The focus of ‘The Dollar and Its Discontents’ by Olivier Jeanne () is on the performance of the dollar as a store of value. The author is of the view that, for countries that accumulate international reserves through the current account (through trade surpluses), the appropriate way of assessing how well the dollar does as a store of value is by looking at the real return that the countries have received on their dollar reserves in terms of their own consumption. And, measuring the return on dollar reserves in this way, he notes that it was indeed very low and is likely to continue to be low in the future.
For example, the consumption-based cumulated return that China received on its dollar reserves in the 2000s was negative, and equal to minus 17 per cent, the paper reports. “That is, by investing the equivalent of 100 units of Chinese consumption in US Treasury bills at the beginning of 2000 and rolling over this position for ten years, the Chinese authorities were left with enough dollars to buy 100-17=83 units of Chinese consumption at the end of 2010.”
If that is grim, what follows can be grimmer: That ‘the consumption-based return on dollar reserves was even lower for the other BRIC countries (Brazil, India and Russia).’ These low consumption-based returns, as Jeanne explains, are due to the fact that the currencies of those countries have appreciated in real terms relative to the dollar. The author suggests that there is a kind of “saver’s curse” in international finance: “Countries that accumulate more net foreign assets also tend, in equilibrium, to have a lower consumption-based return on those assets.”
Wish our central banker told us in plain English whether we have enough of the right value in store!
Exchange rate risks
What can happen if you involve non-finance departments in the management of exchange rate risks? An increase in speculation, cautions a recent research paper titled, ‘Corporate foreign exchange speculation and integrated risk management’ by Tom Aabo, Marianna Andryeyeva Hansen, Christos Pantzalis ().
Based on a study of non-financial firms in Denmark, the authors find that the more non-finance departments are involved in the management of exchange rate risks, the more the firm speculates both in terms of selective hedging and in terms of active speculation. “These findings are particularly interesting given the trend towards a more integrated risk management perspective in which risks are managed across the firm and several departments are involved as opposed to the more traditional silo-based risk management isolated to specific departments.”
Following Smith (1776), the authors expect speculation in non-financial firms to be primarily driven by an irrational belief in a comparative information advantage and in good luck. The question they phrase is whether such an irrational belief will be strongest among ‘experts’ in the finance departments or among ‘non-experts’ in the non-finance departments.
The alternative lines of reasoning mentioned in the paper are as follows: One, the experts in the finance department in fact believe that they are ‘experts with a comparative information advantage as opposed to the non-experts in non-finance departments who know little about foreign exchange markets.’ And, the alternative line of reasoning is that the experts in the finance departments actually realise that they do not have superior information but the non-experts in the non-finance departments do not realise their own limitations…
Topical read for finance professionals.