Present Value: Eswar Prasad and Andrew Karolyi discuss emerging markets and cryptocurrency
By Eric Jo, MBA ’21
Present Value, an independent editorial project produced and hosted by Johnson students, had the pleasure of interviewing Eswar Prasad, Nandlal P. Tolani Senior Professor of Trade Policy and professor of economics at the Charles H. Dyson School of Applied Economics and Management at Cornell University, and Andrew Karolyi, Harold Bierman Jr. Distinguished Professor of Management and professor of finance at the Samuel Curtis Johnson Graduate School of Management, deputy dean and dean of academic affairs, Cornell SC Johnson College of Business, and professor of economics in Cornell’s College of Arts and Sciences.
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The dollar trap: global reserve currency
In his book, The Dollar Trap: How the U.S. Dollar Tightened Its Grip on Global Finance, Eswar Prasad focuses on the relationship between emerging market economies and the U.S. dollar as the incumbent global reserve currency. He explains how this phenomenon affects monetary policy from the perspective of an emerging market.
Prasad argues that the strong breadth and depth of the U.S. financial market has placed it at the pinnacle among developed nations. He points out that although the global financial crisis had its origins in the U.S., the U.S. dollar outperformed many other currencies and more capital flowed into the U.S. financial system during the crisis, contrary to what many would expect. In this Present Value episode, Prasad explains that global investors turned to U.S. financial markets for safety because there was no place more secure to park their money. Emerging markets wanted protection, and U.S. financial markets provided that protection in spite of the turmoil in its own markets.
Prasad acknowledges that the Chinese renminbi has made progress in becoming a viable alternative global reserve currency. However, he contends that open and transparent government, rule of law, and an independent central bank are prerequisites for a currency to qualify as an alternative to the U.S. dollar. Prasad attributes much of the progress of the renminbi to the struggle of European currencies rather than progress towards any of these stated requirements.
Central banks and politics
Commenting on the pressure the government has put on the Federal Reserve to support its trade war with China, Prasad emphasizes the importance of the separation of politics and central bank policy. While he acknowledges that every government institution, including the Fed, is ultimately accountable to the people, he believes that the separation of politics and financial policy is what makes the Fed so effective. Although the government has the discretion to agree and approve of the Fed’s mandate or goal, historically the Fed has determined how it achieves that mandate independently. “If you have the government telling the Fed how it should achieve its mandate—and, more importantly, [if the government] tries to switch its mandate … that is a real risk … to the credibility of the institution,” says Prasad.
Due to the sheer size of the U.S. central bank, the Fed’s actions can create unintended consequences impacting global markets and politics, notes Andrew Karolyi. To illustrate, Karolyi points to the quantitative easing program post-financial crisis, which plunged interest rates in the U.S. and led to an exodus of institutional investors in search of yield from U.S. financial markets into emerging markets (among other options). Later, when Ben Bernanke dialed back on quantitative easing, a sudden retrenchment of capital back to the U.S. led to large instability in the emerging markets, leaving many international central bankers upset with the Fed’s actions. Karolyi cites this as a clear example of the Fed acting in its own best interest and not at the whim of politics—but having unintended global consequences, nevertheless.
Cryptocurrency as a reserve currency
Prasad argues that cryptocurrencies have the potential to be viable substitutes to fiat currencies, although right now they have limited store of value and lack trust among the general public. The quality and security of the underlying technology will matter a great deal as cryptocurrencies pursue replacing sovereign currencies. Prasad further explores this possibility, naming several countries that have experimented with central bank digital currencies—essentially, cryptocurrencies designed to broaden financial inclusion. In spite of conceptual difficulties and design issues, he believes digital versions of central bank currencies are inevitable.
Karolyi notes that settlement, audit, and reporting systems must be robust for cryptocurrencies to become viable alternative to fiat currencies and that the underlying blockchain technology is paramount. Currencies will become increasingly more digitized and will continue to face regulatory challenges. A successful digital currency must find the right balance between its technological viability and the willingness of governments to back it.
For more, check out the full-length Present Value podcast, Emerging Market Phenomena | Andrew Karolyi and Eswar Prasad. Listen, subscribe, and share!
About Andrew Karolyi
Andrew Karolyi is the Harold Bierman Jr. Distinguished Professor of Management and professor of finance at the Samuel Curtis Johnson Graduate School of Management, deputy dean and dean of academic affairs for the Cornell SC Johnson College of Business, and professor of economics in Cornell’s College of Arts and Sciences. A scholar in the area of investment management with a specialization in the study of international financial markets who recently completed a four-year term as executive editor of the Review of Financial Studies, he has published extensively in journals in finance and economics and has published several books and monographs.
About Eswar Prasad
Eswar Prasad is the Nandlal P. Tolani Senior Professor of Trade Policy and professor of economics at the Charles H. Dyson School of Applied Economics and Management at Cornell University. He is also a senior fellow at the Brookings Institution, where he holds the New Century Chair in International Economics, and a research associate at the National Bureau of Economic Research. His research has spanned labor economics, business cycles, and open economy macroeconomics, and he has co-authored or edited several books and monographs on financial globalization, China, and India.