25th Annual Financial Markets Conference - Rewiring for Resilience in an Evolving Financial Network - Policy Session 2 Transcript - May 17–19, 2020

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May 17–18, 2021
Virtual

Policy Session 2: Is the Financial System's Backbone, the U.S. Dollar, Also a Transmitter of Stress?

The limited scope for reducing policy rates over the last decade has induced central banks to place increased reliance on balance sheet policy, which raises a variety of underexplored topics.

Transcript

Robert Kaplan: Good morning. I'm Rob Kaplan. I'm the President and CEO of the Federal Reserve Bank of Dallas. The theme of this session: Is the Financial System's Backbone, the U.S. Dollar, Also a Transmitter of Stress?

We've got a very distinguished panel. First, we're going to hear a presentation on this topic from Arvind Krishnamurthy, who is the John S. Osterweis Professor of Finance at the Stanford Graduate School of Business, and also Research Associate at the National Bureau of Economic Research. After Dr. Krishnamurthy makes his presentation, we will hear from a first discussant, Thomas Jordan, who is the chairman of the governing board of the Swiss National Bank. Then we will hear a second discussant, Michael Howell, who is the founder and managing director of CrossBorder Capital. Then, we're going to do a moderated Q&A, and we look very much forward to hearing your questions.

Let me just make a few opening remarks to set the stage before I turn it over to Professor Krishnamurthy. The central role of the U.S. dollar in the international financial system was highlighted by the global scramble for dollars in March 2020. This reliance on the dollar provides some significant efficiencies during normal times, but also can mean stresses in the U.S. dollar can have a global impact.

Just by way of context, I don't need to tell you the U.S. dollar is the world's dominant currency. It's estimated it accounts for roughly 40 percent of world trade, even though the U.S. is a counterparty for only about 10 percent of world trade. International firms issue debt in dollars in order to tap world markets. The value of U.S. dollars in banks outside the United States is nearly equal to the asset value of the entire U.S. banking system. The dollar is the world's reserve currency, and central banks around the world hold dollars in insurance to stabilize their economies in times of crisis—and approximately 40 percent of U.S. government debt is held by foreigners.

This dollar dominance leads to the term the U.S.' "exorbitant privilege"—in that the U.S. is able to borrow cheaply from the rest of the world, and as a result of that it really accords some enormous benefits to the United States. What explains the dollar's dominance? What makes the dollar a U.S. safe haven? Why do foreign investors pay more for U.S. dollars (what Dr. Krishnamurthy refers to as the "convenience yield")? Why does this premium on U.S. dollars increase in times of crisis?

A couple of other questions that I'm sure we'll cover today are: Will the fiscal position of the United States change investors' perceptions about the safety of U.S. assets and impact U.S. dollar dominance? And if this were to happen, where else would people go? The dollar, really, at the moment has no other imminent rival. There are issues around the world that would limit the ability for this to happen, but technology and evolution of economies around the world in the years ahead could affect this.

So, these and many other questions we are going to talk about today; and with that, let me turn it over to Professor Krishnamurthy.

Arvind Krishnamurthy: OK, thank you, President Kaplan, for the introduction actually laying out those issues which is what I'm going to get into. Thank you also to the Atlanta Fed for having me here. I'm just going to start my share screen. OK, so hopefully that's good for everyone to see.

I want to just jump right in and talk, really about three things: just walk you through a little bit of data on the features of the dollar-centric, international financial monetary system we live in, then talk a little bit about how the dollar being central has had implications both for macroeconomic firms in the U.S. as well as for what Hélène Rey and others referred to as "the global financial cycle." Last, and perhaps more speculatively, I'd like to talk a little bit about the factors that are underlying the world's dollar equilibrium and maybe looking forward to the future, thinking about possible challenges to the dollar's centrality.

With that, let me just go into some data. President Kaplan made this point but it's a remarkable point and just worth noting: the dollar is the dominant currency in invoicing of world trade. Look, for example, at this left panel here; the bar chart here is the fraction of world trade that involves the U.S., which is about 10 percent. The right panel, the right bar chart here, is the fraction of world trade in which the currency used in a particular trade contract is the dollar (or another currency).

What you observe is that the dollar is a much larger share of invoicing of imports and exports than it is in actual trade. What that means is that, for example, there's a lot of trade that is happening between two economies—in which the U.S. is not one—in which the invoicing is done in dollars.

These pictures are from Gita Gopinath's Jackson Hole paper from a few years ago. I should say that in all of the slides that I go through references are at the end of this slide deck.

The same pattern of dominance in trade is also true in banking if you look outside the U.S. You know that banks outside the U.S. take dollar deposits and make dollar loans. it's just worth noting how big the size of that banking system is. The "outside U.S." banking system is on the order of loans and deposits $13 [trillion] and $12 trillion. A very large number, particularly commensurate to the other major international currencies, the euro and the yen. The U.S. dominates in terms of world finance.

This dollar financing dominance is not just true in banking. It's also true in the corporate bond market. You see the same type of patterns when you look at choice of denomination of currency in corporate debt issues for multinationals. A multinational will issue in its own local currency but will often also tap the dollar bond.

This third chart is from some of my own work, just documenting funding advantages to being able to issue in dollars. Look in particular at the black line. Here, the black line traces what's known as the Treasury basis. What is the Treasury basis? It's the yield on a one-year U.S. dollar Treasury, so the one-year Treasury bond, minus the yield on a foreign G10 bond. Think, for example, of a Canadian government bond, one-year, that is swapped into dollars using a foreign exchange hedge.

Consider the cost of that so that you have effectively converted the Canadian dollar bond into a dollar bond and compare that yield to the U.S. dollar bond. What you observe is that the black line is consistently negative, which is to say that the U.S. dollar, U.S. Treasury bond, has a yield that's lower than its counterparts in other G10 countries on a swap basis. That number is, on average, about 20 basis points. My work on this shows that that 20 basis points is actually a sliver of a bigger funding advantage—which really is about 1-2 percent, based upon econometric analysis, so there's a significant funding advantage.

The funding advantage goes up during times of financial crises, so the black line here, for example, drops to near -1 percent. While this graph ends in 2017, if you look at the COVID period last March you would see the same pattern where the black line goes negative. That's a U.S. Treasury, U.S. government funding advantage. The same is true of private assets. The blue line is the LIBOR basis, so the same thing for LIBOR rates, which are bank deposit rates. And you see the same pattern, not quite as pronounced as for Treasuries, but the same pattern applies out in LIBOR.

Then on the right graph, this is the same graph for corporate bonds, particularly high-grade, safe corporate bonds, you see the same pattern. It's particularly true for short-maturity, high-grade corporate bonds. What that tells us is that there's a funding advantage: a lower yield, if you are a high-grade issuer who can issue dollar bonds.

Let me just put this together and talk about what it is that's driving the world equilibrium which we're seeing. The way I think about this is that dollars, or more precisely safe dollar assets, are world money. That is to say, within any country there's a demand for money that shows up in bank deposits, in money market funds, in commercial paper, and in Treasury bills. That's true within any country, and within every country. Across the globe, that money demand particularly centers on the dollar.

