By the same author MONEY, HARD AND SOFT

Transcription

1 THE DOLLAR-MARK AXIS

2 By the same author MONEY, HARD AND SOFT

3 THE DOLLAR-MARK AXIS: ON CURRENCY POWER Brendan Brown

4 Brendan D. Brown 1979 Softcover reprint of the hardcover 1st edition All rights reserved. No part of this publication may be reproduced or transmitted, in any form or by any means, without permission First published 1979 by THE MACMILLAN PRESS LTD London and Basingstoke Associated companies in Delhi Dublin Hong Kong Johannesburg Lagos Melbourne New York Singapore Tokyo British Library Cataloguing in Publication Data Brown, Brendan The dollar-mark axis 1. International finance I. Title 332.4'5 HG3881 ISBN ISBN (ebook) DOI /

5 To Irene Brown

6 Contents List of Tables List of Figures Acknowledgements List of Abbreviations Introduction I. CURRENCY GEOGRAPHY I Freedom is not Independence I Valley of Ignorance I2 Currency Arithmetic I9 Currency Areas, Blocs and Zones 23 Currency and Physical Geography Compared MONEY POLYTHEISM 35 Exchange Rate Forecasting 36 Mushrooming Transaction Costs 40 In Search of a Standard 49 Dollar in Decline ALTERNATIVES TO THE DOLLAR 6I Growing Pains 62 Gold Renaissance 67 EEC Alternatives to the Dollar 74 Currency Anarchy 78 Political Risk TWO TIERS- AND A BLACK MARKET 87 Trading Banknotes 87 Two-tier Money 96 Luxembourg and Lichtenstein THE ILLIQUIDITY TRAP I06 Market Liquidity 106 vii ix X xi xii xiii

7 viii Contents Diversification in Market-Making 112 Satellite Market Formations 117 Chicago Bulls DOLLAR COMMONWEALTH 131 International Dimension of Dollar Growth 131 Alternatives to the Euro-Bank 135 Faults of Asymmetry 138 Euro-Armageddon 140 Index 147

8 List of Tables 1.1 Correlation Matrices 1.2 Manufactures Trade 1.3 Mark Zone Dominance 1.4 Real Effective Exchange Rate Changes 1.5 Declining Polar Power of British Pound 1.6 Public Bond Offerings 5.1 Open Interest by Maturity 6.1 Offshore Dollars in Europe IX

9 List of Figures I.I Exchange rate adjustment 8 I.2 Choosing the numeraire I5 I.3 Impact adjustment of current accounts to IO pu cent oil price increase 2I I.4 Impact excess demand for zonal currencies 22 I.5 Intra-zonal imbalance, subsequent to trans-zonal adjustment Components of SDR and EUA Speculative numeraires in commodity markets 55 3.I Dimensions of political risk 83 4.I Two-tier market matrix I 00 5.I Grading market liquidity I Satellite outright forward quotation I Market-making in spot, swap, forward-forward and outright forward markets I Market-making practices in near and distant forwards I24 X

10 Acknowledgements Many have spared graciously of their time to provide me with valuable insights into the functioning of markets described in this book. Robin Pringle allowed me to draw on part of my article of February 1978 in The Banker. Robert Aliber gave me the opportunity to present my analysis of zones at a conference at the University of Chicago. Leo Helzel supported enthusiastically my belief that a popular demand exists for study in international risk management. He both introduced me to foreign exchange dealers at The Bank of America in San Francisco, and promoted my work at Berkeley. Bankers in Amsterdam and Luxembourg discussed freely the mechanics of the international banknote market. Hali Edison made many helpful suggestions towards chapters l to 3, and gave numerical assistance. The American Express International Banking Corporation accommodated my research. As with Money, Hard and Soft, this book owes its creation to the joint partnership of my mother, Irene Brown. xi

11 List of Abbreviations CD CME Com ex Om EEC EUA GNMA GNP IMF IMM LDC LME OPEC SDR Sw. fr. T-Bill UK us Certificate of deposit Chicago Mercantile Exchange New York Commodity Exchange Deutsche mark European Economic Community European Unit of Account Government National Mortgage Association Certificate Gross National Product International Monetary Fund Chicago International Monetary Market Less developed country London Metal Exchange Organization of Petroleum Exporting Countries Special Drawing Right Swiss franc Treasury Bill United Kingdom United States xii

