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CiteIn case you haven't noticed, the dollar is now closer to 1.30 (v. the euro) than 1.20 – or even 1.15. Carry is no longer king. There is talk of a "regime change" in the fx market. Or at least an attitude change. If the G-7 takes imbalances seriously, the fx market will too …
It isn't just the euro either. The pound generally seems to move in tandem with the euro (Sorry, Maggie). And Canada has a strong dollar policy even if the US doesn't. The loonie, like oil, is testing multi-year highs.
It sort of feels a bit like 2004 all over again. At around $1.26 for euro, the dollar is about where it started 2004 – and about where in started in the fourth quarter of 2004 as well. Korea is back in the market as well, fighting won appreciation. Steve Johnson of the FT:
Furthermore, the final communique from last weekend's G7 meeting, which called for greater currency flexibility in emerging Asia to help reduce global imbalances … also led to expectations that the dollar might finally weaken against Asian currencies.
Indeed this happened – for an entire 24 hours – before Japan started complaining about the speed of the move and South Korea backed up its own complaints with a wall of intervention to stop the won from strengthening.
I feel for the Koreans. The Bank of Korea seems to want to run an independent monetary policy. They don't want to be part of the dollar block. But it is hard out there for a won … when the rest of North Asia sits out the dollar move. Japan's Vice Minister is working hard to keep the yen very, very weak in real terms. And China decided not to operate a basket peg last week. The won isn't just strong v. the dollar. It is also strong v. its etymological cousins the yen and the yuan.
The US may – or may not – have a weak (strike weak; insert competitive) dollar policy. Tim Adams certainly would like China to have a strong RMB policy. Bernanke denied the G-7 statement signaled any intent to manage the dollar down, but he also said the G-7 wants market determined exchange rates. Bloomberg:
Bernanke today also said it is “not correct'' that the G-7 sought to weaken the dollar. The group “supports a market- determined dollar,'' he said.
In the first quarter, countries outside the G-7 spent about $180b (by my calculations) resisting market pressures for their currencies to appreciate. A market exchange rate for the dollar right now means a weaker dollar … Just ask Korea's central bank.
And even if the US doesn't have a weak dollar policy, the Saudis clearly have a weak riyal policy. The Saudis – along with the GCC – have intervened heavily this year to drive the purchasing power of their currencies down. That's right. The Saudis and the rest of the Gulf buys European, not American – at least when they purchase goods rather than financial assets. And even as oil has soared (in both euro and dollar terms), the external purchasing power of the Gulf currencies has fallen.
The fall in the real value of the currencies of the oil rich states in the gulf over the past few years is an immensely underreported story. Since 2002, oil has gone from $20 to $75 – and the purchasing power of the Gulf currencies in places like Europe has gone way, way down. Look at the real exchange rate graph on p. 29 of the WEO, then skip to the analysis on p. 81 (in the second chapter). The real depreciation of the Gulf currencies is one big reason why very little of the Gulf's oil windfall – only 15% according to the IMF — has been spent on imports.
China clearly has a weak RMB policy. It intervened actively last week to drive the RMB down against the euro. Forget about a basket peg. A basket peg requires that the RMB appreciate against the dollar when the dollar falls v. the euro to keep the RMB from falling too much v. the euro. That would have meant letting the RMB go through 8. China refused. Maybe they didn't want to reward Dubya for his snub summit. Or maybe they never really stopped pegging to the dollar. No matter. In real terms, the RMB is weaker now than it was at the beginning of the year.
You know that old canard that China is just taking market share from the rest of Asia. It ain't true. US imports from East Asia (the Pacific Rim category in the US data) are on track to rise from 3.75% of US GDP in 2002 to 4.75% in 2006. And Eurozone imports from Asia rose from 3.6% of Eurozone GDP in 2002 to 4.6% of Eurozone GDP in 2005, as imports from China nearly doubled (rising from 62b euros to 118b euros) in three years Fact-based economics should trump anecdote-based economics: electronics assembly has shifted to China from elsewhere in East Asia, but that isn't the only thing that has shifted.
I mention this because in a world where the two key surplus regions – a block in emerging Asia centered around China and a block in the middle east centered around the Gulf – tie their currencies to the dollar, global adjustment works a bit differently.
Dollar depreciation can lead to a surge in dollar zone exports to countries outside the dollar zone. Look at Chinese exports to Europe. They grew at an average annual pace of 24% from 2003- 2005, in euro terms.