So, there's a demand to hold particularly safe dollar bonds, Treasury bills, bank deposits, et cetera. What that does is drive down the yields on these safe, dollar-denominated bonds that I just went through. The pattern of finance is really just a reflection of this. Banks, firms, and governments tap into this demand. There's a ready supply of dollars available in cheap funding, so everyone in the world is essentially tilting their borrowing positions towards issuing particularly dollars because of these convenience yields on dollar bonds, and less so towards euro and yen.

To link this back to the trade pattern that I showed you: trade, particularly that relies on trade finance, so, exporters and importers rely on trade finance, and there's an ample supply of dollar finance. Dollar funding is cheap for banks, so likewise dollar lending in trade finance will be cheap, in particular, from dollars. That means that if I'm an exporter and I'm borrowing in dollars, it makes sense for me to invoice in dollars in order to reduce my currency mismatch. In my mind, that ties together the patterns in finance and trade. What it tells you, really, is at the center of this is a demand for safe dollar bonds.

The macro implications of this: the fact that dollar funding is cheap basically means that dollar leverage is cheap, and so that's going to induce, within the U.S., inherently higher leverage and potentially a leverage cycle. This, for example, is an argument that's been made by [former Fed Chair Ben] Bernanke in the savings glut argument, as well as by Ricardo Caballero and others, in how global imbalances have translated into high leverage in the U.S. and potentially drove the mortgage boom in early 2008.

I want to talk about the international dimension of this, which is that the same factor—that dollar leverage is cheap—also means that entities around the world will also find it advantageous to issue in dollars. Inherently, because a non-U.S. issuer is going to be currency mismatched, that's going to induce currency mismatch around the world. High dollar leverage is going to translate into high currency mismatch around the world, and that is the pattern of the global financial cycle.

The global financial cycle is this co-movement in prices and credit terms, in particular across the country. It is very closely tied to patterns in the dollar exchange rate and the cost of dollar credit. That's not a surprise. If the world is dollar-biased, in credit terms, then tightening on dollar credits, say, when the Fed raises interest rates, will spill over to the rest of the world. A dollar appreciation, as often happens during a financial crisis or during a downturn, will hit currency mismatch borrowers and transmit stresses across the system.

To fill in on this last point a bit more: During a global crisis, the Fed effectively ends up being the central bank to the world. That is, the prevalence of dollar credit around the world puts the Fed in a unique position. The way I think about this is, during a crisis there's a flight to the dollar. Treasury yields fall, the dollar appreciates; that's effectively an expansion of balance sheet space for the Fed.

One way of thinking about the dollar swap lines that the Fed extends to the rest of the world is it's recycling. Some of these flow back into the rest of the world in expanding swap lines. What that effectively is doing is acting as a lender of last resort that's allowing the rollover of dollar debt to be easier. I know that President Jordan will say a bit more about this.

The patterns I've talked about are ones that have really been strengthening over the last few decades. One way of understanding this is that money demand, this demand for dollars in the world, is really growing in proportion to world GDP, whereas U.S. GDP, as a share of world GDP, has been shrinking. What the world has been doing over the last several decades is concentrating this demand into a dollar market, that as a fraction of the world has actually been shrinking; and what that means is that some of these cycle patterns have been strengthening as we've gone forward.

So that begs the next question, which is: What about the next few decades? Is something likely to change? And what might change? To try to make some headway on this, I think one needs to step back and try to understand, what is it that underlies the equilibrium that we observe in the world? What's the deep force that has made the dollar the central world money?

Let me just say a little bit about history. The history of the world on this dimension has just a little bit of variation. The sterling used to be the reserve currency of the world, until about World War I, and possibly the introduction of the Federal Reserve in 1913. The interwar period perhaps has two reserve currencies. Bretton Woods puts the dollar du jour as the central currency of the world. In the early '70s, when we go off Bretton Woods, we go through a period of some instability. What has developed and is now de facto, that is, as a natural phenomenon, is that the dollar has been the reserve currency of the world for the last several decades.

It's worth noting that this is a natural phenomenon. We've settled on one, perhaps two in some periods, of currency. That's an important observation, because if you think about portfolio theory it would suggest that what you'd like is a basket of currencies for diversification purposes. I make that point because what it tells you is that this reserve currency phenomenon is one that, at heart, is about complementarities. That is, to some extent I drive on the right side of the road because everybody else is driving on the right side of the road. We use dollars because everybody else is using dollars.

So, the central research question is: What are the economic factors that are driving complementarities in the choice of the dollar? I'd say this is a very active research question right now, and I'll give you my top sense. Broadly speaking there are two places one can look for complementarities. One is in financial markets, and the other is in goods markets. My own view of the world, and I can say more about this, is that the central complementarities that drive the dollar reserve currency are in financial markets.

Let me just say a bit more about that. I think of the U.S. being the reserve currency as akin to the U.S. providing a parking structure to the world. The world needs to park dollars, park money, assets, in safe places for periods of time that they can get in and take out. It's like the U.S. is running a very large parking structure that allows investors around the world to park money, and then pull out money when they need to. What's the precondition for that? Well, you need a very large parking structure in order to accommodate all of the demands of the world.

If you imagine, for instance, that the Canadian dollar was the reserve currency of the world, the parking structure would be too small. There isn't the size, absolute size of the economy, to support the large float that's necessary to be a reserve currency of the world. I think, in my mind, that's a central factor for why the U.S. has been the reserve currency of the world over the last couple of decades. That draws in buyers and sellers, enhancing the liquidity of safe dollar claims, actually, also enhancing the safety of these claims, which then feeds back via complementarities.

For example, equilibrium outcomes reinforced the dollar equilibrium as people pull in. The financial markets in the U.S. are very well developed, which at the margin pulls people in. It enhances liquidity, repo, securitization, payment systems. All of that enhances this and increases the complementarity of the dollar choice. The dollar is a hedge. It appreciates in times of a global crisis. What that means is, ex ante, you want to hold dollars because it's the asset that will appreciate in a time of crisis, which, again, is a complimentary force.

On the goods market side, as I talk through, firms will invoice in dollars because financing in dollars is cheap. If my costs are in dollars, I'm going to charge in dollars, but that means somebody else's costs are in dollars, and now you see that an ecosystem can develop by a complementarity in dollars as well.

Those are our equilibrium outcomes that enhance the dollar choice. There are also deliberate policy choices that enhance the dollar equilibrium. For example, the U.S. has a very open capital account. The parking structure in the U.S. is large, it's easy to get into, and it's easy to get out of. That is an important component of what has rendered the U.S. being central to all of this. I talked about the Fed swap lines. That effectively has made an issuer of short-term debt more willing to issue dollar bonds, because the Fed's lender of last resort capacity and swap lines are extended to other issuers, so that you bring in borrowers into the U.S. ecosystem.

