Brad Setser

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Euro continues to soar, renminbi hits new lows …

by Brad Setser
December 24, 2004

If anyone thinks that what the world really needs right now is a weaker Chinese renminbi, do let me know. Yet that is exactly what the markets have delivered this week …

It seems pretty clear that Bush economic policy is not passing the global test. But the tumbling dollar (it has tracked the renminbi down … ) has yet to hit the Bush Administration where it would hurt: the price for the ten-year treasury bond needs to start to tumble as well. That just might prompt a much needed reevaluation of the Administration’s second term economic priorities.

My guess is that Europeans were not buying many Treasuries to begin with, so the fall in the euro-dollar is not (directly) hurting the folks who are lending support to the Treasury market. Despite the rise in the Korean won and some other less-than-fixed-but-not-freely-floating Asian currencies, key emerging Asian economies are still providing substantial support to the Treasury market, and probably to other US fixed income markets as well. Let’s see what happened to China’s reserves in q4. Korea’s too.

Speaking of Europe: French Finance Minister Gaymard suggests that the time has come for international policy coordination. I agree. Alas, support from France probably just assures that it won’t happen, at least in the current political environment.

And speaking of coordination, shouldn’t Europe start by coordinating its own message? If France and Germany are worried about the Euro’s strength, why is the Dutch Finance Minister, Gerrit Zalm,( the Dutch currently hold the rotating presidency of the EU) going around saying the ECB should raise rates. Wouldn’t that just increase demand for euros? Eurozone policy coordination is still very much a work in progress. Lower ECB policy rates to support Eurozone demand would be a core component of any sensible plan for international macroeconomic coordination.

European policy makers minds are no doubt focused on oysters and champagne, not international macro, on the day before Christmas. Markets are thin. So I’ll try to keep this post thin too –

Happy Holidays/ Merry Christmas to all.

18 Comments

  • Posted by Billmon

    “French Finance Minister Gaymard suggests that the time has come for international policy coordination. I agree.”

    However, if coordination is needed, it’s needed most between the parties to BW2. But if the NATO allies, bound together by a web of defense treaties, shared historical experiences, a common culture and a common enemy (the USSR), couldn’t coordinate even a semi-soft landing for the breakup of BW1 — in an era of generalized prosperity yet — what hope is there now? In terms of international relations, this looks an awfully lot more like the early 30′s than the late 60′s.

  • Posted by p

    I’m confused … how is coordination going to help this problem … why can’t the market handle this problem … why must a group of nations get together and manage an issue that is by definition a market issue … I think the real issue is that we do not let the market operate thus creating this problem (may very well be a perceived problem).

    One line of economic logic is that we must drive greater exports and reduced spending/saving from the US. This logic while textbook valid, is wanting from the reality that we find ourselves. How did we get this deep if the textbook logic is true? Did it get manipulated by those who will solve this problem when they get together again?

    Another line of economic reasoning is that the tautology that we are looking at (around current account deficits) explains not reality but one theory of macro economic flows that is at odds with explaining US T Bond rates. This is a major challenge to the theory – either explain the gap or reject the theory. We cannot keep using the argument just wait and see – it’s not a theoretical explanation.

    I will contend that the concern is justified but that we have a political rather than an economic problem. The ascendency of China and Asia as an economic power is pushing aside the on the margin explanations. With over 1B people China will rival the western world. Over the long haul the current account deficit with China/Asia is irrelevant to the growing economic power that China/Asia represents.

    It is here that the wealth / value argument has value. US household wealth is real and significant and does not get reflected in the current savings-consumption debate. It is this sum that weighs both for the US today and for China/Asia tomorrow. That is, us HH wealth is real and significant. This value easily counters the current deficits. Likewise, the future projected wealth of China/Asia continues to fuel investments into the region. Without this weight we have no real basis for discussion. The on the margin analysis represented by the tautologies are empty.

  • Posted by steve kyle

    dear p

    sure you can let the markets deal with it. they will do just that in the end. the point is that there is more than one possible way to adjust to the current imbalances. we ought to choose the most pleasant one rather than just letting things fall where they may. it isnt as if “the markets” just made these imbalances happen all by themselves. what we are seeing is the result (at least partly) of conscious policy decisions taken by the guys in charge of our fiscal and monetary policies.

    and please, lets not imagine that because “theory” cant explain the timing of exchange rate, investment flows and interest rate changes that there is nothing to worry about. On the basis of your theory I guess it must be true that I havent really made 20% returns on my euro vs. dollar bets over the past couple of years.

    the real world is messier than the theories. thats why we can make money on it when theory says there arent any unexploited profit opportunities.