Over the same time period, US exports to Europe actually fell slightly in euro – though not in dollar — terms.
In the past repeats itself, the current bout of dollar (and RMB) weakness could lead to a bigger Chinese current account surplus and more Chinese financing of the US – particularly if it if creates expectations of RMB appreciation and stronger inflows fuel much stronger reserve growth.
Or dollar depreciation can slow the increase in imports in the Gulf, so more of the $75 a barrel oil windfall is saved and thus sent back to the US. It is easy to be a Saudi prince these days … 8 mbd of exports at $75 brings in $220b, or about $10,000 for every Saudi …
Both Chinese export growth and restrained import growth in the Gulf – relative to the surge in oil revenues — may have a bigger impact on the overall current account deficit of the dollar zone than any impact a depreciating dollar has on the US current account.
I do think the dollar matters. The fall in the dollar since 2002 is a big reason why US export growth has been very robust in 2004, 05 and so far in 06. But the US export sector is – sadly – tiny. Goods exports are only ½ goods imports. That means exports have to grow really, really, really fast to offset rising imports from China and the oil states.
It is far easier if rising surpluses in China and the Gulf offset the still (rapidly) growing US deficit, keeping the dollar zone's overall deficit from rising too much. Plus, so long as China attracts inflows of capital from outside the dollar zone and channels them to the US, it can help finance the overall deficit of the dollar zone (read the United States deficit).
Of course, all this has a price. Global adjustment is a lot harder is the currencies of big surplus countries are tied to the dollar (this is where I disagree with Stephen Roach). The dollar right now is depreciating against another deficit region (the eurozone) rather than against surplus regions … the natural adjustment process has been thwarted.
Moreover, private actors inside the dollar zone are not, by and large, willing to finance the US. Chinese savers don't want to buy (over-priced) US assets at the current exchange rate (look at the pattern of hot money flows). And no one really knows who private savers in the gulf want to finance since the oil sheiks don't distribute the oil surplus directly to their people, but rather stock it away – whether in government deposits at the central bank (Saudi Arabia), an oil fund held at the central bank (Russia) or various government run investment authorities (Abu Dhabi, Kuwait, the Emirates … ). Saudi central bank foreign assets rose $24.6b in the first quarter, Russia's reserves rose $23.65b over the same time. And Russia added another $11b in the first three weeks of April alone …
Central banks in the dollar zone's surplus countries have to finance the dollar zone's deficit country. That as Dr. Roubini and I have long argued means that the central banks will lose money over time. Yu Yongding and his colleagues at the PBoC are aware of this too.
And following the dollar down has other costs as well. China's economy is on the verge of overheating, if you haven't noticed. The last thing China needs is an even weaker currency, more stimulus for its export sector, more capital inflows, more funds for the banking system to play with, and more investment. Andy Xie is right.
Sun Bae Kim of Goldman framed the issue well. In early 2004, China was in a similar position. And it opted to restrain domestic demand by curbing bank lending while keeping the RMB constant. The result was a big rise in its trade surplus. It could do the same thing this time around; restraining domestic demand growth without letting the RMB move, slowing imports and pushing up China's trade surplus. That would help generate the financing the US needs …
Or it could start to let the RMB rise, let a stronger RMB help the central bank out and begin to move out of Stephen Jen's dollar block …
Far be it from me to predict what course China will choose – or what course the GCC will choose. I am confident though that dollar-block weakness will put more strain on the central banks in the surplus countries of the dollar block. Some decisions that could be postponed back when the dollar block was rising will come back to the fore. But I certainly don't know when the world's central banks will say "enough."
They haven't yet. Faced with renewed pressure, Korea and India have both stepped into the market and bought more reserves rather than let their currencies move. Russia's reserve growth in April should be kind of impressive. Saudi Arabia's non-reserve foreign assets should grow fast too.
In the first quarter, I suspect that the world's central banks – including Japan — added nearly $200b to their reserves. China, Russia and Saudi Arabia combined for over $100b. Annualized, that is $800b. Most of that came from central banks in the dollar block. And that was with a relatively stable dollar. With a weaker dollar, the amount of intervention needed to sustain the current (not entirely market-determined) equilibrium might be $250b, or a $1 trillion annual pace.