I could go on and talk about other policy choices here. These are just a couple of the important ones. To go forward on this, what might it take to dethrone the dollar? As I've talked through this, one thing that should be clear is you need a large income base to back the substantial quantity of safe assets. That's a necessary condition to be the reserve currency, really, any crypto model is too small. If I think about the last couple decades, the euro area looked like a potential challenger. Some of the patterns that I talked you through in trade and finance were strengthening until the financial crises of a decade ago. In particular, with regards to the euro, that all has gone backwards, so the last decade has seen, in many ways, a strengthening of the dollar in those trade and financing patterns.

Then of course, going forward there's another question. Could another country take its place? Maybe the euro area, maybe another country like China. It's worth noting that for a switch to happen, and really, we've seen one switch historically, the U.S. to UK switch. It's just worth noting that U.S. GDP was larger than UK GDP late into the 1800s, and yet the UK remained the reserved currency. So these things switch slowly, and in my mind, the way the switch happened was that the U.S. on the one hand developed a financial market and developed a stock of safe assets that allowed it potentially to be a reserve currency in the early 1900s, the creation of the Federal Reserve being an important one, and at the same time the two World Wars left UK finances in shambles, which made them relatively less safe. That allowed the dollar to step in to become the reserve currency, post-war.

What could happen in the future? U.S. budgetary forecasts do undercut that, and it makes you worry about whether something similar will happen going forward. I mentioned openness to capital flows. I think you need to be investible. The parking structure needs to be open. The U.S. financial system has an open capital market that allows flows in and out. In comparison, China at present is not much investible. So potentially a big economic base but not yet a big financial base, and that seems important going forward.

I'll say just two last things, particularly about digital currency because that's been in the news recently. How does digital currency fit into this? I view digital currency as just one piece of an element that makes your financial system. In many countries, especially, let's just think, for example, about an emerging market that wants to create a local digital currency. It's a defensive move that's trying to keep the dollar at bay. My understanding of China is that this is, to some extent, about domestic policy objectives with the domestic banking system in China, but it's also keeping the dollar at bay rather than necessarily expanding the reach of the renminbi.

For example, if the U.S. was to introduce a digital currency, that would expand the footprint of the dollar. And there are other things that one could imagine that could expand the footprint, so the U.S. being in this dominant position also plays into that. I will stop here and turn it over to my fellow panelists.

Kaplan: With that, we will go to Thomas Jordan.

Thomas Jordan: Thank you, Rob, and let me also thank the Atlanta Fed and its president for inviting me to this conference. It's really a pleasure to be part of this panel. Now, the U.S. dollar clearly plays the key role in the international monetary system today. Let me congratulate Professor Krishnamurthy for his excellent presentation. Arvind has convincingly demonstrated the reasons for U.S. dollar dominance, and I agree with most of his statements.

I would like to discuss the dollar's role in my capacity as a central bank representative from a small, open, and strongly globalized economy with an important currency, as well as a large financial center. My remarks are divided into three parts: I will first discuss what U.S. dollar dominance means for Switzerland; I will then look at the importance of the U.S. dollar swap lines, as Arvind mentioned before; and I will then conclude with some thoughts on the robustness of the dollar's dominance and very briefly, I will also address what it would mean for Switzerland if the dollar became less dominant.

I start with the question: What does it mean for Switzerland that we have this U.S. dollar dominance? We, Switzerland, have very strong global trade and financial linkages. Switzerland is highly exposed to external disruptions. Exchange rate movements, in particular, have a major influence on both inflation and economic activity in my country. Shocks in the dollar funding markets, whether they originate in the U.S. or elsewhere, are often transmitted quickly to the rest of the world, including Switzerland. Let me briefly explain how shocks in the dollar funding markets can affect us.

Swiss banks are significant intermediaries for U.S. dollar transactions in the global financial markets. Swiss Bank does have substantial assets and liabilities denominated in U.S. dollars, so impaired conditions in global dollar funding markets do affect financial stability in Switzerland. In turn, financial stress in the Swiss banking system can have a negative impact on macroeconomic developments.

In addition to this financial stability perspective, there's also a monetary policy perspective. The Swiss franc is an important safe haven currency. It tends to appreciate when global risk sentiment deteriorates. A worsening in dollar funding conditions can change global risk perceptions, and potentially increase the demand for Swiss francs as a safe haven. Strong, upward pressure on the Swiss franc can then pose considerable challenges for Swiss companies and jeopardize price stability.

We have observed many times in the past that the availability of U.S. dollar funding can shift very quickly. For instance, because of changes in U.S. monetary policy, or because of changes in global risk sentiment. During such periods of stress, U.S. dollar funding markets can dry up, and especially banks outside of the U.S. can find it difficult to obtain the necessary U.S. dollars. From the perspective of both financial stability and monetary policy, we therefore have a strong interest in orderly market conditions for dollar liquidity outside of the U.S. as well.

This brings me to my second part of the remarks, namely the relevance of the U.S. dollar swap lines between the Federal Reserve and other central banks, including the Swiss National Bank, as an important element of international crisis prevention and management. From our perspective, the swap lines are very crucial. Swap lines provide an important signal to market participants and act as an important liquidity backstop to ease sudden strains in global dollar funding markets. The Federal Reserve uses the swap lines to provide dollar liquidity to other central banks. We and other central banks then provide those to our own domestic banking systems, or more generally, to our counterparties.

The swap lines make it possible to provide U.S. dollar liquidity to banking systems outside of the U.S., and especially, and this is important, if you're in different time zones. Thanks to these swap lines, dollar interest rates behave more homogeneously around the globe during a period of stress. Let me give you a short example. Most recently, bilateral swap lines were used during the COVID-19 crisis. The severe economic downturn led to a significant increase in demand for U.S. dollar liquidity, and a deterioration in dollar funding conditions. Especially non-U.S. banks were willing, or forced, to pay an increased premium in the foreign exchange swap market in order to secure their U.S. dollar funding.

As a result, the U.S. dollar swap basis increased significantly. The swap basis quantifies the difference of dollar funding costs for non-U.S. banks relative to U.S. banks, and is thus a very good indicator of international market stress. The use of the dollar swap lines quickly eased the stress in U.S. dollar funding markets during the COVID-19 crisis. In Switzerland, the swap line was especially used during March and April of last year, 2020. The swap basis consequently returned to the pre-COVID level. These coordinated central bank actions, in my view, those proved very effective.

Now let me come to the last part of my remarks, and to the question: Just how robust is the dominance of the U.S. dollar, in fact? Arvind already alluded to this point, that a global currency status can be gained or lost; however, this happens very, very rarely. The last time this happened was before World War II, when the U.S. dollar replaced the pound sterling as the world's leading currency.

What would it take for a country and its currency to break the U.S. dollar dominance? Let me mention three points that I believe are relevant. It goes a little bit in the same direction as Arvind mentioned, but from a little bit different perspective. The first point is, this country would have to have a very large GDP relative to the world's GDP, because economic size matters. I think Arvind made this point very, very convincingly. However, in my view, it will take more than that to gain global currency status.

