Foreign Exchange Trading: 2019 Edition

Every so often, new data provide us a glimpse of parts of the world that few people ever see. Last week, the BIS’s Triennial Central Bank Survey of Foreign Exchange and Over-the-counter (OTC) Derivatives Markets in 2019 provided just such a view. The headline is that average daily foreign exchange (FX) turnover, adjusted for double counting, is $6.6 trillion per day. That is, nearly 8% of global GDP changes hands in FX markets every day! (For a summary, you can listen here.)

Numbers of this magnitude raise a host of questions. In this post, we explore three: first, who is shifting such large volumes of currency around, and what motivates them? Second, history teaches us that disruptions in FX markets can destabilize the broader financial system: are there signs of emerging risks? Finally, what do we learn about the relative position of the U.S. dollar?

To anticipate our conclusions, the fraction of trading involving nonfinancial entities is relatively small, so the bulk of these transactions (like those in most financial markets) are between intermediaries. In addition, there are hints of growing systemic risk in the FX settlement system, so we need to remain attentive. Finally, no other currency is threatening the dominance of the U.S. dollar—at least, not yet….

Brexit Stress Test

The U.K. Brexit referendum is providing us with the first significant test of our sparkling new regulatory system. Everyone knew about the referendum months in advance, giving them plenty of time to prepare. Yet, we are left with some fundamental questions related to global financial stability. Do banks have sufficient capital and liquidity to withstand the “shock?” Will financial markets continue to serve their key functions? Or, is the financial system only as strong as its weakest link? Will turmoil once again prompt liability holders to run, triggering asset fire sales, and compelling central banks once again to do whatever it takes to keep avert a meltdown?

As the rating agencies might say, we are on “stress watch” with a negative outlook. Or, to mix metaphors, numerous lights are flashing yellow, so we are worried...

Global Finance Requires More Global Cooperation

“We have listened to the wisdom of an old Russian maxim, doveryai, no proveryai—trust, but verify.” President Ronald Reagan at the signing of the INF Treaty, December 8, 1987.

In July 2010, central bank governors and supervisors from the 28 jurisdictions that make up the Basel Committee membership were hammering out the agreement on new capital and liquidity requirements now known as Basel III. There was a large sticking point. Some members were standing firm on their desire to have higher capital requirements. Others felt that this would make credit more expensive and less plentiful.

Had agreement not been reached, those insisting on more capital might have said: “Go ahead, be permissive. But if you let your banks operate with low levels of capital, we’ll restrict our banks from doing business with them.” Fortunately, it didn’t come to that....

AIIB: The first international financial institution of the 21st century

In 1945, a group of 43 nations led by the United States, then the world’s dominant economic power, created the International Bank for Reconstruction and Development (now part of the World Bank Group) and the International Monetary Fund – the “Bretton Woods institutions” – to promote reconstruction after World War II. However, the global economy has evolved much faster than the operations of either the Bretton Woods institutions or some of their regional siblings like the Asian Development Bank (ADB), the African Development Bank (AfDB), the Inter-American Development Bank (IDB), and the European Bank for Reconstruction and Development (EBRD).

What happens when official international financial institutions (IFIs) fail to respond to a changing environment? The same thing that happens to firms that stop innovating. New, more competitive institutions (firms) arise that compel them to change or – like dinosaurs – become extinct. We may be witnessing this process of creative destruction right now. Last month, a group of 57 founding nations led by China signed the articles of agreement to establish the Asian Infrastructure Investment Bank (AIIB) with an initial subscribed capital of $100 billion…

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Money, Banking, and Financial Markets