I know that is a big number. But I am not joking. If carry is no longer king, sustaining a $1 trillion US current account deficit may take $1 trillion in reserve accumulation … Along with the continued willingness of all private investors – American and non-American alike – to continue to hold their existing dollar assets …
Single-most important observation: “market forces” are consistent with a weaker dollar. Obviously the G7 aren’t going to proactively pursue a weaker dollar policy through FX intervention — at least not until Sep
But as you observe, declaring that the G7 could like “market forces” to prevail is certainly consistent with a weaker dollar. Too bad nobody on the JEC had the sensibility of asking Bernanke what he thought those market forces were or would be in the future – surely the FED stopping has an important role to play.
Question: do things get potentially mess ahead of the mid-term elections if China’s stays the course? It sure seems that they are digging in their heels.
Brad — you wrote in the previous blog comment, about the Dialynas paper : “I wonder if foreigners would be as willing to buy agencies and MBS even at decent spreads over zero rate treasuries in that context. The fed can fix some rates, but not all.”
As yields fall, existing holders of long term debt could expect capital gains that would partly offset currency valuation losses. The hedge fund community would certainly help here : the US doesn’t have a big export base, but it sure has a big “financing base” !
And after all, this ZIRP policy would be designed in the first place to prevent further dollar accumulation by foreigners, to bring the CA deficit down — Dyalinas describes it as an implicit import tax, in response to the subsidiary pegs provide.
raphael kahan
So — in a way, the Gulf states are actually one of the strongest forces supporting the dollar. Well, I guess the silver lining would be that Saudi Arabia and China have inadvertently pegged to each other, so crude isn’t getting any cheaper for them…
Is it possible at this point that the trade flows in and out of the rest of the dollar zone are so large that the acts of the U.S. have limited effect on the dollar itself due to all this inertia swinging around with it? I’d love to break down the relative size of trade flows within and without the dollar zone if I had time.
These big numbers sure are fun to watch. Wish I didn’t have to live through the aftermath.
Bill Gross: the way a reserve currency nation gets out from under the burden of excessive liabilities is to inflate, devalue, and tax.
Gross: “It will be an easier task, in fact for GM to renovate its product line than for the U.S. to revamp its.” I am starting to sound like a moderate …
John Mauldin: Feldstein is only acknowledging what everyone knows. The dollar must fall over time as part of the process to balance the trade deficit. The imbalance can go on for a lot longer than most dollar bears think, but not indefinitely. Better to start the process now and have it go slow and, if not actually smoothly, then not precipitously. Feldstein is giving intellectual cover for a policy everyone knows will be implemented, whether actively with worldwide cooperation or forced more violently by the markets.
China’s current-account surplus rose to $160.82 billion in 2005, more than double the $68.66 billion surplus recorded in 2004, the country’s foreign-exchange regulator said.
Indian firms have unveiled 47 overseas acquisitions valued at $2.2 billion so far this year, and are on track to surpass last year’s record $3.7 billion in Indian foreign acquisitions.
Brad–I agree that China and oil producers have a key role to play for reducing the global imbalances: they have to appreciate their currencies and increase absorptions. At the same time, the US must reduce fiscal deficit and increase household savings, probably through higher tax and interest rates.
The end result of these may well be a significant slowdown or a recession in the US economy, coupled with a large dollar depreciation. Whether the US as well as China and oil producers are prepared to accept this as a necessary price for avoiding the global imbalances to explode, we have to see.
Imagine the political uproar if Saudi Arabia started to overtly manipulate the price of oil (by taking some production off the market) during a US slowdown, and if US imports from China continued to rise during the slowdown b/c China’s currency stayed unchanged … manipulated oil and manipulated $/ RMB — at the same time.
Thanks for the data on China’s current account surplus. Not really a surprise, but still good to know. I have gotten enough wrong that I am happy to score a few successes. And the one thing I got right was China’s current account surplus.
Better read maudlin.
by the way, if everyone knows the dollar has to fall, why wasn’t that expectation factored into US real rates (the Krugman question?)
Imagine the political uproar if Saudi Arabia started to overtly manipulate the price of oil (by taking some production off the market) during a US slowdown
There’s very little to imagine, because this would immediately result in war. The Guardian had an interesting story on this:
http://observer.guardian.co.uk/comment/story/0,,1764542,00.html
Any subsequent analysis is too complicated to evaluate beyond, “really bad.” A much more clever strategy by Saudi Arabia, though with slightly more domestic complication, would be simply to unpeg its currency. How could America object to that?