The second point is, this country's financial markets would have to be as open and deep as the U.S. markets were at that point, and this country's economic and legal systems would have to be as credible as those of the U.S. were at that point. In that context, it's often argued that the introduction of a central bank digital currency [CBDC] by a contender country would or could make a big difference.

In my view, the introduction of a CBDC would have only a limited impact on the openness and deepness of financial markets of a specific country. Openness and deepness do not depend only on technological aspects. The launch of a central bank digital currency, even by a first mover, would therefore probably not be enough for a high integration of this currency into international financial markets and for breaking the U.S. dollar dominance. Moreover, most cross-border payments relevant for this dominance are already electronic.

The third point I believe is important, the third point that could be relevant for losing the dominance, is if the U.S. were to make some political decision on its own that makes the dollar less attractive for global use. For example, measures that would limit the openness of U.S. capital markets for many countries or reduce the credibility of the U.S. economic system.

Considering these points, I see very little evidence at this moment that we are close to a break of the dollar's dominance. No other jurisdiction in the world has the same combination of institutional stability and deep and open capital markets. Furthermore, existing strong dollar network effects are very difficult to circumvent and thus play an important role in sustaining U.S. dollar dominance.

Finally, the dollar swap plans also support U.S. dollars in international financial markets. Consequently, in my view, it could take a long time for a challenger to displace the U.S. dollar as the dominant currency. Nevertheless, we can still ask what it would mean for Switzerland if the dollar became less dominant. Switzerland remains highly exposed to external disruptions. This is true no matter which currency actually is dominant. Developments in the country of the dominant currency would have spillovers on the global economy and financial activity, including in Switzerland, just as is the case these days with the dollar.

Having multiple reserve currencies would of course reduce dependence on a single country, on a single currency, and on a single central bank, but it would also mean fewer network effects and fewer economies of scale. This could increase the cost of transferring capital and risk around the global financial system.

If there are tensions in the funding markets of the global reserve currency, the influence on financial and economic conditions in Switzerland are considerable. This is the case, independent of whether there is one global reserve currency or several, and this is a situation that we have to live with.

All in all, for us the quality and the stability of the leading reserve currency are thus crucial. So, too, is the way the central bank of the leading country, together with all the major central banks, eases, if necessary, funding tensions in international financial markets.

Thank you. Back to you, Rob.

Kaplan: Thank you, Chairman Jordan. Let me now turn to our next discussant, Michael Howell.

Michael Howell: Good morning. Thank you. It's a great honor for me to be here, and to be discussing Arvind's paper. I think this is probably the most important area of macro finance, the whole issue of safe assets and the U.S. dollar. The world has changed a lot, and very significantly, since I started at Salomon Brothers in the mid-1980s. We then used to speak about a first world, a third world, and by location the second world, which were the Soviets. Now we have one world, and that one world needs a global currency. We've got a global currency, it's called the U.S. dollar; but the U.S. dollar faces challenges, and I think we need to address those challenges.

As a practitioner, as a money manager, we've learned a lot from Arvind's work over the last few years and gained lots of insight from the papers he's written, which have really become standards in the literature. What I'd like to do is to make three observations, and perhaps leave with a plea for policymakers. If I can, I will try and share my slides with you.

In terms of what I'd like to say, the first thing is that because of the huge amounts of debt that we've got in international capital markets today, capital markets are much more refinancing mechanisms rather than new financing mechanisms. In other words, balance sheet and liquidity, and safe assets matter a lot more than interest rates. In other words, the amount of transactions that are involved in refinancing outstrip those for new financing by about four to one.

Therefore, we need to ask ourselves: How do policy rates really affect supply and demand for safe assets? And the answer is, it's a complex issue. The slide that I've put in front of you is looking at 10-year term premia on the U.S. Treasury market, and I've cut this in different ways to try and make sure the point is clear. The left-hand slide looks at nominal term premia. Highlighted in the shaded bars are periods of QE by the Federal Reserve. During those periods, whether on the data that we've compiled or the data that comes from the New York Fed, the ACM data, it seems to be fairly clear that periods of QE actually lead to rising, and not falling, term premia.

This is rather counter to the traditional narrative. In other words, central bank QE drives yields up, it doesn't push them down. That is actually what you would expect from a safe asset. If systemic risk is falling, you would anticipate that investors would need fewer safe assets. The U.S. Treasury bond is the key safe asset in the global system, and therefore demand drops away and investors shift along the risk curve into other assets. And you can see it on the right-hand chart, where I think it's unequivocal, where what we've done is to strip out the effects of inflation, or volatility in the bond market, to try and show this is clear. In other words, demand is a critical element in any assessment of safe assets.

The second thing to think about is how rapidly supply and demand can change. What I've highlighted here is history. Arvind spoke about what happened in the interwar period, and here is some of the detail. What I've looked at is data going back to 1913, spanning to the mid-1930s. What this illustrates is the speed or alacrity with which the world system switched from sterling pounds into American dollars, and then it was back again. The blue area in the chart on the left is U.S. contribution to cross-border funding; the orange is sterling's contribution.

In 1913, at the time the Federal Reserve was established, the U.S. participated, or had virtually no participation, in global finance. In fact, U.S. banks I think were prohibited from doing that. By the time of the late 1920s, the U.S. dollar was dominant. Well, look how rapidly it fell away. The key point in all this is essentially that financial markets change quickly, and as financial markets change the use of currency can also change a lot more rapidly than many people would suggest.

The third point is to look at the demand for safe assets in the U.S., and what I've tried to show here in this chart is how the demand changes and how financial flows, cross-border financial flows worldwide, basically are moving rapidly between different regions. I've split here the U.S., which is the black line, labeled as the Americas, from Asia, which is in orange, and from Europe, which is the blue line.

Very broadly speaking, to summarize this chart there have been three big periods of large demand for U.S. dollar safe assets. One was in the mid-1980s when, under a regime where the Japanese dropped their exchange controls, Japanese insurance companies became very aggressive buyers of the U.S. Treasury market, and you can see the black line spiking higher. I should actually at this stage refer you to the note at the bottom, which this data is compiled by looking at what foreigners put into the U.S., taking the U.S. as a residual. In other words, the sum of all these numbers is zero. In other words, there's no balancing item which occurs in the national accounts; there's no error.

This is probably a more accurate way of doing things, simply because of the way that U.S. data is booked, and a lot of offshore booking clouds the picture. This is from the perspective of who is investing in the U.S. The second period was the mid- to late-1990s, the Asian crisis, where there became a very significant demand for U.S. safe assets.

Then there's been the more recent period in the wake of the global financial crisis, as Thomas and Arvind both alluded to. What we've seen is tremendous demand for dollars through this period, partly as a result of Basel III regulations, partly as a result of the fact there's been very little issuance of safe assets in the European area, particularly of German bunds, partly to do with the fact that the Chinese under Xi Jinping in 2015 went on an anti-corruption drive which drove a lot of money into dollars, and partly because of the Euro banking crisis from 2010 to 2012. What you've seen there is tremendous demand for dollars, and the COVID crisis is responsible for the latest uptick.

