Brad Setser on Addressing the Global Dollar Shortage and COVID-19's Implications for Worldwide Trade Imbalances

Episode Summary

Executive Summary: Brad Setser explains how COVID-19 exposed and intensified the global dollar shortage, why demand for dollars shifted from European banks in 2008 to Asian banks and insurers today, and how Fed swap lines, a new repo facility, and IMF lending can stabilize markets without ending the dollar’s global dominance. He also assesses likely post-crisis changes in globalization, supply chains, and China’s economic model.

Main Topics: Global dollar shortage and why it matters (Priority: 5/5): Setser describes the worldwide use of dollars for trade finance, banking, and asset holdings, and explains how shortages emerge when institutions around the world need dollars but cannot easily access them. From European banks in 2008 to Asian financial institutions in 2020 (Priority: 5/5): The center of dollar funding stress has shifted from European banks before the global financial crisis to Japanese, Taiwanese, Korean, and some European insurers and banks now. How dollar funding works and how crises spread (Priority: 5/5): He explains cross-currency swaps, repo, commercial paper, and dollar lending books, emphasizing that non-U.S. intermediaries can create systemic stress when they rely on short-term dollar funding. Fed swap lines, standing repo facility, and IMF backstops (Priority: 5/5): Setser lays out a tiered response: swap lines for selected central banks, a Fed repo facility for reserve-rich central banks, and IMF lending for countries with insufficient reserves. Signs of dollar stress and crisis monitoring (Priority: 4/5): He identifies cross-currency basis spreads, dollar borrowing rates, and uptake of swap lines as the main indicators of stress, while noting the broad dollar index is only an imperfect proxy. COVID-19, global imbalances, and possible deglobalization (Priority: 4/5): The crisis may shrink trade and change global imbalances through tourism shocks, lower oil prices, and pressure for more regionalized supply chains and onshoring of strategic goods. China’s position and reform needs (Priority: 4/5): Setser argues China may gain short-term benefits from lower oil prices and PPE exports, but long-run resilience requires deeper domestic reforms toward consumption, better taxation, and stronger social spending.

Key Arguments: Dollar liabilities and dollar funding needs are concentrated among advanced-economy financial institutions, not just emerging markets. The dollar funding epicenter moved from European banks in 2008 to Asian banks and insurers, especially in Japan, Taiwan, and Korea. Crisis dynamics are driven by short-term dollar borrowing used to fund longer-dated dollar assets, making institutions vulnerable to runs and funding squeezes. Fed swap lines and the new repo facility are appropriate crisis tools because they prevent disorderly asset sales and stabilize global dollar markets. IMF resources can and should serve countries that lack reserves or are not suited for Fed facilities; the IMF has substantial lending capacity. The broad dollar’s global role is likely to persist, though Europe’s failure to supply an equivalent safe asset limits euro expansion. COVID-19 may reduce trade, tourism, and oil demand, potentially shifting current account balances and encouraging more regional supply chains. China’s long-term economic durability depends less on exports and investment-led stimulus and more on consumer-led growth, tax reform, and expanded social welfare.

Data Points: Global dollar liabilities outside the U.S.: $12–13 trillion - BIS estimate cited in the discussion of foreign dollar-denominated debt and lending Outstanding Fed swap lines: Close to $400 billion - Setser cites this as evidence of real global dollar funding stress IMF New Arrangements to Borrow: A little over $200 billion to a little over $400 billion - Planned doubling in IMF backup lending capacity IMF total lending capacity with additional support: Close to $1 trillion - Setser’s estimate if NAB increases and bilateral lines are maintained China personal income tax revenue: Around 1.3% of GDP - Used to argue China has room to reform taxation and support consumption U.S. personal income tax revenue: 10% of GDP - Benchmark used in comparing China’s tax system Timing of second build-up in dollar funding needs: Started around 2014 - Setser links this to Asia’s search for yield and low rates Current account surpluses before the crisis: Over half a trillion dollars - Northern Europe and Northeast Asia were running very large surpluses Fed swap line country examples: Mexico, Korea, Brazil - Setser notes these were among the countries that received swap lines in 2008 and should again Fed repo facility collateral: U.S. Treasury securities - Explained as a low-risk way for reserve-rich central banks to get dollars

Pivotal Quotes: "The center here is clearly the insurers and then a set of asset managers in Asia, which are managing insurance money and managing pension fund money." — Brad Setser: Describing the shift in dollar funding demand from European banks to Asian non-bank financial institutions "The Fed has avoided a disaster and in the process saved some countries and some institutions." — Brad Setser: Assessing the purpose and effect of Fed swap lines and related crisis facilities "I think aspects of globalization will be reconsidered. There'll be reluctance to have full supply chain dependence on one country." — Brad Setser: Discussing likely post-pandemic changes to trade, production, and supply chains

Implications: The pandemic reinforced the Fed’s global lender-of-last-resort role and may push regulators to tighten dollar-borrowing rules abroad. It could also accelerate supply-chain diversification, regionalization, and reforms in China, while leaving the dollar central to global finance.