  • Posted by anne

    http://www.nytimes.com/2004/12/25/international/asia/25china.html?ex=1104977006&ei=1&en=1545d715c58cab8a

    China’s Elite Learn to Flaunt It While the New Landless Weep
    By JOSEPH KAHN

    BEIJING – Chateau Zhang Laffitte is no ordinary imitation. It is the oriental twin of Château Maisons-Laffitte, the French architect François Mansart’s 1650 landmark on the Seine. Its symmetrical facade and soaring slate roof were crafted using the historic blueprints, 10,000 photographs and the same white Chantilly stone.

    Yet its Chinese proprietor, a Beijing real estate developer named Zhang Yuchen, wanted more. He added a manicured sculpture garden and two wings, copying the palace at Fontainebleau. He even dug a deep, broad moat, though uniformed guards and a spiked fence also defend the castle.

    ‘It cost me $50 million,’ Mr. Zhang said. ‘But that’s because we made so many improvements compared with the original.’

    Rising out of the parched winter landscape of suburban Beijing, like a Gallic apparition, the chateau is a quirky extravagance intended to catch the eye of China’s new rich. They can rent its rooms and, later, buy homes amid the ponds, equestrian trails and golf course on Mr. Zhang’s 1.5-square-mile estate.

    It is even more conspicuous to its nearest neighbors, 800 now landless peasants who used to grow wheat on its expansive lawns.

  • Posted by anne

    What will determine where we go from here is the way in which China and India and Brazil handle the essential task of equitable growth. Possibly, Dear Brad will think to post more of the superb New York Times China series. Peace to all.

  • Posted by marku

    Happy holidays, Brad.
    Thank you for this blog, and the the questions in comments that you thoughtfully answer

  • Posted by anne

    For a century, we wondered and worried about why developing nations lagged so sorely behind the developed. Now we are evidently finding a catching up by China, India, Brazil, and South Africa. There are other hopeful economies as well, and there is China for them all as a goad and goal. Imagine 2.5 billion people seeing themselves anew in hope. We must weld this revolution in development to economic and sociological models.

  • Posted by anne

    Peace and contentment to all.
    Thank you, Dear Brad.

  • Posted by anne

    http://www.nytimes.com/2004/12/26/international/americas/26argent.html

    Economic Rally for Argentines Defies Forecasts
    By LARRY ROHTER

    BUENOS AIRES – When the Argentine economy collapsed in December 2001, doomsday predictions abounded. Unless it adopted orthodox economic policies and quickly cut a deal with its foreign creditors, hyperinflation would surely follow, the peso would become worthless, investment and foreign reserves would vanish and any prospect of growth would be strangled.

    But three years after Argentina declared a record debt default of more than $100 billion, the largest in history, the apocalypse has not arrived. Instead, the economy has grown by 8 percent for two consecutive years, exports have zoomed, the currency is stable, investors are gradually returning and unemployment has eased from record highs – all without a debt settlement or the standard measures required by the International Monetary Fund for its approval.

    Argentina’s recovery has been undeniable, and it has been achieved at least in part by ignoring and even defying economic and political orthodoxy. Rather than moving to immediately satisfy bondholders, private banks and the I.M.F., as other developing countries have done in less severe crises, the Peronist-led government chose to stimulate internal consumption first and told creditors to get in line with everyone else.

  • Posted by anne

    I am sympathetic to the sense that we have a political-economic problem, as China looks to become an influence and model through developing nations at least on the order of America.

  • Posted by IJ

    International policy coordination, yes. But coordination to what policy?

    Anne’s post on Argentina indicated serious problems. Argentina prospers now because of its protectionism. But the IMF (UN special agency) is said to prefer ‘one-size-fits-all’ globalisation, with no protectionism.

    Moreover, the IMF’s view on optimum currency areas would be interesting. For example, should Euroland disband to floating rates for each nation (one-size-fits-all)?

  • Posted by DF

    Brad, I see no reason at all for the euro zone to lower it’s rate…

    Just try to remember …

    Back in the 1920′s … One old super power did not want to see it’s currency devaluate. It enacted deflationist policies (bashing unions, shipping jobs abroad). It looked for support abroad. And a new emerging power brought it by keeping it’s interest rate low… So low it engineered a massive asset bubble. Which popped in 1929.

    Stock markets and housing markets are at bubble high. Why should the euro central bank lower its rate ?

    saving rates are already falling in europe to US lows…

    Lowering rate in europe would only widen the imbalances and postpone the crisis.

    What I do not understand is why europeans do not force the remnibi up. They should be buying remnibis by the billions. THe low dollar is not hurting the euro economy so much, but the low asian currencies do.

