Famous and influential CEOs and investors couldn't escape two questions in recent months.
The other question is related to the first: is the U.S. dollar in the process of losing its status as the world's reserve currency, or de-dollarization, that it has had since the end of World War II?
This question arises from blunt headlines saying that Russia is now considering using China's yuan for its global trade. Then talk followed that Saudi Arabia, a major US ally, was considering charging in yuan for its oil exports to China.
Things accelerated: France was reportedly considering buying gas from China with yuan, while Brazil and Beijing were considering no longer using the US dollar in their bilateral trade relations.
The avalanche of rumors about the demise of the US dollar was such that some headlines said that the Brics countries -- an acronym for Brazil, Russia, India, China, and South Africa -- were considering developing a new reserve currency, while India was in the process of settling some trades in rupees.
All this news had a common theme: The de-dollarization of the world economic stage was under way.
The greenback had lost or was in the process of losing its place as the top choice in world trade and finance, this theme suggested. It was circulating mostly among conservatives and critics of the policies of President Joe Biden's administration. The death of the US dollar on the global stage was inevitable, they predicted.
This narrative is based primarily on the fact that in the aftermath of World War II, the US gross domestic product accounted for almost half the world's GDP, a situation that placed the US dollar as the main currency of global exchange, store of value and unit of accounting.
But the US economy is no longer as dominant as it was, these critics say, so the reign of the US dollar is also nearing the end.
"Over the past few years, the Federal Reserve has telegraphed that they intend to monetize the debt by printing trillions of dollars, even as they insist that they're fighting inflation," the teenager said. "Already other major economies in the world such as China, Saudi Arabia, and Brazil, are moving away from the dollar in anticipation of this. My question is, are we likely to face a time in the future when the US dollar is no longer the global reserve currency?"
"How is Berkshire prepared for this possibility? And what can we do as American citizens to attempt to shelter ourselves from what's beginning to look like the beginnings of de-dollarization?"
Buffett responded bluntly. He said he was not worried about other countries trying to reduce their reliance on the US dollar. For him, there is no risk of another currency replacing the US dollar as the world's reserve currency. In contrast, he warned the federal government against overspending because it could erode the value of the greenback and fuel inflation. He also warned that overprinting money risks causing consumers to lose faith in the value of their savings, which is not welcome.
"We are the reserve currency. I see no option for any other currency to be the reserve currency," the billionaire said, adding that nobody understands the situation better than Fed Chair Jay Powell even though he's not in control of fiscal policy.
'It's Madness to Just Keep Printing Money': Buffett
"Nobody knows how far you can go with a paper currency before it gets out of control, particularly if you're the world's reserve currency...And you don't want to try and pick out the point where it does become a problem because then it's all over," he argued.
He referred to the aftermath of World War II, noting that inflation grew quickly back then. As a result, "we should be very careful," the legendary investor said, warning that people need to trust that their savings will retain most of their value or they will lose faith in the currency.
"Once you let the genie out of the bottle and people lose faith in the currency they behave in an entirely different manner than they do when they feel whether they put some money in the bank or pension plan or whatever it may be, that they're gonna get to have something with roughly equal purchasing power."
Buffett said that Berkshire is "better prepared" than most investments to withstand inflation, but not "perfectly prepared."
"It's madness to just keep printing money," the billionaire argued.
He admitted, however, that the circumstances which caused the inflation were exceptional, going so far as to speak of "semi war".
When the coronavirus pandemic hit in early 2020, restrictive measures and lockdowns followed to limit the spread of the disease. To avoid an economic disaster, the federal government announced stimulus packages for households and businesses, especially small businesses. This situation led to an imbalance between supply and demand, which led to inflation at its highest level in several decades. The Fed is raising interest rates, which had been cut to near zero throughout the pandemic, in hopes of curbing rising prices for goods and services.
Like Buffett, some experts including Ian Bremmer, founder and president of Eurasia Group, believe that the US dollar is far from losing its throne because there is no viable alternative.
In 1945 the dollar replaced the pound sterling as the currency of global trade. The yuan, they say, cannot replace the dollar despite Beijing's aspirations because China "lacks the investor protections, institutional quality, and capital-market openness required to internationalize a yuan that is still not fully convertible overseas."stimulus pandemic coronavirus fed federal reserve pound us dollar yuan spread gross domestic product gdp global trade interest rates stimulus oil africa india brazil france russia china
Disney World brings back fan favorite transportation choice
Not every major company has done the same thing (we’re looking at you, Starbucks).
