Comments on: The PBoC - and the Economist - argue that exchange rates don’t matter, but look at this graph … http://blogs.cfr.org/setser/2007/05/29/the-pboc-and-the-economist-argue-that-exchange-rates-don/ Wed, 07 Jan 2009 21:50:57 +0000 http://wordpress.org/?v=2.6.1 By: A. Person http://blogs.cfr.org/setser/2007/05/29/the-pboc-and-the-economist-argue-that-exchange-rates-don/#comment-96836 A. Person Thu, 31 May 2007 10:14:46 +0000 http://blogs.cfr.org/setser/2007/05/29/the-pboc-and-the-economist-argue-that-exchange-rates-don/#comment-96836 I am a bit confused. I was taught there was an inverse relationship between exchange rates and exports. That is, when home country currency appreciates, exports decrease and when home country currency depreciates, exports rise. It has to do with the fact that imports become cheaper or more expensive to the foreign country. If this is true, and it certainly seems so. This seems to run counter to what some say about US trade deficits not being linked to fixed exchanged rates. I am a bit confused. I was taught there was an inverse relationship between exchange rates and exports. That is, when home country currency appreciates, exports decrease and when home country currency depreciates, exports rise. It has to do with the fact that imports become cheaper or more expensive to the foreign country. If this is true, and it certainly seems so. This seems to run counter to what some say about US trade deficits not being linked to fixed exchanged rates.

]]> By: RebelEconomist http://blogs.cfr.org/setser/2007/05/29/the-pboc-and-the-economist-argue-that-exchange-rates-don/#comment-96835 RebelEconomist Wed, 30 May 2007 22:39:41 +0000 http://blogs.cfr.org/setser/2007/05/29/the-pboc-and-the-economist-argue-that-exchange-rates-don/#comment-96835 Macro Man: I would not argue that central banks have entirely removed risk. It usually needs a bit of pain before they act - eg 1987 crash, 1998 Russia/LTCM, 2001 WTC - but nothing that becomes so pervasive that it permanently changes the "buy on dips" culture in asset markets. So spreads will react to crises, but should be narrower on average. Investors buy the highest yield because they have been conditioned to see risk as uncomfortable but ultimately an opportunity. Instead of reading this blog on a Wednesday night, watch "Property Ladder" on Channel Four! I agree with HZ - people who have been through hard times are more cautious (although I do think there is more to it than war; Switzerland has avoided war recently). I am sure that if the Americans introduced the workhouse for bankrupts, the deficit with China would narrow sharply, with or without a change in yuan/dollar. I do think that central banks should be taking more account of these factors than they are now. My knowledge of the macroeconomic models that central banks use is poor, but I guess that something like "time preference" appears as an exogenously determined constant. Brad makes a good point about Euroland sovereign spreads being tight, and I agree that they may well discount some sort of bailout, which could be fiscal transfer as well as monetary easing. I suspect though that they are more correlated with risk spreads globally than the creditworthiness of European countries, just as Euroland yields often react more to US than European economic data. Macro Man: I would not argue that central banks have entirely removed risk. It usually needs a bit of pain before they act - eg 1987 crash, 1998 Russia/LTCM, 2001 WTC - but nothing that becomes so pervasive that it permanently changes the “buy on dips” culture in asset markets. So spreads will react to crises, but should be narrower on average. Investors buy the highest yield because they have been conditioned to see risk as uncomfortable but ultimately an opportunity. Instead of reading this blog on a Wednesday night, watch “Property Ladder” on Channel Four! I agree with HZ - people who have been through hard times are more cautious (although I do think there is more to it than war; Switzerland has avoided war recently). I am sure that if the Americans introduced the workhouse for bankrupts, the deficit with China would narrow sharply, with or without a change in yuan/dollar. I do think that central banks should be taking more account of these factors than they are now. My knowledge of the macroeconomic models that central banks use is poor, but I guess that something like “time preference” appears as an exogenously determined constant.

Brad makes a good point about Euroland sovereign spreads being tight, and I agree that they may well discount some sort of bailout, which could be fiscal transfer as well as monetary easing. I suspect though that they are more correlated with risk spreads globally than the creditworthiness of European countries, just as Euroland yields often react more to US than European economic data.

]]> By: bsetser http://blogs.cfr.org/setser/2007/05/29/the-pboc-and-the-economist-argue-that-exchange-rates-don/#comment-96834 bsetser Wed, 30 May 2007 20:14:18 +0000 http://blogs.cfr.org/setser/2007/05/29/the-pboc-and-the-economist-argue-that-exchange-rates-don/#comment-96834 I understand your suspicions about the headline inflation data as well. even if it was a bit higher though, it wouldn't change the basic story. it isn't 10% (like in the Gulf), i don't think. but the idea that chinese inflation was less than us inflation so china depreciated v usa in real terms after 04 does seem a bit strange. I understand your suspicions about the headline inflation data as well. even if it was a bit higher though, it wouldn’t change the basic story. it isn’t 10% (like in the Gulf), i don’t think. but the idea that chinese inflation was less than us inflation so china depreciated v usa in real terms after 04 does seem a bit strange.