    Merry christmas to all and happy holidays.

    It’s really a cool blog and resourcefull pages in here.

  • Posted by Pall

    Since the Chinese find themselves taking responsibility for the US’ irresponisble fiscal behaviour, and while the RMB remains firmly pegged to the USD with no flotation or adjustment in sight, might it not be interesting to view the US economy and the Chinese economy as one whole instead of two seperate economic entities?
    At present the US half provides most of the spending and the Chinese half most of the savings, but what would the whole balance sheet look like?

  • Posted by IJ

    Is there enough will to coordinate monetary policies? Should Euroland stick with the euro, or scrap the experiment and reintroduce floating rates for each nation?

    Euroland seems to going in the right direction. A reduction of the number of currencies in the world is thought the way forward. The goal is to create greater financial discipline and better governance in globalisation. This month’s IMF’s ‘Financing & Development’ considers single currencies in an article: ‘A single currency for Africa?: Probably not, but selective expansion of existing monetary unions could be used to induce countries to improve their policies’.

    “In August 2003 [following much political pressure, including the creation of the African Union], the Association of African Central Bank Governors announced that it would work for a single currency and common central bank by 2021. The AU’s strategy relies on the prior creation of monetary unions in five existing regional economic communities. These regional unions would be an intermediate stage, leading ultimately to their merger, creating a single African central bank and currency. A plan with such widespread economic and political consequences throughout the continent deserves careful examination.”

    “What does the economic literature, derived largely from Robert Mundell’s seminal 1961 article setting forth the “theory of optimum currency areas,” have to say? In a nutshell, a common currency can save on various types of transaction costs, but a country abandoning its own currency gives up the ability to use national monetary policy to respond to asymmetric shocks. These costs, in turn, can be minimized by greater flexibility of the economy. That is, a country relinquishing its national monetary sovereignty may nevertheless be able to adapt to these shocks, mainly through labor mobility, wage and price flexibility, and fiscal transfers. The likelihood of a country experiencing asymmetric shocks depends on how similar its production and export structures are relative to its partners in the monetary union.” http://www.imf.org/external/pubs/ft/fandd/2004/12/pdf/masson.pdf

    The willingness to make fiscal transfers within a single currency area is declining. This imperils a single currency. Never mind imperilling globalisation.

  • Posted by DF

    The way I see it, as dollar slides … It is natural that US asset prices inflate.
    Investors find US assets cheaper. Profits of US companies should be on the rise.

    The weird thing is that the euro zone markets have not fallen. It’s as if euro markets remain followers of US markets even though they should now be at odds.

    I’m surprised to see no negative effect of the fall of the dollar on euro asset prices.
    In fact I’m surprised to see so little worry given the magnitude of the fall. May be all actors expect the euro central bank to lower its rate. But that would be the biggest error of them all in my humble opinion.

  • Posted by brad

    pall — i did muse about the dollar-renminbi zone as a single economic unit (and draw a US is to China as E. Germany is to W. Germany analogy, since both E. Germany and the US depend on implicit fiscal subsidies, E. Germany via the budget and the USA via the PBOC’s balance sheet) in this post. But obviously, the argument could be taken further. combine the two and you do have both savings to finance investment (China) and spending to spur consumption (USA) …

    http://www.roubiniglobal.com/setser/archives/2004/12/martin_wolf_exp.html

  • Posted by jm

    “p” writes: “… how is coordination going to help this problem … why can’t the market handle this problem … ” and “US household wealth is real and significant.”

    Markets? What markets? If there were any real markets left they would have handled it long ago. Is the very existence of the current monstrous imbalances not prima facie evidence that the markets have been totally subverted by the central banks, IMF, GSEs and other entities unencumbered by market restraints?

    US household wealth? Of just what does it consist? In Japan, after decades of “greater fool theory” pricing in the real estate market, some semblance of sanity has emerged, and the conventional wisdom is now, “Kane wo umanai fudousan wo kauna!” (“Don’t buy land that doesn’t yield income.”) Just how much income does US household wealth yield today? Dividends, interest rates, rents? All are low, despite mad growth in the money supply.

    Anne’s post about Chateau Zhang Lafitte and the 800 peasants it displaced is tres apropos. Able to sell the labor of their countrymen at an 80+% discount, the elite of China have it even easier than their Japanese counterparts*. Were free markets allowed to have anything to do with the yuan/dollar or yen/dollar exchange rates, a great many very powerful people in Asia would soon be in very deep trouble.

    *(whose manipulations now perhaps get them only a 20% discount — but with Chinese labor available, perhaps they now have less need to underpay their own…)

  • Posted by Guest