I would add one big factor on top of this one.
The housing bubble is finally popping in the USA. Sales are down. Prices will follow, and then bankrupcies.
I think it is fair to expect a credit crunch sooner than later.
How will foreigners lend the USA if the US citizens want less and less debt ?
The federal government will be the only agent able and willing to borrow more.
HAHAHA. America begged for everyone to make the dollar worthless! Now we get our magic wish. Unlike Jack and the Beanstalk, we won’t find a pot of gold after planting our beans.
Maybe Jack’s cow has Mad Cow disease.
Anyway, inflation will rage here thanks to the weak dollar after we are unable to export inflation which seems to be our chief export item anyway. Labor’s race to the bottom will mean a destroyed America.
Also, it is our own gas guzzling that is driving inflation of oil prices. Not the Chinese. And it is our oil companies turning into a consortium of monopoly powers that is driving up the cost of energy, not the Chinese.
“Bill Gross: the way a reserve currency nation gets out from under the burden of excessive liabilities is to inflate, devalue, and tax. ”
I think he’s wrong about the tax part, but we shall see…
Brad,
Bottom Line: The only “way out” is an equilibrium interest rate level which keeps foreigners buying bonds and supporting the dollar, but doesn’t choke off the housing sector or shave too much off its underlying asset values. Is this possible? Time will tell if “Goldilock’s” shows up at the door.
Personally, I think slim and none, and Slim just left town…
I take the matter to task and at length in the referenced post. http://naybob.blogspot.com/2006/05/mayday-mayday-mayday.html
The Nattering Naybob
“by the way, if everyone knows the dollar has to fall, why wasn’t that expectation factored into US real rates (the Krugman question?)” – perhaps because central banks care much more about maintaining near-term exchange rate stability than mitigating long-term losses on reserves?
Brad, what’s interesting to me about a Emerging Europe/ Emerging Asia comparison is not that they’re similar. As you pointed out in the previous thread, EE stimulates both domestic investment and consumption, and runs a current account deficit financed by return-seeking foreigners betting that newly opened economies will grow, fast. EA shows restrained consumption and investment relative to exports and foreign investment, and requires no net financing from foreigners (though probably enjoys benefits of diversification and technology transfer from asset swaps with foreigners).
Broadly speaking, I think EE is developing on a very “orthodox” track, while post 1997 EA is developing very strangely. It looks like one of those pseudo-controlled experiments history sometimes offers up to social scientists. You’ve certainly been critical of EA’s unorthodox track. In a forward-looking way, which group of countries do you think will emerge from their development process “better off”, and why?
EA + petrostates + US consumption contribute to an externality — global imbalance — and nearly everyone in this discussion agrees with you that these imbalances are serious, that rebalancing will at some point be difficult and painful for much of the world. Regardless of who is responsible for global imbalance, which group of countries (EE or EA) do you think is better prepared to weather the storm?
The vast continent of Atlantis rises from the sea, and its people emerge from the large clamshells in which they’ve been cryogenically preserved. They are eager to move from a 10K B.C. agrarian economy to integration in the modern, industrial world. Which model do you suggest?
Are Poor Nations Wasting Their Money on Dollars? Poor nations are financing much of the United States’ current deficit, and they are losing money in the process.
“Imagine the political uproar if Saudi Arabia started to overtly manipulate the price of oil (by taking some production off the market) during a US slowdown”
Well, Iraq used to pump 3.5 million barrels under Saddam, and now under Bush plumps 2 million. Does that help?
Roach is certainly more optimistic:
“No, I am not prepared to give an unbalanced world the green light. But it’s time to give credit where credit is due: First, to globalization for holding down inflation. Second, to central banks for collectively embarking on policy normalization campaigns. Third, to the stewards of globalization for facing up to the imperatives of architectural reform. And fourth, to Asia — especially China — for recognizing the unsustainability of export-led growth models. Notwithstanding the risks noted above — all of which need to be taken very seriously — I am delighted that the global economy finally seems to be taking its medicine. Let’s hope the cure works.”
http://www.morganstanley.com/GEFdata/digests/20060501-mon.html#anchor0
Brad
Sorry to go low-brow, but, while i check this site everyday for the excellent global macro stuff, a couple more lines like “it is hard out there for a won…” might actually make me pony up for an RGE subscription.
