The global financial system faces looming risks, including an escalating dependence on the U.S. dollar and the compartmentalization of global trade, warned Pierre-Olivier Gourinchas, chief economist at the International Monetary Fund (IMF). Gourinchas spoke at a Bank of Canada event on Monday.
Today, Gourinchas delved deeper into the issues, explaining the self-sustaining dominance of the U.S. dollar due to surging foreign demand. This necessitates currency management by foreign entities to secure dollars, leading to economic uncertainty.
The pandemic-induced interest rate environment and elevated rates pose unique challenges in meeting U.S. dollar demand. The U.S. government issues dollars by selling bonds, and part of the proceeds are used for bond cancellation. To mitigate these challenges, Gourinchas suggested a “global financial safety net” for dollar liquidity during crises. This proposition contrasts with countries’ current “self-insurance” approach.
Gourinchas also highlighted geopolitical pressures impacting global trade. Countries like China are increasingly favoring sphere-of-influence models over geographical proximity for trade partnerships, which increases the risk of a silo effect.
In response to this trend, the U.S. and its allies have turned to “friendshoring”. This strategy focuses on politically compatible countries for new trade connections and leads to trade diversion from efficient but geopolitically risky jurisdictions. As a result, business costs are escalating.
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