]]> By: HZ http://blogs.cfr.org/setser/2007/05/29/the-pboc-and-the-economist-argue-that-exchange-rates-don/#comment-96833 HZ Wed, 30 May 2007 18:31:02 +0000 http://blogs.cfr.org/setser/2007/05/29/the-pboc-and-the-economist-argue-that-exchange-rates-don/#comment-96833 Brad, I see what you mean and I won't repeat my suspicion about the headline inflation figure here. Brad,
I see what you mean and I won’t repeat my suspicion about the headline inflation figure here.

]]> By: bsetser http://blogs.cfr.org/setser/2007/05/29/the-pboc-and-the-economist-argue-that-exchange-rates-don/#comment-96832 bsetser Wed, 30 May 2007 16:40:37 +0000 http://blogs.cfr.org/setser/2007/05/29/the-pboc-and-the-economist-argue-that-exchange-rates-don/#comment-96832 guess (off-topic) -- i am not really fond of way off topic comments, and particularly not fond of long off topic comments. RGE agreed to open up the comments sectiont to all -- something i heartily applaud. but comments that venture too far off topic are a recipe for trouble. future restraint would be appreciated. cheers. guess (off-topic) — i am not really fond of way off topic comments, and particularly not fond of long off topic comments. RGE agreed to open up the comments sectiont to all — something i heartily applaud. but comments that venture too far off topic are a recipe for trouble. future restraint would be appreciated.

cheers.

]]> By: bsetser http://blogs.cfr.org/setser/2007/05/29/the-pboc-and-the-economist-argue-that-exchange-rates-don/#comment-96831 bsetser Wed, 30 May 2007 16:28:50 +0000 http://blogs.cfr.org/setser/2007/05/29/the-pboc-and-the-economist-argue-that-exchange-rates-don/#comment-96831 HZ -- for data on the Chinese real exchange rate, see either the world bank's big report on east asia (issued in march or early april) or the imf's regional outlook. both provide the data. tis true. $ depreciated v. euro -- rmb followed $ v. euro, china trades a lot with europe -- and chinese inflation has been low, so no real appreciation there. RE -- PBoC in particular has been a big buyer of MBS, both those with an Agency credit guarantee and so called private MBS. Other parts of the MBS market are dominated by private players looking for yield. Pick your reason why they are there rather than in say l-term treasuries. As for the ECB not doing bailouts, well, maybe. But credit spreads among european sovereigns are really tight (or at least were last i checked). ITaly is as good as germany -- and so on. I don't think even the greeks trade at a premium ... and then we can really debate how any crisis inside the eu but outside the eurozone (think eastern europe) will be handled. but i don't find credit spreads on eastern european sovereigns rich right now ... HZ — for data on the Chinese real exchange rate, see either the world bank’s big report on east asia (issued in march or early april) or the imf’s regional outlook. both provide the data. tis true. $ depreciated v. euro — rmb followed $ v. euro, china trades a lot with europe — and chinese inflation has been low, so no real appreciation there.

RE — PBoC in particular has been a big buyer of MBS, both those with an Agency credit guarantee and so called private MBS. Other parts of the MBS market are dominated by private players looking for yield. Pick your reason why they are there rather than in say l-term treasuries.

As for the ECB not doing bailouts, well, maybe. But credit spreads among european sovereigns are really tight (or at least were last i checked). ITaly is as good as germany — and so on. I don’t think even the greeks trade at a premium … and then we can really debate how any crisis inside the eu but outside the eurozone (think eastern europe) will be handled. but i don’t find credit spreads on eastern european sovereigns rich right now …

]]> By: HZ http://blogs.cfr.org/setser/2007/05/29/the-pboc-and-the-economist-argue-that-exchange-rates-don/#comment-96830 HZ Wed, 30 May 2007 15:23:52 +0000 http://blogs.cfr.org/setser/2007/05/29/the-pboc-and-the-economist-argue-that-exchange-rates-don/#comment-96830 "Relying on ex rate alone won't solve the problem" That is, without creating worse problems. Of course there is a rate that can balance the trade, but at what price? “Relying on ex rate alone won’t solve the problem”

That is, without creating worse problems. Of course there is a rate that can balance the trade, but at what price?