joshb
Me — i forgot, we here in the US are the ones manipulating the market price of oil. Keeping Iraqi (and ANWR) oil off the market, and making sure there is a bit of a fear premium built into Iranian supply …
I am not as optimistic as Roach. q1 growth was very imbalanced. folks right now are resisting $ depreciation. so the wrong currencies are appreciating. I don’t see any evidence China is turning words into action. The US is maybe going to make fiscal (and national savings worse) with an oil rebate — but part of it may be that I see a Chinese RMB move as more central than Roach does, as it woudl be the thing that forces China to deliver on its promise to boost domestic consumption and use that to drive growth. He puts more of a focus on less central bank accomodation.
Abuse of the Reserve currency status of the US Dollar
by Clive Maund
http://www.safehaven.com/article-5072.htm
” Many citizens of the United States see their country as the center of the universe, which is understandable as it is continental in size and has a massively powerful military and – until now – has possessed the “de facto” world currency. However this view can create a dangerous myopia, particularly for U.S. investors who tend not to invest outside their own country. The United States has exploited the advantage and leverage potential resulting from possession of the world currency to the absolute limit, and created debts and obligations that are of truly astronomic proportions and are physically impossible to correct. The inevitable consequence of all this is that the dollar is now buckling and is set to plumb much lower levels, which will pose a grave risk for the world financial system. “
Brad, If these are any indication, I doubt you have to worry about oil rebate.
“Aides for several Republican senators reported a surge of calls and e-mail messages from constituents ridiculing the rebate as a paltry and transparent effort to pander to voters before the midterm elections in November.
But disapproval started flowing in almost as soon as the idea surfaced, said aides in several Republican offices. One senior aide to a Southern lawmaker said the calls were surprisingly harsh. Some complained that the rebate would amount to only two fill-ups at the gas station.”
“…The sound of falling dominoes will be loudest in the world’s financial markets, as investors reduce their leverage and retreat from risk. Bond yield spreads will widen against corporate credits and against emerging markets, but inflation risks will ease. Stock markets will need to adjust to lower corporate earnings expectations. Commodity prices will move lower. The U.S. dollar will be firm; the Canadian dollar should ease to 83-84 cents by year-end, and to 80-81 cents by late 2007…” http://www.edc.ca/english/docs/ereports/commentary/publications_10790.htm
one response to complaints about paltry pandering is an even bigger pander … I hope “me” is right, but no guarantees
I had an interesting discussion with a mid-level member of the State Department (retired) on how one might inflate the money supply without tripping the alarms.
Naturally, it’s always possible to print money off the books using Treasury equipment. But this would have to be done on relatively small scale, since otherwise it would become public knowledge.
A second way might be with sloppy accounting. The Pentagon can’t account for over a trillion dollars. Payments to the Indian trust fund have been diverted, but Interior can’t tell us to where. At least a hundred billion is missing.
And finally, one might set up bogus banks. Using the financial leverage available to banks, one could create huge amounts of money.
Maybe “dark matter” is actually black ops? Pure speculation, but something is fishy. Bushco should have hit the financial wall two years ago.
Charles of MercuryRising
http://www.phoenixwoman.blogspot.com
Brad said yesterday:
“I wouldn’t mind seeing the saudi government cut its citizens a check for a good chunk of the oil windfall. Sort of like what microsoft did with its cash … when it upped its dividend.”
The Saudis dropped the price of gasoline to consumers by 33% yesterday. Presumably redistributing the new wealth, but it seems a somewhat provocative thing to do considering the current reaction to high prices in the US (probably won’t be reported though).
Petrol Price Reduced by Over 30%
King Abdullah reads your blog!
well, it does reduce the incentive to smuggle iraqi oil into saudi arabia –
and encourage more saudi demand growth, which doesn’t help anyone. would rather distribute more cash and less cheap oil …
and given how strong the response is on china and the RMB and how limited the response on my call for GCC to drop their dollar pegs, tis clear i don’t have much of a following in the middle east!
Economist Jesper Koll on US Dollar devaluation outlook
http://www.businessweek.com/globalbiz/content/apr2006/gb20060427_608325.htm
If Wall Street crashes, the policy response would be clear, decisive, and ruthless. Unlike the Bank of Japan during the 1990s, the Fed would likely slash interest rates and raise dollar liquidity almost instantly. Too much has been learned about the collapse of asset bubbles and the threat that poses to the financial system. So the world would be flooded with U.S. dollars. The yen could shoot to 80 to the dollar or even higher; the euro might surge to $1.40. This would kill any hopes of a global recovery.
