All speeches are available online at www.bankofengland.co.uk/news/speeches
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Third, a growing asymmetry at the heart of the IMFS is putting the global economy under increasing strain.
Huge network effects mean the dollar has remained dominant in the IMFS despite the transformation of the
global economy. At the time of the Latin American debt crisis, EMEs made up a little more than one third of
global GDP. Since the last Fed tightening cycle, their share of global activity had risen from around 45% to
60%. By 2030, it is projected to rise to around three quarters.
As well as being the dominant currency for the invoicing and settling of international trade, the US dollar is
the currency of choice for securities issuance and holdings, and reserves of the official sector. Two-thirds of
both global securities issuance and official foreign-exchange reserves are denominated in dollars.
12
The
same proportion of EME foreign currency external debt is denominated in dollars
13
and the dollar serves as
the monetary anchor in countries accounting for two thirds of global GDP.
14
The US dollar’s widespread use in trade invoicing and its increasing prominence in global banking and
finance are mutually reinforcing. With large volumes of trade being invoiced and paid for in dollars, it makes
sense to hold dollar-denominated assets. Increased demand for dollar assets lowers their return, creating an
incentive for firms to borrow in dollars. The liquidity and safety properties encourage this further.
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In turn,
companies with dollar-denominated liabilities have an incentive to invoice in dollars, to reduce the currency
mismatch between their revenues and liabilities. More dollar issuance by non-financial companies and more
dollar funding for local banks makes it wise for central banks to accumulate some dollar reserves.
Given the widespread dominance of the dollar in cross border claims, it is not surprising that developments in
the US economy, by affecting the dollar exchange rate, can have large spillover effects to the rest of the
world via asset markets. As Hélène Rey has put it,
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and as Arvind Krisnamurthy and Hanno Lustig echo in
their paper for this symposium, the global financial cycle is a dollar cycle.
In part, that arises because movements in the US dollar significantly affect the real burden of debt for those
companies (especially in EMEs) that have borrowed unhedged in dollars, and tend to reduce the dollar value
of companies’ collateral.
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Both result in tighter credit conditions and, in the extreme, defaults.
Fluctuations in the dollar also significantly affect the risk appetite of global investors. As discussed by
Şebnem Kalemli-Özcan earlier today, these risk spillovers can have a significant impact on receiving
economies, especially in EMEs where global risk perceptions interact with country-specific risks.
For EMEs, this manifests in volatile capital flows that amplify domestic imbalances and leave them more
vulnerable to foreign shocks (Charts 3 and 4). One fifth of all surges in capital flows to EMEs have ended in
financial crises, and EMEs are at least three times more likely to experience a financial crisis after capital
flow surges than in normal times.
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While the typical EME receiving higher capital inflows will grow 0.3
12
Gopinath, G and Stein, JC (2018), ‘Banking, Trade, and the Making of a Dominant Currency’, Working paper, Harvard University. The
euro is in second place at 20% and the yen is in third at 4% (ECB Staff (2017)).
13
Gourinchas, P, Rey, H Sauzet, M (2019), ‘The International Monetary and Financial System’, NBER Working Paper No. 25782.
14
Ilzetzki, E, Reinhart, C and Rogoff, K (2017), ‘Exchange arrangements entering the 21
st
Century: Which anchor will hold?’,
forthcoming in the Quarterly Journal of Economics.
15
See Krugman (1980).
16
Rey, H. (2013). "Dilemma not trilemma: the global cycle and monetary policy independence," Proceedings - Economic Policy
Symposium - Jackson Hole, Federal Reserve Bank of Kansas City.
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Reflecting the fact that most of the assets of EME companies are priced in local currency. See Bruno, V and Shin, HS (2015), ‘Cross-
Border Banking and Global Liquidity’, Review of Economic Studies, Oxford University Press, Vol. 82(2), pp. 535-564 and Cesa-Bianchi,
Ferrero, Rebucci (2018), ‘International Credit Supply Shocks’, Journal of International Economics, Vol. 112, 2018, pp. 219- 237.
18
Ghosh, AR, Ostry, JD, and Qureshi, M (2016), ‘When do capital inflows surges end in tears?’, American Economic Review. Surges
are defined as a net capital flow observation that lie in the top thirtieth percentile of both the country-specific and the full sample’s
distribution of net capital flows, expressed in percent of GDP.