12 In trod ucti on The myth of Sisyphus is a parable about futility. Sisyphus was condemned by the Gods to push a heavy stone to the top of a mountain. He knew that when it reached the top it would fall to the bottom, and then his labours would recommence. Political initiatives in currency markets are futile if they amount to much more than an official stamp on developments that are rooted in the marketplace and the behaviour of transactors there. The future of the US dollar and how to create a zone of currency stability within Western Europe were the focal points of international monetary cooperation in the late 1970s. In The Dollar-Mark Axis it is shown how both problems were being resolved already by natural evolutionary forces in the world's money marketplaces. In a free currency market, unscarred by central bank intervention, the West European currencies would have tended to float together against outsiders. Diminishing international use of the dollar as a unit of account was not in itself destabilising, so long as the switch to other monies was symmetric for borrowers and lenders. Dollar universalism of the 1950s and 1960s was succeeded by bipolarism. Swings in the mighty dollar-mark axis cause orbital currencies to the dollar and mark to rotate also, although to a lesser degree. The Dollar- Mark Axis studies how currencies move in a bi-polar world. In chapter I, the currency map is drawn, and the workings of axis power demonstrated. In chapter 2, the implications of zonal motion both for borrowing and lending decisions internationally are explored. The secret of dollar-mark axis power is the issuance of the two major international monies- the US dollar and Deutsche mark- by the largest economy in two different trade blocs. Chapter 3 depicts a kaleidoscope of the polar relationships that would exist if the dollar or mark were to be displaced by another smaller currency at one end of the axis. Could the Swiss franc, for example, become polar inside Europe? In reaching an answer, the comparative advantage of large relative to small economies in issuing an international money must be assessed. Paper monies are creatures of governments, which are rarely well xiii

13 xiv Introduction disposed to principles of free trade. Unrestricted tradability in paper monies has proved exceptional. Throughout the late 1970s, international use of both the Swiss franc and the Deutsche mark was cramped by central bank policies. Two-tiered credit and exchange markets, with the inevitably associated black market, are the subject of chapter 4. Transaction cost considerations are the basis of many judgements made by operators in financial markets. The role of the market-maker in reducing transaction costs and promoting liquidity is examined in many different markets in chapter 5. The large share of the US in world trade and investment assures a high level of liquidity in dollar denominated markets. Innovations in liquidity creation, with special reference to the new currency and financial futures markets in Chicago, are studied. Too often freely floating currencies have been attacked at a macro-level for leading to high transaction costs and hampering international trade. In reality, at a micro-level, skilful design of markets and instruments can increase liquidity, just as engineering skill can reduce frictional costs in transportation. In the late 1970s, a great expansion occurred in the international use of money. Less developed countries (LDCs) and other sovereign borrowers increasingly used the euromarkets as a source of financing. OPEC and tax refuge money had no natural currency home and were deployed in the four major international monies~ dollars, marks, Swiss francs, and gold. The euro-banking industry grew very fast to service the expanding commonwealth of users of these monies. It has become anachronistic to discuss monetary policy solely in terms of national demand and supply for money in countries whose issue is used widely beyond the national frontier. In chapter 6, a synthesis is presented of national and euro monetary analysis. The Dollar-Mark Axis is a companion volume to my earlier book, Money, Hard and Soft (Macmillan, 1978). Although both form part of a whole study, they can be read and understood separately. Both volumes share a scepticism of currency politics and are concerned rather with the science of money market structure. How should the investor or borrower choose between competing international monies, and how can each reduce systematically their transaction costs? International currency history is still short. In the twentieth century we have seen the world's first international paper money- sterlingreturn to performing only domestic functions. Is it now inevitable that the US dollar will follow the same course, and is the Deutsche mark the dollar's probable successor? Or have we entered an age in which no one

14 Introduction international money will be predominant? The answers must involve determining the bases of a currency's power to attract users worldwide. Currency power is the subject of The Dollar-Mark Axis. XV Brendan Brown January 1979