Clearly, the U.S. won’t lift a finger to stop the dollar’s fall. It doesn’t have the foreign currency reserves to do so. If private borrowers of non-dollar currencies go bankrupt, the U.S. government will simply allow them to default. Unlike Thailand, Korea, or Russia, the U.S. — as the world’s largest developing debtor country — can, and will, force its creditors to deal with the problem.
Specifically, if default causes problems for Japanese life insurers or European banks, their respective governments will have to bail them out. If Asian currencies get too strong, Asian authorities will have to intervene to support the dollar. China’s taxpayers would have to bear the costs of the fall in Beijing’s dollar-denominated foreign exchange reserves. The U.S. simply will not borrow from the IMF or deflate domestic demand to bail out foreign lenders.
“…investors have increasing faith that “THEY”, the practitioners of Intelligent Design (ID), can manage the global financial system and global economy. (“THEY” includes the Fed, the ECB, the SEC, the Bank of Japan, the IMF, the Basel Bankers Club, and the avowed Maoists behind China’s tempestuous love affair with capitalism.)…. The global economy booms along, based on the twin oxymorons: 1. China, the most conspicuous practitioner of uninhibited capitalism, the driving force of the global economy, and the price-setter for industrial commodities, is run by self-professed Maoists…. 2. The OECD economies and financial markets, supposedly driven by the activities of practitioners in free market risk-based activities, rely heavily on governments and government-created agencies to manage the supposedly unmanageable – free, competitive economies…”
http://corporate.bmo.com/publications/basicPoints/default.asp?id=6478
If Stephen Roach gets this one wrong, he’s in danger of becoming a contra-indicator.
Anyone remember his reversal on bonds on May 31 last year?
“Given my concerns over the US current account deficit, I have long in the bearish camp with respect to the US bond market outlook. A rethinking is now in order. The likelihood of a China-led slowing of Asia has prompted me to change my view. I now suspect bond yields will stay low for the foreseeable future, and I wouldn’t rule out the possibility that they might even drift lower.”
10-year note yield (12 month graph)
“Specifically, if default causes problems for Japanese life insurers or European banks, their respective governments will have to bail them out.”
Yes, of course. Do you honestly think the United States will have to or would want to or has any obligation to help bail out Japanese life insurers or European banks? Bloody hell, the average Japanese citizen and the average European both live a Hell of a lot better than the average American. They can look after their own.
Yeah Roach capitulated on bonds a bit too early …
I never knew a communique without any commitment to do anything (And lots of demands on non G-7 countries) could have such an impact –
the market starts selling dollars
and Roach turns into a bull …
tho he has sort of set things up in an interesting way, at least rhetorically. Now that he is a bull b/c he thinks the g-7 can address global imbalances, he can threaten to turn bearish on a dime if the g-7 doesn’t follow up …
I think part of it is that he doesn’t put a premium on exchange rate adjustment, so isn’t concerned that there isn’t much evidence of any change in Chinese policy. I was expecting a bit more in the run-up to hu’s trip, so rather than being positively surprised by the g-7 statement, i was negatively surprised by a RMB above 8
At least Bill Gross is still grumpy, comparing the US to GM
p.s. FT has really played up Roach, and they really played up the IMF’s multilateral surveillance (huge change v another meeting in a hotel conference room where nothing happens and nothing is agreed). At least on their web site/ US edition … not quite sure what is going on.
Folks here need to take a deep breath sometimes. Don’t get too confused between the financials and the physicals.
Seems obvious that a declining dollar will encourage ALL the U. S. trading partners, who want to maintain an export surplus, to try to peg their currency to the dollar. The trading partners with the large stash of foreign reserves are in the best position to protect their exports. We have never observed a declining U. S. currency when 1/2 or more of the trading partners have both the motivation and the ability to isolate their currency from the effect of the decline of the dollar.
2) Is the J curve expected? In 1985, the dollar declined drastically for two years, 1985 and 1986, yet it was 1987 before the dollar value of the U. S. trade deficit begin to decline. Assuming nervous players, the two year wait could cause the dollar to overshoot on the way down.