The point here is, we're starting from a very high base, and what you typically see is that from these bases, dollar demand tends to drop. These are challenges, and the challenge is already summarized in this final slide. What it basically says is that our experience of QE periods shows that demand is a critical element to understand in a safe asset regime. History shows that safe assets come and go. They can disappear as quickly as they appear, and then they may reappear as well. So we shouldn't be short-sighted to dismiss other currencies, particularly the yuan, as maybe a potential rival.

The U.S. has seen waves of capital inflow. Those will come and go in the future. But the biggest threat, in our view, is posed by China and her upcoming financialization. To put them into perspective, in the year 2000 China was responsible for about 6 percent of the total pool of world savings and credit—"global liquidity," we would dub it. Today, China is responsible for 27 percent of that global pool. It's come from virtually nowhere to become a dominant player, and as it starts to financialize and develop its financial economy it needs to stop exporting American dollars and start exporting yuan.

The quote that I put here from Major-General Qiao Liang, who's often the spokesman for geopolitics in China, puts it in black and white terms. "It's clear. China sees the dollar as a rival and wants to displace it, particularly in Asia." How is China going to do that? I wrote a book a year or so ago, called Capital Walls, which addressed some of these issues. What it said was that if you look at what China needs to do, there's a list of bullets that I highlight. One is to open up a trade credit market and redenominate more trade in yuan. That is exactly what America did in the wake of World War I. That's how the dollar became a dominant currency in the 1920s. China is following that road.

Secondly, to open up the bond and the equity markets within China to foreign capital. That, as we know in the last 18 months, is happening, and the flows of capital into China are substantial. Third is to develop not only a digital yuan, but actually to develop the architecture to allow peer-to-peer transfers, and to allow other countries to share in that architecture. That is something that the U.S. needs to speed up and needs to transfer its technology very quickly to other potential users around the world.

What we really need in the world economy is not so much digital central bank currencies, but a bridge currency, an electronic bridge currency, that can replace SWIFT [Society for Worldwide Interbank Financial Telecommunication]. I would say America already has that in the form perhaps of Ripple XRP.

Finally, what we need to see, or what China needs to do if it's to establish the yuan, is to do more "lender of last resort" support to offshore yuan markets. In that regard, I would say, look at the number of swap lines that China is currently putting in place. There are 32. There is an objective in doing this. The objective, I think, reinforces the idea they want to establish a trade credit market and swap lines, as Thomas already alluded to, is critical to the role of the dollar. So, let's not be complacent. China is there, it's a major threat. The dollar is dominant right now, and for the prosperity and health of the West we need to make sure it maintains its dominance.

Thank you.

Kaplan: Thank you, Michael, and thank you to all our presenters. Let me just remind the audience that if you have a question, please submit it in writing. I'll be getting these questions as we talk. I've got some questions of my own, but please submit your questions and we'll try to get them in here.

Let me start, after those excellent presentations. Chair Jordan went through the hurdles, the "how hard it would be" to unseat the dollar, and Michael Howell just went through a scenario of why China might make more progress than we think in clearing those hurdles. And I guess I'd like to start with Professor Krishnamurthy: What do you think? How likely is it, and again, this is over the next 10 to 20 years, that China could clear enough of these hurdles to start to be a factor in threatening U.S. dollar dominance?

Krishnamurthy: Yes, President Kaplan. I'd answer that question first of all by asking, "Which things matter more?" There are a number of factors that we know go into the dollar being the reserve currency. Michael pointed out things that the U.S. has done historically that China's thinking about. Which of these things matter the most? And my take, from my reading of history and the data, is that the important thing is the investability. The quantity of liquid safe assets is sort of the centerpiece that makes you be a reserve currency.

I say this, for example. If you think about the last 20 years, it was clear that when the euro system was created that was looking like a potential competitor, and it was a financial competitor. The introduction of the euro created a large quantity of euro-wide safe assets; now, the European debt crisis basically said that that was not true, that it was fewer than people thought, which seems to have taken the euro out of the running.

In reverse, I would say the question is: When will it be that China could generate enough investible safe assets? At present that seems further away. It's not a "never." The capital account needs to be opened, and the rule of law over debt issuances needs to be better. There needs to be just more quantity of high-quality liquid and safe assets. I think that's possible. Michael talked about the interwar period. I think that an important component of the interwar period was, as he pointed out, the rise of cross-border financing, the importance of the Federal Reserve Act, actually, which then allowed for a larger quantity of U.S. dollar safe assets in the world.

Those same patterns, in my mind, are the preeminent ones. I actually think that some of the invoicing trade stuff is secondary. I would put the financial element as being the central one driving this. Digital currency, other forms of payment technology, all help, but quantity is the key thing. I'll turn it over to others.

Kaplan: Let's hear from Michael Howell, or Chair Jordan, your thoughts on this.

Howell: I would like to return to this point about how quickly things could change, and Larry Summers said earlier on that we will likely face, unfortunately, another COVID-like pandemic within the next decade. Well, let's go back to the one we've just had, this current COVID.I If the U.S. had not stepped up with swap lines as it did with some alacrity, what would have happened to the world economy, the world financial system? Would it have turned to China? Would certain countries have turned to China, because of their enormous financial resources?

All I would say is that, in the background there I stress the point about complacency, and that's "never say never;" but just look at what China is doing. It has the ability to redenominate a lot of its trade in yuan. It is, after all, the world's biggest mercantilist economy right now.

Secondly, why is it putting in place all these swap lines? Why does it have 32 swap lines currently in existence? There must be some ulterior motive.

Jordan: Let me just add one other dimension I believe is important, and this is the geopolitical situation. If you compare the situation we had after World War I between the U.S. and Britain, the political system was more or less the same. It was the bigger country, the more important country, also a deep recession in Europe, deflation in the UK that made it much more attractive to have the center in New York than in London for financial transactions.

Now here, I think that it's a little bit more complicated. As long as we have these political tensions between two different political systems, I think it is much harder for China to get to this dominance except when they decide to become very similar to the Western world, and then obviously you could have the same situation again.

As long as these very important differences, and maybe even the tensions could increase over time, then in my view it could be more difficult. Or the world could split into two parts, where we have some where maybe the yuan dominates and some where the dollar dominates. I think this is an important element, and the currency has to be completely convertible and the trust to go in and out has to be the same. It's really not only the openness of the capital account, but also the credibility that you can use the capital account at every moment that you need to get back your capital. I think this dimension is also an important one.

Kaplan: Let me ask a couple of follow-up questions. These both came in, but they underlie this. I think you've indicated a little bit where you would come out on this. Let's say Saudi Arabia and other global oil producers decide to change all their invoicing on oil purchases to China to renminbi. If that were to happen: material impact on your thinking, or how would you react to that? Anyone who wants to start.

