What doesn’t destroy me makes me stronger.
It’s said of many things, but it seems especially true of the U.S. dollar since the financial crisis. The crisis began in the U.S. with toxic subprime mortgages but after the dust settled, the U.S. dollar emerged as an even more dominant currency.
That is the view of Poets&Quants’ Professor of the Week, Brent Neiman of the University of Chicago Booth School of Business, in three recent papers he wrote with Matteo Maggiori, now of the Graduate School of Business at Stanford University, and Jesse M. Schreger of Columbia Business School. (One paper was co-authored with Andrew Lilley, a Ph.D. candidate at Harvard University.)
”Over the last decade, use of the dollar to denominate globally traded assets has significantly expanded, and it has done so at the cost of the euro,” the researchers write. “The U.S. dollar appears today to be the world’s only international currency.” (The British pound and Chinese yuan have gained some ground over the last ten years, but they still have only small shares of the international currency market.)
THE GREENBACK HAS GONE FROM STRENGTH TO STRENGTH
Neiman and his co-authors observed this shift in several areas: global capital flows, ownership of dollar-denominated assets, and as a barometer of investors’ appetite for risk. But whatever measure they used, the greenback has gone from strength to strength while the euro has weakened. In 2005, the researchers report, 41% of global holdings of cross-border debt was denominated in dollars, while 38% was in euros. Since the crisis, “the euro’s share rapidly declined to 22 percent, while the dollar’s share rose to 63 percent.”
Also, after the financial crisis, “international bond portfolios exhibited a dramatic shift away from the euro and into the dollar,” Neiman and his co-authors write. “There has been a broad reconnect of exchange rates with capital flows emanating from the U.S. and…these flows strongly co-move with U.S. investors’ risk-bearing capacity.”
In other words, dollar-denominated assets (particularly U.S. Treasuries and investment-grade corporate bonds) have become “safe havens” to which investors flee when market or geopolitical risk rises. “Several proxies for global risk factors also start to co-move strongly with the dollar and with U.S. purchases of foreign bonds around 2007, suggesting that risk plays a key role in this finding,” the researchers write.
U.S. COMPANIES APPEAR UNIQUELY ABLE TO BORROW FROM FOREIGNERS
Why has this happened? One reason is that U.S. corporations, the authors write, “appear uniquely able to borrow from foreigners even without issuing foreign currency bonds.”
Meanwhile, debt crises wracked European countries like Greece and Portugal early in the decade, putting the whole euro project in jeopardy. “Borrowers and lenders alike might, on the margin, prefer to avoid a currency the value of which – and, even, the mere existence of which – might be in question during the next crisis,” Neiman and his co-workers observe.
But as the euro faltered, the dollar passed its trial by fire. “Dollar-denominated assets performed well precisely when such performance was most highly valued, a key feature of an international currency,” the researchers note.
PAYING NEGATIVE INTEREST RATES
When the financial crisis hit, few would have predicted a resurgent U.S. dollar. Back then, hard-money conservatives warned about the vulnerability of “fiat” currencies, particularly the dollar, and urged investors to load up on gold.
But now the “fiat” dollar looks stronger than ever, particularly since some $15 trillion worth of non-U.S. debt is paying negative interest rates. Neiman and his co-authors quote Ethan Ilzetski of the London School of Economics and Carmen M. Reinhart and Ken Rogoff of Harvard, who said in a recent paper that “the dollar is as dominant today … as it was at the time of the early Bretton Woods era.”
Neiman, 42, is the Edward Eagle Brown Professor of Economics at Chicago Booth, endowed by a former banker who was a delegate at the 1944 Breton Woods conference that created the International Monetary Fund and the World Bank. Previous occupants of the endowed chair included Nobel Prize winners Merton Miller and Myron Scholes.
TEACHES CLASSES ON INTERNATIONAL FINANCE POLICY
Neiman’s research focuses on international finance and trade. He teaches classes on international finance policy to MBAs and global strategy and economics to executive MBAs. Having earned bachelor’s degrees in economics and engineering from the University of Pennsylvania, he got his master’s in mathematical modeling from Oxford University and his Ph.D. in economics from Harvard. He previously worked at McKinsey & Company and as a staff economist at the President’s Council of Economic Advisers. He has been at Booth since 2008.
Howard R. Gold is a contributing writer to Poets&Quants and a columnist for MarketWatch. His work has appeared in Forbes, Barron’s, Money and USAToday. He also writes for Chicago Booth Review and Chicago Booth magazine, though Professor of the Week gives Booth the same coverage as other leading business schools. Follow him on Twitter @howardrgold.