RR — Back when the dollar was on a prolonged plummet, Brad frequently scrutinized the data for any evidence of a J-curve kicking in. (He never found much evidence for it.) Perhaps if this new downdraft continues, we’ll be treated to more of the same. Good point, though, about the possibility that FX traders, suddenly reconverted to the idea that balance of payments matters, might ignore such niceties as a J-curve and way overshoot. Ya gotta love rational markets.
Re currency pegging, note that any country can prevent appreciation against another currency, regardless of their stash of reserves. The only constraints are the central bank’s ability to sell and pay the interest on sterilization bonds, or its willingness to tolerate a loose monetary policy and potential inflation. The process of preventing appreciation is precisely what leads to large FX reserves. It’s much easier to debase a currency, than it is to strengthen one. (A stash of FX reserves in required when a central bank wants to intervene to prevent depreciation, though this is a dangerous game that draws speculators to sell short until CB reserves are exhausted and they can finally profit on inevitable depreciation.)
Anecdotal, but nevertheless:
I was in my local bookstore (in The Hague) earlier today
and noticed that with a $1.26 euro books are at least 50% more expensive than at Amazon US(including shipping).
Guess I will do some work on that J-curve.
in case you haven’t noticed, japan has not intervened since march 2004. and no matter how much the mof gripes, it’s highly unlikely to intervene again given japan’s solid growth (that outpaced the US in 3 of 4 quarters last year and is not just export-led anymore) and the emergence from deflation. japan’s massive intervention from jan ’03 to march ’04 was partly aimed at keeping currency appreciation from derailing a recovery and exacerbating deflation. the yen is super weak on a real basis for a lot of other reasons than the mof’s complaints, namely low interest rates.
btw, china’s plans seem pretty clear: they’re gradually, oh so gradually weaning themselves off the dollar bloc but have a LONG way to go in developing actual market mechanisms for that to happen. the treasury’s just put out its annual survey of foreign US securities purchases/holdings, which is more accurate that the TIC data and better represents what china is doing because it doesn’t have the UK distorations. china bought no less than $165 bln of tresauries/agencies/agency MBS/corp bonds between june 2004 and june 2005 vs TIC data showing just $76 bln of purchases in the 12 months to june 2005 (kudos to wrightson icap for compiling). and chinese buying of freddie/fannie MBS quadrupled to $56 bln, while holdings of agencies themselves topped $130 bln. welcome to the wonderful world of the dollar globalization bloc.
Tim, appreciate the comment. I think the MoF’s verbal intervention may have a bit bigger impact than you do, but Japan’s big decision recently was not to sell $ when the yen was weakening in 05 … as it could have done to unwind some of its 03/04 dollar purchases. but no doubt interest rate differentials are the main driver.
Am curious tho about two things:
a) why the survey data eliminates custodial bias — Gulf holdings still seem rather low to me. tho the China only data does seem better (need to take a look at the 04 v. 05 twelve month comparison) — if you could shoot me the study, I’d also be grateful. that said, Daniel Gros argued I thought persuasively that the survey data tends to undercount foreign holdings of US debt, largely because some custodians don’t want to reveal too much information. that is why the sum of (debt) flows is smaller the debt stocks in the survey data.
b) what market mechanisms China needs to allow a faster rate of crawl or undertake a series of step revaluations? I don’t quite see the whole market development argument. Chinese firms don’t have much of an incentive to demand hedging instruments since the government pretty much “hedges” for them by preventing any big moves in the RMB/ $ (and importers have no incentive to hedge given that it is a one way bet). China isn’t ready for a free float and I wouldn’t want its undercapitalized state banks making big punts on the fx market (more losses for Chinese taxpayers), but its infrastructure has been robust enough to allow a 2.1% step reval and a slow rate of crawl since then. What market development is needed to make greater use of either mechanism.
Agreed that Feldstein is also providing an intellectual cover for the eventual “competitive dollar” policy. Nevertheless, intellectual cover may be a disparaging usage here. I don’t fully agree with the diagnosis that it’s US fiscal profligacy which is a key driving factor for the CAD widening in US. Afterall, there are many big economies with large current account surpluses and large fiscal deficits. The real reason may be that FX intervention through much of the rest of the world has repriced US asset prices so much that the savings rate of US households has moved to negative territory.
here’s the link to the treasury’s annual benchmark survey of foreign portfolio holdings of us securities:
http://www.ustreas.gov/tic/fpis.html