"Global Liquidity and Procyclicality"
A stronger US dollar is putting strains on global financial markets and the banking system, leading to tensions not only in emerging market economies, but in “safe haven” currencies such as the Japanese yen and the Swiss franc.
One intriguing development has been the breakdown of covered interest parity (CIP), which ensures that interest rates implicit in currency markets are consistent with those in money markets. CIP broke down during the financial crisis, and deviations have reappeared in the last two years, with the size of the deviations fluctuating in step with a stronger dollar.
The breakdown reflects, in part, the tensions created by the divergence of monetary policy among major central banks and the withdrawal of easy dollar credit conditions that prevailed after the financial crisis, all in the context of the dollar’s special role in the global financial system. As the dollar has strengthened, investors have found it harder to roll over hedges put it place when the US currency was depreciating and investors were borrowing more in dollars to take advantage of low interest rates.
BIS data show that the euro and the yen may be starting to take on the features of an international funding currency, following in the footsteps of the dollar.
About our speaker
Hyun Song Shin is Economic Adviser and Head of Research at the Bank for International Settlements. Before joining the BIS, he was the Hughes-Rogers Professor of Economics at Princeton University. In 2010, he served as Senior Adviser to the Korean president, taking a leading role in formulating financial stability policy in Korea and developing the agenda for the G20 during Korea’s presidency. From 2000 to 2005, he was Professor of Finance at the London School of Economics. He holds a DPhil and MPhil in Economics from Oxford University (Nuffield College) and a BA in Philosophy, Politics and Economics from the same university.