Last week, I argued that the emerging world’s governments have been provided the US with an enormous credit line – one large enough to prop the dollar up – even in the absence of any formal institutions to help coordinate their actions. This credit line has even been increased as the United States financing need increased – largely because falls in private financing to the US translated into increased intervention by central banks unwilling to allow appreciation against the dollar. A desire not to appreciate (by too much) against the RMB, together with policy inertia in the Gulf, substituted for formal coordination.
But that doesn’t mean that the existing system hasn’t given rise to some coordination failures. I want to highlight two –
A lack of coordination between central banks and sovereign wealth funds inside a de facto currency union. This coordination failure effectively shifts unwanted dollar exposure – as the core issue facing the global financial system is who holds the unwanted exposure to a depreciating dollar and the resulting losses (see Barry Eichengreen's 2004 paper) – from a country’s sovereign wealth fund to its central bank.
And a lack of coordination across countries that may have allowed some Gulf countries with sovereign wealth funds to shift exposure to the dollar to emerging Asian economies reluctant to allow their currencies to appreciate against the RMB.
Both arguments are a bit speculative. Absent detailed information about the portfolios of the GCC investment funds and emerging Asian central banks, I cannot prove either argument. I still suspect both are potentially real issues.
First, the lack of coordination between a region’s sovereign wealth fund and its central bank.