Tag Archives: exchange rates

Obama In China: Breaking The Exchange Rate Deadlock

President Obama leaves next week for a high profile trip that includes meetings with other “Asia-Pacific” countries (in the APEC forum) and a visit to China.  The President has had considerable diplomatic success on the economic front to date, including at the G20 summit in April and – to a lesser degree – at the follow-up September summit in Pittsburgh.

But the issues facing him now in Asia are particularly difficult, primarily because of China’s exchange rate policy.  China essentially pegs its currency (known as the yuan or renminbi) against the US dollar, which means that it rises and – most recently – falls in tandem with the greenback.

Many countries operate de facto pegs of this nature, but China is problematic for three reasons: it is a large economy (10 percent of world GDP, if we adjust for purchasing power), it runs a big current account surplus (exporting more to the world than it buys from the world, in the range of 6-12 percent of the Chinese economy), and it consistently has a bilateral surplus with the US that is galling to many on both sides of the aisle on Capitol Hill (and their constituents). Continue reading

Defending A Peg: Lessons for the US Banking Authorities

You’ve seen it a thousand times.  A country’s exchange rate used to make sense, but now it is hopelessly overvalued.  And, consequently, your pegged exchange rate now looks like a one way bet.  Every Financial Times subscriber starts to think about how to either get out of your currency or, if they are feeling aggressive, how to more actively speculate that the exchange rate will soon depreciate.

And the beauty of this situation – from a speculator’s point of view – is that the relevant authorities will never move quickly or decisively to the inevitable end point.  Sooner or later, the currency will be devalued and, if the country’s citizens are lucky, sensible economic policies (and perhaps external financial support) will be put in place to support the new exchange rate.  But, for a surprisingly long time, the government will make statements along the lines of, “we will defend our exchange rate,” “we have plenty of reserves,” “we will never devalue,” or – my favorite – “the fundamentals are fine.”

This analogy sprang to mind when I read this morning’s joint statement by Treasury, the FDIC, OCC, OTS, and the Fed. Continue reading

Currency Crisis for Beginners

(One of our objectives is to help non-specialist readers understand what they are reading in the news. Instead of appending everything onto the very long Financial Crisis for Beginners page, I’m going to start doing individual posts and linking from that page to the posts. Advanced readers can choose to skip the “beginners” posts – or they can help improve them through comments.)

In honor of Paul Krugman, recent Nobel Prize winner and “inventor” of the currency crisis, we seem to be experiencing a global currency crisis. This may prompt the question: what is a currency crisis?

Different countries (or regions, like the Eurozone) use different currencies. These currencies generally float against each other, meaning that their relative prices are set by traders on foreign exchange markets, although sometimes they are fixed (meaning just that the central bank acts on the market to keep its exchange rate where it wants it). Changes in exchange rates are normal and are driven by a number of factors, such as interest rates in different countries: a higher interest rate creates demand for a currency, and as with most things higher demand leads to a higher price (meaning that currency has greater value). More generally, a currency’s value should be related to the long-term attractiveness of the economic opportunities available in that currency.

Continue reading

Starting to Wonder About Internal G7 Dynamics, Just A Little

The G7 did speak on major exchange rates, over the weekend, as expected. But they only spoke about the yen’s “recent excessive volatility.”  This was about the least they could say under the circumstances, and it is not clear that it will do anything – other than encourage further flows into the dollar.

Why did they not mention the dollar, the euro, and the British pound? One possibility is that they are happy with the appreciation of the dollar and the depreciation (falling value) of the euro and the pound. This would be a bit strange, given that dollar depreciation – from 2002 through the summer – was considered by the G7 to be a reasonable component of the global adjustment process that would put current accounts onto a more sustainable path (yes, notwithstanding “strong dollar” statements from the US.)  The dollar was getting close to what the G7 (and the IMF, who do a lot of the technical work in this regard) saw as a plausible “medium-term” value, at least as measured against a broad basket of currencies.  Now the dollar has taken off (i.e., rising in value against almost all currencies). How does that help with anything?

It could be the case that the Europeans like the depreciation of their currencies, as this will help cushion the recession.  The falling value of the euro makes interest rates cuts in the eurozone less likely, because the European Central Bank (ECB) will see the depreciation of the euro as helping the real economy and also increasing (their) fears about inflation.  But given the ECB’s obsession, even today, with inflation – and thus its unwillingness to cut interest rates, come what may – it might be that depreciation is the eurozone’s best short term hope (as well as its likely medium term future, as sovereign risks materialize for smaller countries).

Still, it would be odd if no one at the G7 table isn’t already raising the dangers of deflation (falling prices), particularly in the US – I’m looking at the representative of the Federal Reserve at this point.  Commodity prices are falling worldwide and now the price of imports into the US will decline sharply.  If this feeds into low prices (i.e., a lower price level, not just slower inflation) then short-term, of course, US consumers benefit.  But if lower prices lead to lower wages, then just think what that does to anyone’s ability to pay their mortgage or any other debt – these are almost always fixed nominal amounts.

When people talk about avoiding the mistakes of the Great Depression, they mean in large part not allowing prices and wages to fall.  And the faster and further that the dollar appreciates, the more likely we are to worry about deflation.

What then are the internal G7 dynamics?  Based on what we saw, and didn’t see, this weekend, I would guess that recriminations and nonconvergent policy views prevail. The spirit of cooperation we saw around bank recapitalizations, just two weeks ago, must have evaporated.  We may not want to rely on the G7 to lead the way.  Can I interest anyone in a G20 summit?