That went away during the pandemic because customers did not like the idea of touching a dispenser that another person had just touched. Never mind the shared counters drinks were placed on, the napkin and straw dispensers that everyone touched — pouring your own milk or cream came with an enhanced risk of illness.
In reality, maintaining milk stations — sometimes more than one in each store — cost the chain a lot of money. Keeping the dispensers filled was labor intensive and customers got mad when one was empty. And people likely used or wasted more milk and cream compared with the current policy, where those are kept behind the counter.
Starbucks made the change at a time when companies could do anything if they used "public safety" as the reason. Some of those changes, however, were not reversed once the impact of covid lessened and most of society returned to normal
Walt Disney (DIS) - Get Free Report, for example, got rid of parking trams at Disney World. That made sense since the trams were not built for social distancing and smaller crowds meant shorter walks to the parks.
In September Disney fully restored that service, which surprised some park visitors. Now, the theme park giant has brought back another transportation option that some thought might be gone for good.
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Disney World improves transportation
Disney World's massive property creates unique transportation challenges. Magic Kingdom, for example, is not within walking distance from its de facto parking lot, the Ticket & Transportation Center.
To get people to its signature theme park, the company offers its famed monorail and a ferry boat service. You can also ride the monorail to Epcot, between the Magic Kingdom and Epcot, and to the Contemporary, Grand Floridian, and Polynesian Resorts.
Disney World also offers a boat service between Epcot and Hollywood Studios. In 2019, the company added Skyliner, a gondola service that connects the Pop Century, Art of Animation, Caribbean Beach, and Riviera Resorts with Epcot's International Gateway and with Hollywood Studios.
Adding Skyliner made staying at the theme park's value resorts, Pop Century and Art of Animation, a lot easier. Those properties used to be served with buses, which were often stressed during peak times.
Skyliner, which is open air, did not close during the covid period, aside from areas where properties it connects were closed.
The service has been popular as it has made it faster to get between parts of the massive theme park in a way that, like the monorail, feels like a ride, not simply transportation.
Disney brings back a popular transportation choice
Disney World's size means that no one transportation solution will work.
The company has brought back another — one that many thought might be a permanent covid casualty. The theme park company disclosed the move on its Walt Disney World Cast and Community Facebook page.
"Guests at Walt Disney World will once again be able to sail across Bay Lake between Disney’s Contemporary Resort, Disney’s Wilderness Lodge, and Disney’s Fort Wilderness Resort & Campground. Marked with its signature blue flag, the watercraft 'blue route' will return for afternoon and evening voyages beginning Oct. 1, making it even easier to grab a bite to eat at neighboring resorts."
That was met with excitement from followers of the page.
"I had almost given up hope on this completely! I am so happy to see this service return," Denis Iverson McGilvery wrote.
That was the general sentiment shared by hundreds of followers, while a few hoped for even more returns to service.
"This is great news! Hoping to see the second launch at Disney Springs open up soon as well," Elizabeth Kelley added.social distancing pandemic
Working with Communities: The Importance of Partnerships in Our Industry’s Success
NAIOP’s 2023 chair talks about four topics that often arise during his visits to chapters across North America: community relations, e-commerce, EV trends…
Since assuming the position of NAIOP chair in January, I’ve had the pleasure of visiting chapters from Orlando to Milwaukee to SoCal, talking with thousands of members about current market conditions, the forces impacting our industry, and our future as an organization. Four topics have frequently arisen during these conversations, regardless of chapter location or size. These include:
1. Community Relations. In today’s environment, it’s essential that developers fully understand the impact of their product type on the communities in which they operate, particularly regarding the types of jobs, hours of operations and the environmental impacts of their project (traffic, water, energy, etc.). Whether developing in South Florida, New Jersey, Chicago or Los Angeles, our chapters report increased anti-growth sentiment and the importance of engaging with the community early and often.
2. E-commerce’s Role: Facility Demand and Data. E-commerce sales as a percentage of total retail sales were on a growth trajectory before the pandemic, turbocharging the industrial sector. While truck traffic associated with home deliveries has received attention from news organizations, non-governmental organizations and policymakers alike, consumer behavior as the driving force is often ignored. Further, some research suggests that ordering goods for delivery is better for the environment because people make fewer individual trips to malls, grocery stores and other local shops. Comprehensive research about e-commerce’s environmental footprint is needed to help educate our external audiences and debunk common misconceptions.
