Time to Hedge our Forex Reserve Bets?

Is it still a smart move to pin our hopes on the stability of the U.S. economy? That’s essentially what we’re doing when we continue to use the U.S. dollar as our official reserve currency.

Using data from the Bank of Jamaica (BOJ), Trading Economics puts Jamaica’s foreign exchange reserves at a little over US$3.343 billion in May and anticipates they will be roughly US$3.45 billion in 12 months’ time. Looking even further ahead, their analysts expect the size of the country’s forex reserves to hit around US$3.6 billion in 2020. Whether these predictions pan out or not, isn’t it time for Jamaica to hedge its bets and diversify, spread the risk around a bit to offset volatility? Any individual or institutional investor understands the wisdom of this approach. And even the man on the street is familiar with the concept of not putting all his eggs in one basket.

For years, there have been rumblings about the need to have other options to the U.S. dollar as the premier global reserve currency, a position it has held since the world’s developed countries met at Bretton Woods, in 1994, to peg the exchange rate for all currencies to the greenback. Back then, the U.S. had the largest gold reserves, and this helped shaped the decision to have the dollar replace the British pound sterling as the global reserve currency. Today, the U.S. still has the most gold (over 8,000 tons were in its central bank vault as of June 2018) but is that really a good enough reason for Jamaicans to sleep soundly at night?

The alarm bells are becoming louder. In an August 9 article in the Jamaica Observer newspaper, BOJ Deputy Governor Natalie Haynes and National Commercial Bank Assistant General Manager Peter Higgins warned of the pitfalls of our heavy reliance on storing excess hard currency in U.S. dollars. The article points out that, with HSBC moving away from U.S. dollars in an effort to manage its risk, Bank of America (BOA) is now the only overseas bank where Jamaica’s local banks can store their excess U.S. currency. There is a dire warning from the BOJ’s Haynes that if BOA decides it will no longer accept our cash, Jamaica’s banking system would be paralyzed. Why give so much power to a country where the rules of the game are — under the current leadership — constantly being rewritten? President Donald Trump has not been shy in letting us know he is not above using the U.S. dollar as a tool in his various battles. In an August 8 tweet he criticized, yet again, his country’s Federal Reserve for what he sees as too-high interest rates that keep the dollar strong and put American manufacturers at a disadvantage as it makes their exported products more expensive.

This latest salvo was widely seen as a reaction to the weakening of the Chinese yuan, a move Beijing employed after Washington said it would slap $300 billion of Chinese goods with a 10 per cent tariff as of next month. But Trump began harping on the interest rate issue only a few months after he appointed Jay Powell as Fed chairman in early 2018 — and he hasn’t let it go since. He wants a weaker dollar. Whenever that happens it means Jamaica, and all the other countries that hold their reserves in U.S. dollars, loses money.

The Fed has so far staved off Trump’s attempts to guide its movements but why push our luck?

Isn’t it time to consider other options?

Source: IMF

The U.S. dollar is not the only game in town in the eyes of the IMF and other global organizations. Other possibilities include the euro, Japanese yen, Chinese yuan, British pound sterling and Canadian dollar, among others. But any currency that aspires to become the premier global reserve currency has to be able to offer what the U.S. dollar does… and more. It would need to be freely convertible (that rules out the Chinese yuan) and inspire confidence (this is where the euro runs into challenges as the Eurozone is still in limbo while Britain tries to unravel its Brexit mess). And while it is the “go-to” currency when all others are having convulsions (usually from the latest tweet), the yen, much like Japan’s leader Shinzo Abe, is still a bit of an unproven entity. The British pound and the Canadian dollar have long-term political stability and democratic rule on their side, but some argue that their financial markets have neither the depth nor liquidity for the job.

So where does that leave those looking for an alternative to the U.S.? Where else could Jamaica’s leaders put the country’s nest egg? Because that’s what the country’s forex reserves are, our rainy-day fund in case of emergency. It’s also a powerful tool in determining the value of the Jamaican dollar, and a healthy balance inspires international confidence in the country.

One argument that’s worthy of consideration is for us to keep our reserves in a combination of the world’s largest currencies, with each given a weight based on agreed-upon factors. A mixture of the euro, Canadian dollar and yen would be a good start. Other countries have, over the years, begun diversifying. For example, in July China’s State Administration of Foreign Exchange said it has adopted an “ultra risk averse strategy” in managing the country’s US$3.1 trillion in assets. According to Chinese academics, the country’s central bank has been strategically reducing the weighting of US dollars in its forex reserves while beefing up holdings of the euro and currencies of other major trading partners. Of course, this hasn’t gone down well with the U.S. which has for years reaped the benefits of its dollar being the premier global currency.

And even though the size of Jamaica’s reserves pales in comparison to that of China and other much larger and wealthier economies, any major policy shift, by the BOJ, to move away from our current unhealthy overreliance on the U.S. dollar will not go unnoticed by those in the White House. Not in today’s climate of winner takes all.

But just because something isn’t going to be easy doesn’t mean we shouldn’t try. We should not allow fear of failure to hold us back, especially if remaining where we are is so much worse. We know that Haynes and his colleagues at the BOJ are aware of the precarious position in which the country finds itself. The question is, what are they going to do about it?

By Claudia Clay

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