Now in order to better understand where the implications of all of the shifts that we see in the world in terms of the relative size of different economies. The role that they play in global trade, and also the importance of their currencies when we comes to keeping research. I would like to walk you through a concrete example. Let's assume that I owe you $1, right? I have a debt with you, and you really want your money back. So I'm going to offer you two ways of paying you back that debt that I have with you. The first way is I can give you a dollar bill. You should buy a federal reserve here in the United States. We all know what this currency's all about. And remember, if the currency, that right now, is supposed to be the safest and is certainly the most widely used one as a reserved currency. And then the second way in which I'm going to offer you to pay my debt back is by giving you a personal cheque of mine drawn on my bank account. I've written the cheque to the author of Cash for one dollar, and I've signed the cheque. By the way the bank account number at the bottom of the cheque is a phony one so don't try to hack my bank account. Now what's important about this example is that you think carefully as to, what is it that you will prefer. What is in your best interest? To take from me the dollar bill or to accept my personal check? Now, some of you might be thinking, I would like to take the cash but then my reply to you would be, well, both pieces of paper, are a form of cash. The only difference is that the first $1 bill has been issued by the Federal Reserve Bank and the second one is a piece of paper that is linked to my bank account. So really it all comes down to your choosing between Uncle Sam and me. And you could be wondering well, to what extent should I trust the professor versus Uncle Sam? And of course I think you are on the right path, but at least to say you should always taken a paper money from the source that you think is safer or from the source that you think you have more confidence in. It's all about trust at the end of the day. So, I'm sure that most of you, if not all of you will take the dollar bill over my wonderful personal cheque and I should congratulate you for making the right choice. Now, let's complicate matters a little bit. I'll show you hear a picture of a very famous painter, one of the most famous painters in the history of art. His name is Salvador Dali. He was mostly active as a painter in the 20th century and remember that his paintings sale nowadays for tens of millions of dollars, he's a very famous painter. Now I didn't choose Salvador Dali because he's from Spain but rather because he was the first artist in history to try to make money not just by producing art but also by selling his brand name. That is to say by licensing or franchising with companies. So he would allow companies to use his name in order for those companies to sell certain products or services. And of course in exchange he would collect the fee. So what I'm about to tell you is a true story in its entirety. And at the end of the story, there will a question that you need to answer. So the story begins in New York, in the 1960s. Dali and a whole bunch of friends went to a famous restaurant in New York city. And at the end of the meal, Dali pays for the check with a personal check of his. He wrote the name of the restaurant, he wrote the amount, the date, and then he signed. Normally what would happen is he would give the check to the waiter, the waiter would give the check to the manager of the restaurant and the manager would turn the cheque on its back, endorse it, that is to say sign it, and send it to the bank for deposit. Now that day, Dali, who remember was not just a very good painter but also a savvy businessman, decided to run a little experiment. And after he filled out the front of the cheque with the amount and the date and his signature, he turned the cheque on its back and then he did a little sketch of a figure that is actually very typical of his style as a painter, remember he was a surrealist painter. So as you can see it's an elephant with elongated legs. It's a beautiful sketch and then he signed it. And then he gave the cheque to the waiter and the waiter gave the cheque to the manager of the restaurant. Remember this is a true story. And the manager of the restaurant turned the cheque on its back, pen in hand, he was about to sign it, so that he could deposit a check on the bank, when he pause for a moment, looking at the sketch of the drawing, and he thought, wait a minute, I know who this guy is, he's a famous painter. And he just gave me an original drawing. So instead of sending the cheque to the bank for deposit, he framed it and he put the picture on the wall of the restaurant. Now everybody went back home and a couple of weeks later Dali, the painter, looked at the statement from his bank, and he notice that the cheque had not been deposited. So the money was still in his bank account. So at that moment, he made two observations. The first observation was, this is a very interesting experiment that I just ran, I'm a genius. And the second thought that crossed his mind was, I can print my own money. That's what he thought, and he was entirely accurate. You see, instead of paying for the meal, with money, usual money, right, which would be dollars in this case, he pays for the meal with his art, with his own currency. So, he went to another restaurant with a whole bunch of friends. This is still part of the true story. And he repeated the same procedure and sure enough, the cheque ended up on the wall with a different drawing but the point here is the cheque was not deposited. And an another restaurant, an another restaurant and the he went to some of the restaurants that already have one of his cheques with drawing on the wall. And sure enough a second cheque with a different drawing ended up on the wall. The same way that a museum often times has more than one painting by the same artist. So, my question to you is the following. Until when do you think that Dali and his friends were able to enjoy a free lunch? That is to say until when do you think, that Dali was able to pay for the lunches with his own currency, that is his artwork as supposed to US dollars. Think about it for a moment, what you need to focus your attention on, is that he's going to a series of restaurants. He's printing money as he goes in order to pay for the meals. Now that money has the form of a piece of art, a drawing, which is different in each case. Now obviously, the drawing must have a market value. But, as he produces more of these drawings, although each one is different, the value of each of the drawings that all ready exists is probably going down. As you produce, as you're giving to the restaurant owners more of these drawings. So there must be a point at which the restaurant owners decide that enough is enough. And that they would like to get their money not in drawings but rather in the form of US dollars. So, that point of venture was reached. In other words, the owners of fancy restaurants in New York realized that the lee was taking them for a ride. When did that happened? Well, it's very simple. Let's assume for a second that you raise on an honor and you have one of his checks in your possession. On the front, there's the money, $351.27, that was the cost of the meal, very expensive meal for the 1960's and on the back, you have an original drawing by one of the most famous artists in history. But this drawing has a price. So as an owner of the restaurant you would deposit the cheque and get your money in dollars when the market value of the drawing becomes less than the value of the meal, which appears on the front of the cheque. At that point you would be very wise to deposit the cheque, right because