Regardless, developers need to clearly articulate e-commerce’s economic impact and the role industrial real estate plays in the community. For that sector – one I’ve been part of for four decades – it means helping policymakers, community groups, the media and the public understand that a) consumers are choosing e-commerce, which requires three times the amount of logistics space; and b) e-commerce can be a more sustainable option compared to traditional brick and mortar. In addition to the economic growth case, it’s important to explain our role as real estate developers in helping their community run smoothly and durably. We should partner with communities to underscore the importance our properties have in the ability to deliver essential goods, including baby formula, medicine, clothing and food.
3. EV Trends. In response to growing truck traffic and climate change concerns, many communities – typically on the West and East Coasts – are imposing requirements around the electrification of commercial vehicles. Southern California leads the pack.
Two years ago, Southern California’s local air quality regulatory body approved the unprecedented Indirect Source Rule (ISR), which required warehouse occupiers to quantify and report vehicle trips to and from warehouses to identify impact and be the basis for issuing taxes. Because of this, and in addition to new laws around electric vehicles at the state level, California businesses are investing heavily in electric trucks and vans and the infrastructure needed to support them.
Members from NAIOP’s California chapters, comprising the NAIOP California State Council, continue to experience the evolving spread of the ISR throughout the state. We also see other states looking at adopting similar “indirect source” concepts, including New Jersey, New York, Washington, Colorado and Nevada. NAIOP will continue to track and provide updates on this issue, as members in urban areas will no doubt keep seeing this policy impacting development projects.
4. Designing Policies with Communities. We have seen an increase in antiwarehouse development sentiment. Some communities have used moratoriums to pause new projects in response to community pushback, typically on environmental impact grounds. NAIOP and other business associations continue to make the case that such moratoriums disrupt the supply chain, hamstring businesses from operating efficiently, and create job and economic losses.
In some communities, NAIOP members have worked with city staff and the community to create good neighbor policy agreements. These volunteer agreements can address issues like setbacks, landscape screening and noise abatement strategies. In some situations, these agreements can help speed up the entitlement process and create a positive relationship with the community. Developers have found that proactively incorporating neighborhood-friendly building features is a more effective approach than having aggressive approval conditions imposed upon their projects that impede functionality and are overwhelmingly expensive if legislated upon them.
This year as NAIOP chair has been a meaningful one for me. As we begin the fourth quarter and the end of my term, I’ll continue to be steadfast in strengthening NAIOP and helping this organization and its members boldly talk about the value our industry brings to communities and the economy. I look forward to my remaining chapter visits and seeing many of you at CRE.Converge later this month in Seattle.
This piece has been adapted from the chair’s column in the fall issue of Development. Access the fall 2023 issue here.economic growth real estate spread pandemic
Options for Calculating Risk-Free Rates
One of the most fundamental concepts in finance is the notion of a risk-free rate. This interest rate tells us how much money investors are guaranteed…
One of the most fundamental concepts in finance is the notion of a risk-free rate. This interest rate tells us how much money investors are guaranteed to receive in the future by saving one dollar today. As a result, risk-free rates reflect investors’ preferences for payoffs in the future relative to the present. Yields on U.S. Treasury securities are generally viewed as a standard benchmark for the risk-free rate, but they may also feature a “convenience yield,” reflecting Treasuries’ special, money-like properties. In this post, we estimate a risk-free rate implicit in the prices of S&P 500 index options—called the box rate—to measure investors’ time preference separate from Treasury convenience yields.
Risk-Free Payoffs from Options
Options with a European-style expiration can be used to replicate a risk-free payoff using the put-call parity relationship. By buying a put option and selling a call option of the same strike price and maturity, an investor receives the strike price in exchange for delivering the underlying asset on which the option is written. By then selling a put option and buying a call option for a different strike price with the same maturity, an investor can construct a risk-free payoff equal to the difference in strike prices, as shown in the chart below. In industry jargon, this trade is sometimes called the box spread. The difference between the price of the box spread portfolio today and its payoff at maturity reveals a risk-free rate that we call the box rate—the rate at which investors can borrow or lend in the option market. Historical estimates of the box rate from a recent paper are available here.
The Box Spread Trade: Replicating Risk-Free Payoffs with Options
Estimating Box Rates
We estimate box rates using S&P 500 index options (SPX options). SPX options are among the most liquid and heavily traded options in the world. They have a European-style expiration and long time-series of available historical data, serving as the basis for the Cboe Volatility Index (VIX Index).