Howell: I would say it would reinforce the case that I'm warning against. That's exactly the sort of thing that we ought to be alert to. After all, if you go back to the history of the U.S. dollar, part of the reason why the U.S. dollar managed to come out of Bretton Woods so strongly was that there was a deal done by Bill Simon (ex-Salomon Brother's partner) when he was Treasury Secretary, with the Saudis, to price oil, OPEC oil, in U.S. dollars. That was one of the foundations for 20 or 30 years of dollar dominance. The Chinese, I'm sure, are very aware of that. They would like to do a similar deal. They've already done one effectively with Russia. Russia prices a lot of its oil, certainly to China, in yuan.

We've got to think there's another world out there which may be not exactly in tune with Western values. They may well like the whole idea of a Chinese digital currency, the whole idea about an authoritarian regime and this type of infrastructure.

Krishnamurthy: I can step in as well, and I'll try to make a slightly different point. I agree with Michael. It will clearly be a factor, and again, the question is: How important a factor? I will note, for example, that during a global downturn that trade contracts during the financial crisis. And yet it's the case that the dollar appreciates, and some of the strengthening effects of the dollar actually are enhanced, the basis widens, for example. That suggests to me that, at least in the medium-term, financial effects are more dominant than these types of trade effects.

I think I agree that if Saudi Arabia was to redenominate away from the dollar that would have an impact. It will have an impact on the demand for dollar financing, on the demand for holding dollar assets, on the demand for the U.S. dollar as a payment system. But I would put it as a smaller factor than the bigger factor, which is: What is it that's driving the demand for dollar assets? I would think, for example, if the world was to change its FX reserve holdings systematically, I think that would have a bigger impact.

Kaplan: OK.

Jordan: Well, my view is similar. I think invoicing is not enough. You need really the wish, then, of these countries to have their reserves placed in China and in renminbi, and not anymore in the U.S. and in dollars. I think these are maybe two separate questions, but of course changing the invoicing currency will have an impact, and it could be the first signal.

Of course, when the opportunity to then also manage reserves in that currency increases and becomes similar to the United States, of course that could have an impact over time. There I agree with Michael, of course.

Kaplan: Let me ask another question. Obviously, as you all know, the United States is increasing its debt-to-GDP. We've had a recent, very large $1.9 trillion package. There are prospects of more spending. Debt held by the public as a percentage of GDP is now gone from in the 70s back a year and three quarters ago to in the neighborhood of 100 percent, plus or minus, and the present value of unfunded entitlements, I don't need to tell you, is in the range of $65 trillion. How does the path of U.S. government debt-to-GDP affect this? We have the "exorbitant privilege." Is there a point where the fiscal position in the United States could jeopardize that exorbitant privilege?

Howell: If I can make that comment, I think absolutely there is a point, but that point becomes a lot closer when you've got a rival international currency like the yuan out there. If the U.S. is the only international currency and people need dollars, then obviously it matters, the fiscal position of the U.S., but it matters rather less. And I think that to maybe keep plowing down this same farrow, one of the things I think we need to be cognizant of is what other countries are doing, other Asian countries are doing.

One of the things on observation which I'll throw out there is that in 30 or 40 years of being in financial markets I've never seen this degree of stability among the Asian currencies before. It's almost uncanny. They're virtually not moving. They seem to be pegging themselves to some sort of underlying Asian unit. Now, has this to do with supply chains across Asia? I don't know. Has it to do with some sort of deference to the yuan? I don't know. But these are issues that I think we just need to confront, because if there is a regional financial crisis, let's say in Asia, and the U.S. is unable to come in and help; if China comes in, that is a meaningful factor in geopolitics worldwide. It will mean it will swing a lot of people towards using Chinese financial instruments.

Krishnamurthy: The point that Michael makes about alternatives is pretty important. That's going to be one central question that floats around. I still view that as many years away. The other point, actually, that Michael mentioned in his presentation: the world has seen an increase in the demand for safe assets in the last decade, and it's a confluence of forces, regulations, uncertainty, demographics. There's a collection of things that probably have played a role in this. And in a way the U.S. debt is sustainable, given that demand.

If that demand was to shift, that's another factor that I think would undercut the U.S. position. You can see that happening relatively quickly, to where if demand shifts down, given the current supply and the expansion in supply, suddenly maybe the dollar doesn't look as strong. Say Treasury bonds are not as valuable. I think about, for example, last year in March, the COVID crisis when it hit, which was an enormous economic shock, the dollar didn't appreciate it as much as it did in 2008. Probably all of you know that Treasury, long-term Treasury bond yields, rose. In a way there's some dysfunction that made me worry a little bit about some of these factors that are playing at the margin. Maybe they could change the equilibrium. It is an equilibrium, so an equilibrium can change quickly. These are all things that certainly are worrisome.

Jordan: Maybe just a comment from my side. The fiscal solidity, in my view, is very important. It's not only the level of debt, I think it's also the potential growth rate of the U.S. debt that is important. If you have a country that is growing a lot, where you have also high productivity growth, this is something that is strengthening this country, independent of whether the debt level is 70 or 80, but the solidity all in all is very important. Then it could have a big impact on the interest rate. So this advantage to have very cheap funding could go away to some extent, but on the other hand, that could also make it again attractive, so the return for investors plays an important role. And if you have the liquidity of the dollar, the deepness of the market, and again, a little bit of a high return, that could then compensate maybe for the impact that we discussed just before.

Kaplan: One of the questions probably won't surprise you, because we get it regularly, is regarding cryptocurrencies and the impact on that. This is, in this discussion, differentiating between cryptocurrencies, i.e., not tied to any underlying currency, versus digital currencies that are. I think the questioner and people realize that these cryptocurrencies are not widely adopted yet for payments. There are moves to increase that, but we're not there yet.

The thought is if the prevalence of cryptocurrencies and the adoption widens, it might not threaten U.S. dollar dominance but maybe would cause global entities to slightly downshift on their allocations, just on the margin, but on the margin could be enough to have a meaningful impact. How would you, all three of you, comment on that scenario? U.S. is still the dominant currency, but people just don't overweight it to the extent they are now, and cryptocurrencies, and I won't mention the names, but there's options and projects that are alternatives to underlying currencies, help speed that underweighting?

Jordan: If I could go ahead in that question. It's very important that we distinguish between cryptocurrencies and the kind of stable coins, the second one that you mentioned before, a token that is related to an official currency like the dollar, the Swiss franc, or the euro. So in my view, actually the cryptocurrencies that are not linked to an official currency are not really a threat to a sovereign currencies. As long as the debt of important countries are denominated in their official currency, as long as the salaries are denominated, and as long as all the prices are denominated in U.S. dollars or in Swiss francs, or the euro, then these cryptocurrencies are mainly investment tools or speculative investment tools, but not rather something that is competing with the dollar and euro, or the Swiss franc.

It has also very little impact on the effectiveness of monetary policy. The stable coin issue, in my view, is also not really a threat to the currency, but rather a question of regulation. It goes very much in the direction of a deposit. Bank deposits are also non-central bank money, but in the same denomination, and you need the proper regulation, so that people who own those tokens, these stable coins, know exactly what it is, and they also get the money back if they attempt to transfer it back into central bank money. There is rather a question of regulation. We can use a new technology for a new form of money, but that is in a way similar to what we know already with bank money or deposits.

