyclical recovery. And at the same time, fiscal policies are contracting on a global basis.”

🛢️ The EU will “ban Russian crude oil over the next six months and refined fuels by the end of the year”. Hungary and Slovakia will be given until the end of 2023.

⚰️ “Chinese district authorities have fired four officials after an elderly patient from a Shanghai care home was believed to be dead and loaded into a hearse.”

☢️ The Canadian provinces of Alberta, Saskatchewan, Ontario, and New Brunswick will work together “to develop innovative nuclear energy facilities”, trialling small modular and micro modular nuclear reactors which are transportable, “never release any radioactive materials into the environment… [and] cannot meltdown”.

👴 If re-elected the Coalition will freeze the deeming rate – used to determine income from financial assets – for nearly a million pensioners, for the next two years.

⛏️ India has ramped up coal production, with output in April 6% higher than it was pre-pandemic. Pralhad Joshi – the country’s Coal Minister (yep your read that right) – said coal is “furthering India’s energy security”.

🥝 The Reserve Bank of New Zealand released its 1H2022 financial stability report, noting that “the near-term risks to the financial system have increased… [but the] financial system remains well placed to support the economy.”

👩‍🌾 “The result was brutal and swift”: A good article on how Sri Lanka’s organic farming experiment went “catastrophically wrong”.

📣 Elon Musk reportedly “told potential [Twitter] investors he could return the social-media company to public ownership after just a few years”.

🏡 Rising rates and declining real incomes are going to hurt: The average Australian mortgage is currently a record-high $600,000, up from $354,000 in 2013.

✈️ Qantas will restore its direct Perth to London route ahead of schedule, after the effective closure of Russian airspace increased the distance and cost of flights from Darwin.

👩‍🏫 Thousands of NSW teachers hit the streets for the second time in six months yesterday “amid an escalating industrial dispute with the state government over pay and conditions”.

🏗️ Ai Group said “The rise in interest rates announced yesterday by the Reserve Bank and the further rises foreshadowed can be expected to ease [construction] demand growth somewhat, particularly in the residential sectors.”

🐍 Only in Australia: A COVID-19 testing facility in Sydney’s west was closed after venomous snakes were found on its grounds.

👆 The Reserve Bank of India unanimously hiked its cash rate by 40 basis points at an unscheduled meeting, the first increase in more than two years as inflation fears grow.

🏄‍♂️ Jack Robinson became the first Australian to win the Margaret River Pro since 1989.