you would get $351 and then with that money you could buy a drawing by the Lee in the market which would be less than that amount and keep the difference. Now why am I sharing with you this little story? Well it's very simple. The little story essentially takes us to the consideration as to why people prefer one form of money over another, why people prefer one currency over another. On this chart, what you can see is the extent to which people between 1995 and 2015 Prefer different kinds of currencies in the world. Here we are talking about governments, because governments holds, if you remember surpluses. So, the world extend governments in the world are relying on the US Dollar versus the Euro versus the Swiss Franc, or the French Franc, or Pound Sterling to keep their surpluses. And as you can see, the Dollar continues to be the preferred currency in the world, the Euro is the number two. Notice that since the beginning of the European, that rises in 2009, preference for the Euro has been declining, and pressure for the US dollar has been on the increase. But my point of showing you this chart Is that, it is or there is a currency that is obviously missing from it, and yet we know that it is a very large and influential economy and that's China and the Renminbi the currency that the Chinese government issues. Where is it on this chart? Well, obviously it is not on the chart And the reason for that is that people have very little trust in it. It's a currency that is just purely a domestic currency that can be used in China, right? When the rest of the owners of New York lost their trust in the lease money or form of money, which was is own drawings, right? As they were losing value, because he was printing many of them Then they went back to the US dollars. They deposited their checks. So my prediction about what is going to be about this interplay between the currencies of the two largest economies right now in the world, the US and China, is that the dollar will continue to play a preeminent role, and not the Renminbi for as long as countries, governments, individuals, companies in the world continue to have trust in the US dollar. Now remember, of course, per the Dali story, the issue with a lower, in the long run, is that we will continue here in this country to print a lot of dollars because we have a deficit. And we also continue as you know to print dollars because we want the economy to get out of its problems in the wake of the crisis of 2008. To the extent that it happens, trusting the lower might heroic in the long run. At the the present time and in the foreseeable future however, think about the following. There's really no alternative to the dollar and that's why it continues to be the preferred currency I believe. Now I asked you earlier why the size of the economy and to what extent the economy is a leader in global trade Matters for all of this. Let me justify those two questions for you. You told that at the present time the US is the largest economy in the world and China is the second largest are current to most statistics but that from the point of view of trade, China is the largest economy followed by the United States. Well, why does trade matter here? Well, because it's always more convenient to use the currency of the largest rating nation in the world. Because then, you will have a lower probability of having to exchange one currency for another in order to engage in trade. It's just more convenient. When it comes to the size of the economy, let's go back to this chart. And I want to bring to your attention the case of Switzerland. Switzerland, as you know, is a very safe country, and has a very safe currency. That's why a lot of rich people in the world decide to put their wealth in Switzerland. But as you can see over here, the Swiss Franc, wich is the currency from Switzerland, accounts for a very small percentage of all the resource in the world. In fact, it's that flat line that you see at the very bottom of the chart. So how come Switzerland is so safe, but so few governments in the world hold their wealth, or their resources in Swiss banks? Well, the reason is that Switzerland is a very small country. They cannot issue enough money So, that the rest of the world holds their wealth in their currency. In other words, you need a large country such as the US or China or perhaps the European Union right on Euro zone to issue the currency that other countries in the world hold. You need as big economy and this is I think a very important source Of instability in the global economy right now. So just to summarize, why does it matter so much, right now in the global financial architecture, which are the dominant reserve currencies. Well, because there are very important benefits that countries obtain from issuing a reserve currency, such as the dollar or the Euro and so on. The benefits include lower transaction costs in trade, they include low interest rates. In other words, because so many people in the world hold dollars, that means that interest rates in the United States are lower, because a lot of people are willing to bring their money to the United States, that makes money cheaper than it would otherwise be here in United States. But also having or issuing the world's dominant reserve currency gives that country prestige and it gives it power and influence. In other words you become an indispensable country whenever there's a big discussion or a big summit in the world about a major financial economic problem you have to be invited, if you are the country that provides the rest of the world with the most important reserve currency. But let's not forget and this is the problem that China has in terms of turning it's currency, Renminbi into a true reserve cash. There's also certain requirements, there's also certain things that you have to do in order to obtain those benefits. First, the currency has to be converted, what this means is that, multi forces have to determine its value which is not true in the case of the remmyb. Also it has to be free capital flows. People need to be able to bring money to your country but also able to take it out without asking for permission. That's true in the United States but that's not true in China. Also there needs to be rule of law. That is to say if as an investor you feel cheated You need to be able to go to court to defend your interests. That's true in the United States. Unfortunately, that's not available for the most part in China. Also, you need a large and liquid market for securities. The United States that certainly has the largest and most liquid market for securities in the world. You also need to have predictable government policymaking. Now, some people may argue that the US have become unpredictable in terms of its policy making. But by a wide margin other countries in the world including China are even more unpredictable. And then lastly you need to have a measure of fiscal responsibility, Because people around the world holding your currency will not want you to overspend and have large fiscal deficits. So I would summarize the situation in the global economy right now in the following terms. By making reference to the so called Spider-Man principle. You will remember from one of the early movies, 'With great power comes great responsibility. So every country in the world would like to have the power that comes from issuing a reserve currency that other countries hold as a store value. But unfortunately you can only persuade other countries to hold your currency If you have your house in order. If you're serious, if you're perfectible, if you have a system that guarantees the rule of law and so on. And this is where, specifically, the global economy right now is an a bind because China not yet offers the rest of the world a currency that can be trusted.