The chart below presents an example of estimating box rates on March 15, 2022, the day before the Federal Open Market Committee (FOMC) began its most recent rate hiking cycle. The top panel estimates the one-year box rate from an ordinary least squares (OLS) regression that exploits put-call parity. The box rate implied by the slope coefficient is 1.59 percent. Since option markets are close to arbitrage-free because of the competitive forces in financial markets, put-call parity holds almost exactly. In this example, the R-squared is .99999992 out to seven nines and the standard error of the box rate estimate is less than .01 percent, or one basis point.
The bottom panel extends the analysis to multiple maturities. The box rates and Treasury yield curve have a similar upward slope. The convenience yield, which is the spread between these curves, ranges from 10 to 30 basis points across different maturities.
Example of Estimating the Box Rate
Box Rates and Treasury Convenience Yields over Time
Analyzing box rates and Treasury yields over time, we find three main results. First, from January 1996 to April 2023, the box rate is 35 basis points above the Treasury rate on average, implying a 35 basis point convenience yield. Second, convenience yields grow dramatically during the financial crisis of 2007-09, reaching a peak of roughly 130 basis points in October 2008 as a one-month moving average. Third, the average term structure of convenience yields is almost flat across maturities out to three years.
The chart below illustrates the first two results. The top panel plots the time series of the one-year box rate and Treasury rate over time. The bottom panel plots the convenience yield, which equals the difference between the two rates. Box rates and Treasury rates closely comove, with the Treasury rate consistently below the box rate throughout the sample. In addition to being consistently positive, the convenience yield also exhibits some time-series variation, spiking most significantly during the 2007-09 financial crisis, while staying at more stable levels between 20 and 40 basis points in recent years.
Box Rate Closely Tracks the Treasury Rate and Implies a Positive Convenience Yield
The chart below illustrates our third result by plotting the average term structure of convenience yields. As we saw in the example above, box rates can be estimated for different index option maturities. We find that the average level of convenience yields is relatively stable and close to 35 basis points across maturities. This means that when the Treasury issues debt at any maturity out to three years, it tends to save around 35 basis points relative to the risk-free rates implicit in the option market.
Convenience Yield Term Structure Relatively Flat out to Three Years, 35 Basis Points on Average
Interpretation and Applications
Treasuries are generally considered to be one of the most liquid securities in the world, as they can be traded quickly, in large scale, and at low cost. Treasuries are also a common form of collateral that play a unique role in regulatory capital and liquidity constraints. Because options are risky financial derivatives, the box rate is an alternative risk-free rate benchmark that is based on option prices that do not embed a safe asset premium. Note that the recent effort to replace LIBOR with a new benchmark interest rate shows the importance of finding risk-free rate alternatives. The box rate, which is based on market prices, is one candidate that may be considered alongside other robust reference rates such as SOFR (Secured Overnight Financing Rate) to support financial stability.
The convenience yield estimated with the box rate is also a potentially useful barometer for stress in the financial system. It measures how much investors are willing to pay to hold Treasury securities instead of less money-like assets with identical cashflows. In historical data, the convenience yield was largest during the financial crisis of 2007-09. Investors and policymakers who want a real-time measure of the scarcity of safe assets may therefore find convenience yields based on box rates useful.
Economic Magnitude of Treasury Convenience Yield
As a back-of-the-envelope approximation, if we apply the one-year convenience yield estimated with the box rate to the amount of Treasury marketable debt outstanding each year, the Treasury convenience yield has saved taxpayers around $35 billion per year over the past twenty years. Given the increase in debt following the COVID-19 crisis, this amount has increased to $70 billion per year since 2020. These significant taxpayer savings bring into focus the importance of suggested reforms and recent research on the Treasury market, where improving the resiliency and functioning of the Treasury market may help to maintain Treasuries’ convenience yield.
Jules H. van Binsbergen is the Nippon Life Professor in Finance at the Wharton School of the University of Pennsylvania.
William Diamond is an assistant professor of finance at the Wharton School of the University of Pennsylvania.
Peter Van Tassel is a financial research economist in Capital Markets Studies in the Federal Reserve Bank of New York’s Research and Statistics Group.
How to cite this post:
Jules van Binsbergen, William Diamond, and Peter Van Tassel, “Options for Calculating Risk-Free Rates,” Federal Reserve Bank of New York Liberty Street Economics, October 2, 2023, https://libertystreeteconomics.newyorkfed.org/2023/10/options-for-calculating-risk-free-rates/.
The views expressed in this post are those of the author(s) and do not necessarily reflect the position of the Federal Reserve Bank of New York or the Federal Reserve System. Any errors or omissions are the responsibility of the author(s).
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