To summarize, I do not really see that as a threat. Cryptocurrencies are mainly an investment vehicle, but not something like a sovereign money, and stable coins, there is really the big question: how to regulate them properly.

Krishnamurthy: Let me just jump in. I agree completely with what Chairman Jordan said. There's one interesting dimension that is just worth noting, which was Libra, which has now changed, I guess, its model. But that was an interesting case. It's closer to a stable coin, and it has the network effects, I think something like 2 1/2 billion users. That seemed like a platform that could be a challenger, in which case the currency was going to be this basket currency, and potentially would have undercut the dollar.

So that seemed to me the closest one, that would be one that could have been a model. But I think on the other ones, even the stable coins and the cryptocurrencies, to me, these are at the margin, not so important.

Kaplan: OK, makes sense.

Howell: I would say that I endorse those comments, and I agree 100 percent that crypto is really a response to monetary inflation. That's why people are buying them. There's clearly a big appetite for this type of stuff, for sure, but it's not anything to do with a transaction's currency. That comes back to being digital, as President Kaplan made clear. I think from a U.S. perspective, if the dollar wants to remain dominant in the world, the key thing to invest in is a digital bridge currency. That needs to be done with some alacrity. That's where the U.S. is behind, and it needs to get in front very quickly.

Kaplan: Because you're concerned that for global payments, having that digital bridge currency is going to be critical because others are going to be developing it?

Howell: I think so, and I think that every central bank as far as one can see is developing their own version of a digital currency. But we need some sort of international payments mechanism, and therefore a digital bridge currency would make sense. The U.S. has the technology, it has the expertise. There have been initiatives, but it just needs to get out there quickly. And I think the COVID crisis certainly should be a spur to that.

Kaplan: OK. So, this question won't surprise you: Over the last several years, the U.S. has much more aggressively used payment sanctions as a tool of foreign policy. To what extent can the U.S. go too far with this? How might this affect the U.S. dollar's role in global markets?

Krishnamurthy: My take on this is the U.S. is so far ahead. In a sense, it's using its "far ahead" as a chip in other dimensions. It can safely back off, and use it, and achieve other objectives, and that seems to me the way to think about what the U.S. is doing.

Kaplan: OK.

Howell: Clearly, the other countries do the same thing, so, why shouldn't the U.S.? There's clearly a division between friends and foes in this world. You're either in the "U.S. club" or you're not, and if you're not there's a risk of running afoul of it. I think that it's perfectly legitimate to do that. If it means that some countries don't want to use your currency, well so be it, you probably wouldn't want them to.

Jordan: I cannot really comment on these sanctions directly but let me stress one point. I think in the big debate we have about cross-border payment, which is extremely important, it's also related to the fact that it became more difficult to have this corresponding banking. And this is very important, that banks across different currencies can make payments efficiently, so allowing corresponding banking, in one form or the other, with new technologies linking financial or payment systems together, will be crucial.

This is something that I think for the efficiency of the world economy—but also, of course, for the relevance of certain currencies, like the dollar, it's very important so that we can interlink the different payment systems. And their corresponding banking will play also in the future, I think, a very important role.

Kaplan: OK. I think in your comments, the three of you in varying degrees touched on this, but let me ask the question we just got in. The COVID crisis in March of 2020 did not turn into a larger emerging market currency crisis, and they comment that even in the aftermath of the taper tantrum in 2013, or the east Asian crisis of the late '90s, we had real disruptions in emerging markets. And the person...I'll use their words: "Was it just luck, or was it something about the fundamentals in emerging markets, or were there specific policy actions by the Fed and other central banks that kept the March 2020 crisis contained?"

Howell: Yes; all of the above.

Kaplan: OK.

Howell: It was partly the Fed. It was the alacrity with which dollars were supplied into the world system, both through swaps and the FIMA repo system. It was also the fact that emerging market borrowers were in probably a better state than many people would have suggested, and the underlying economic fundamentals of a lot of emerging markets have improved enormously over the last decade or so. I think all these factors. It was maybe luck, but it was also many other multifactored things.

Krishnamurthy: I agree with Michael. I think everything mattered. I think luck is important here, too. It's the financial crisis aspect of COVID, what I mean by "financial crisis aspect," I mean the kind of plumbing breakdowns, the systemic crisis issues that were so prevalent in '08, presented themselves in March, but the Fed did a very good job of dealing with it. To that extent, that was important. It's possible that bad luck could have continued, especially for emerging markets. It seems not to have, and I'm sure that's an important.

Jordan: There's one element that is also interesting in that context. If you look at the dollar interest rates, so we had this huge demand for dollars, but at the same time the Fed was the only one, of the big ones, that could lower interest rates. And so that was something that probably also led to a situation where the dollar did not appreciate that much compared to many other countries. This is different from the taper tantrum period, where there was an increase in the dollar interest rates and then the dollar appreciated vis-à-vis most emerging market currencies, but also vis-à-vis others. Now the U.S. were the only one of the big ones that had room to lower interest rates during the COVID crisis, and they did it, and that is probably something that compensated. The dollar appreciated at the beginning, but then compared to the euro, but also to the Swiss franc, then lost quite considerably again. And that was surely reflecting lower interest rates, compared to a more or less stable interest rate situation in Europe.

Kaplan: Right.

Howell: One thing that the COVID crisis has established is that, growing up in the 1980s, there was no lender of last resort in the world economy. Now, I think, very clearly there is. The U.S. is acting, the Federal Reserve is acting, as the world's bank. I mean, that seems to be a clear part of the agenda, and all credit to them, they reacted with alacrity.

Kaplan: Let's pick up where you just left off. One of the questions is: Is there a moral hazard to the U.S. in playing that role?

Howell: Well, if I continue, the question is: Is there a privilege in having the dollar as the world currency? I would suggest there is. The question is, there may be a moral hazard for some constituencies in the U.S. who fail to benefit from that, who don't benefit from that if you print too many dollars. On the other hand, for the U.S. system as a whole, I would say it's a net beneficiary.

Kaplan: Right.

Krishnamurthy: Yes, I'd say there's a micro and a macro dimension to this. The macro dimension is by acting as the lender of last resort. The dollar system is effectively strengthened, so that the U.S, and all dollar borrowers as a whole, benefit. The micro dimension is, yes, there is a moral hazard dimension. You are effectively lowering the cost of rolling over short-term debt, which then affects financing incentives. That's absolutely present, too.

Jordan: I agree with that, that it's probably not a moral hazard in the U.S. or for the others, but rather a little bit in general. So central banks provided all the liquidity, all the time, during the last 50 years when there was a small shock. Of course, that could contribute, in the medium- to long-term, of course, to moral hazard. I think this is something that central banks should be aware of. not only the Fed, but in general when we are providing liquidity in every case when something happens, so that we aren't the lender of last resort or the market maker of last resort. All those issues, I think they are relevant, and we should be aware of possible negative consequences.

Kaplan: OK. I will read this question, as opposed to ask it myself. This is not from me, this is from a questioner, but it's a logical question, and I think I know your views. "Should the Fed make permanent the FIMA Repo Facility that was set up in March of 2020?"

Howell: My answer to that would be, "Probably yes." I think there are clearly questions about it, whether anything should be permanent, but I think that certainly the idea that the Federal Reserve acts in this way as international lender of last resort has got to be established, and maybe people just take it as accepted now. So I would err probably on the side of saying, "Yes, they ought to."

But I think in all of this, what really comes out of it is that it's not really interest rates that matter so much here. We haven't really spoken about interest rates very much. It's about access to dollar flows. It's about flows of capital and how the Federal Reserve controls that. It's one of the things that I alluded to earlier on, that we're living in a world now dominated by debt, where the world financial system is a refinancing system and not a new financing system, and therefore the whole idea of anyone speaking about negative interest rates strikes me as complete lunacy. We don't need negative interest rates. We need flows of liquidity. That's the key thing. Negative interest rates just encourage people to take on more debt, and you don't want that. You want financing flows, and the Fed is there to provide that.

Kaplan: We've talked about a number of issues. We've gotten questions from the audience. What's the question that isn't getting discussed or debated enough? Maybe some would call it an "unknown unknown," a development away from China, away from technology. What are some of the risks that maybe aren't getting enough attention, and we should be thinking about or being more imaginative about discussing?

Krishnamurthy: Actually, I would point to a question, Rob, that you asked earlier about the U.S. budget position. The world is tied up on U.S. Treasuries being safe, being liquid, U.S. inflation being low. In a way, the whole financial system of the world is sort of built on that bedrock. We should worry about that.

Kaplan: Right.

Krishnamurthy: To the extent that the fiscal position worsens...you can imagine scenarios in which fiscal positions worsen. There's a feedback between that to inflation expectations, which then undercut the stability of Treasuries. You can sort of see that there's a scenario like that. It's a black swan, but it's a risky scenario. I think we should be worried about risky scenarios which have huge, in economics language, huge marginal utility impacts, and that is one of those that I think should get more attention.

Kaplan: Tom and Michael, any comments?

Jordan: An important question that bothers me all the time is: Do we do enough, really, to enable the private sector to grow alone, and to adjust sufficiently on its own? We have this oxygen, this support to the private sector, but are the framework conditions really good enough that we have a robust private sector that is capable to adjust, to transform into a new economy with many structural adjustments necessary?

I think these framework conditions are extremely important, and we should be careful not to create a system where everything is guided only by state decisions. The private sector should be in a position, really, to adjust and to become strong enough to go alone. I think this is something that we should not forget.

Kaplan: This structural change you're talking to is in the aftermath of COVID, in particular?

Jordan: Well, in general we are talking now a lot about digitalization, so the economy has to transform. We talked about the green economy, but at the end these firms have to adjust and not everything can be dictated by governments. We have to set the framework, and they should be in a position really to adjust. This is important: the incentives and framework conditions are key, and maybe less industrial policies as used in many countries. We should have the incentives, the structures right, and then the private sector should be in a position to be strong enough to adjust into the right direction.

Howell: I would say that what we've learned is the balance sheet is important. Balance sheets basically need safe assets. Therefore, the whole issue about what makes a safe asset is really a critical issue. Essentially, what we know is that central banks, as part of their toolkit now, have got quantitative easing as a fallback. In every crisis, they deliver more quantity. That creates asset price bubbles. It causes lot of tension within economies, in terms of distribution of wealth and income, and these are issues that may be with us for the long term now.

The world economy is sort of a world financial system. As it gets bigger and bigger it becomes more volatile, and that's a cost. Central banks know how to deal with it, but there are long-term consequences.

Kaplan: On that, you get to my last question. And for the three of you, in light of everything we discussed today, any advice, or, I guess, to put it differently: What advice would you give to the Federal Reserve in our job, in conducting monetary policy? Any advice you'd like to offer, now solicited? I was about to say unsolicited, but I'm soliciting it. Any advice you'd give to us as we work through the challenges we're facing?

Krishnamurthy: Rob, I am not going to be so...I'm going to be humble and say I think you know more than I do about your jobs, so I'm not sure I'm going to give you...the one thing that I just may...this is just a reaction, actually, to something that Michael said earlier. I think the U.S. can be slower on, say, digital currency. I think the position that it's in allows it to observe other countries' experiments and go slower. I think that's generally true. Now, I completely agree with Michael. One has to react. But the urgency is not as much as, say, on other things—like, for example, ensuring that a swap line exists and continues to be there.

Kaplan: OK, very good.

Howell: I would say digital currency is the critical thing, and I think the U.S. has to be there at least in technology, a technology solution, if not actually providing the actual digital coin or whatever. It has to have the infrastructure there to do it, and as I keep mentioning, it's the bridge currency which is really the critical piece of the technology, and the U.S. has got to be a leader in that.

Kaplan: Tom?

Jordan: Well, Rob, this is a very difficult question for me, because we have this rule that we do not give advice to other central banks.

Kaplan: Well, OK, that's fair.

Jordan: Not even in a panel.

Kaplan: All right. Listen, I want to thank Arvind Krishnamurthy, Thomas Jordan, Michael Howell. This has been a fascinating discussion, very thoughtful, and I appreciate very much your work in these areas and your leadership on this topic. And with that, I think I will turn it back over to Raphael Bostic.

Raphael Bostic: Thank you, Rob, President Kaplan, for your masterful moderation of that panel. I agree; it was very, very interesting. You know, at the very beginning of this conference, I promised that we would have a series of speakers who would tell us exactly what they thought, would be very direct, and wouldn't hold back. I think the conversation this morning definitely fit that bill. We started with Professor Larry Summers, who did have opinions about what the Fed should do and was very clear on telling us about them.

Then in this last panel, Rob, I really enjoyed your last question, giving advice. Even though there is always a reluctance to do that on a central bank-sponsored program, all the views were well-taken. On this last panel, I would say, I found it very interesting, the discussion about how strategic central banks and countries need to be in terms of thinking about: How do you maintain your currency in a reserve position so that we in the United States, at least, preserve that extraordinary privilege? Those are things I will definitely think about as we move forward.

To our listeners, and all of you who have joined us: I want to thank you for being here. I hope you enjoyed this program as much as I did. I thought it was just wonderful.

Before I sign off for the conference, I did want to just extend my thanks to my team here at the Atlanta Fed. They worked extremely hard to put together a program that was timely and on point, and also to get speakers who would be insightful and really thought-provoking. I would also like to say "thank you" to my support services and creative services. They're the ones who actually allowed you to see us and hear us, and so I always make a point to acknowledge the folks behind the scenes, because they do a great job.

With that, I will say, "Day 2 for the 25th annual Financial Markets Conference is now closed." I hope you have a good rest of the day, and I hope you take the thoughts that may have been sparked by what you heard today and take them and use them in your line of work.

Thank you and have a great day.