]]> By: HZ http://blogs.cfr.org/setser/2007/05/29/the-pboc-and-the-economist-argue-that-exchange-rates-don/#comment-96829 HZ Wed, 30 May 2007 15:15:43 +0000 http://blogs.cfr.org/setser/2007/05/29/the-pboc-and-the-economist-argue-that-exchange-rates-don/#comment-96829 Macro Man, Maybe in the English speaking countries you find the winners of the major past wars, while on the other side you have Germany, Japan and China ( war and political upheaval). Latin language countries are somewhere in between? Suppose every country has a strict balance of trade policy -- so no one runs a deficit or a surplus. Would ex rate still affect trade flows? Of course it does. But it will have no effect on trade balance a priori. The response is in the trade volume. Non-optimal ex rate reduces trade volume and potentially reduces aggregate productivity. That is the Roach point -- saving/consumption propensity is determinant of trade balance while ex rate play a secondary role but optimal ex rate enhances trade and productivity. Government policies need to account for the different saving/consumption propensities. Relying on ex rate alone won't solve the problem until we live in a homogeneous world. Brad, I think it is rather hard to believe that RMB has depreciated in real terms. What about the outpouring of Chinese tourists? And a major part of their tour is shopping when they go abroad. Sure tax and trade barriers have a lot to do with it. Therein lies the rub -- ex rate is not the only thing that affects trade. Furthermore how are the 90% that don't go abroad or consume foreign products going to benefit from a stronger RMB? Only indirectly. But if the mechanism is not there to transmit the benefit they will only see the downside. I agree with you that the imbalance and the eventual unwinding are worrisome. But ex rate is not the only thing that matters. Maybe in a perfect world with efficient markets able to account for externalities ex rate is the best lever but we live in a far from perfect world -- certainly the Chinese do. It is much easier for them to proceed with structural reforms while they are still in a benign trade environment: get rid of tax and policy preference for export, have a real market based pricing for resources (land, water, energy etc.), and enforce environment/labor rules. All of these will have direct impact on the trade balance. And without these in place how is the market going to price what the best rate is? Macro Man,
Maybe in the English speaking countries you find the winners of the major past wars, while on the other side you have Germany, Japan and China ( war and political upheaval). Latin language countries are somewhere in between?
Suppose every country has a strict balance of trade policy — so no one runs a deficit or a surplus. Would ex rate still affect trade flows? Of course it does. But it will have no effect on trade balance a priori. The response is in the trade volume. Non-optimal ex rate reduces trade volume and potentially reduces aggregate productivity. That is the Roach point — saving/consumption propensity is determinant of trade balance while ex rate play a secondary role but optimal ex rate enhances trade and productivity. Government policies need to account for the different saving/consumption propensities. Relying on ex rate alone won’t solve the problem until we live in a homogeneous world.

Brad,
I think it is rather hard to believe that RMB has depreciated in real terms. What about the outpouring of Chinese tourists? And a major part of their tour is shopping when they go abroad. Sure tax and trade barriers have a lot to do with it. Therein lies the rub — ex rate is not the only thing that affects trade. Furthermore how are the 90% that don’t go abroad or consume foreign products going to benefit from a stronger RMB? Only indirectly. But if the mechanism is not there to transmit the benefit they will only see the downside.
I agree with you that the imbalance and the eventual unwinding are worrisome. But ex rate is not the only thing that matters. Maybe in a perfect world with efficient markets able to account for externalities ex rate is the best lever but we live in a far from perfect world — certainly the Chinese do. It is much easier for them to proceed with structural reforms while they are still in a benign trade environment: get rid of tax and policy preference for export, have a real market based pricing for resources (land, water, energy etc.), and enforce environment/labor rules. All of these will have direct impact on the trade balance. And without these in place how is the market going to price what the best rate is?

]]> By: Guest http://blogs.cfr.org/setser/2007/05/29/the-pboc-and-the-economist-argue-that-exchange-rates-don/#comment-96828 Guest Wed, 30 May 2007 12:25:14 +0000 http://blogs.cfr.org/setser/2007/05/29/the-pboc-and-the-economist-argue-that-exchange-rates-don/#comment-96828 This is the first truly significant synchronous move in equity prices and bond yields in some time. It also has the feel of a classic late stage equity rally staring into the face of climactic Fed tightening. This is the first truly significant synchronous move in equity prices and bond yields in some time. It also has the feel of a classic late stage equity rally staring into the face of climactic Fed tightening.

]]> By: Macro Man http://blogs.cfr.org/setser/2007/05/29/the-pboc-and-the-economist-argue-that-exchange-rates-don/#comment-96827 Macro Man Wed, 30 May 2007 12:11:27 +0000 http://blogs.cfr.org/setser/2007/05/29/the-pboc-and-the-economist-argue-that-exchange-rates-don/#comment-96827 RE, if the moral hazard/Greenspan put argument is correct, how and why did credit spreads widen further in 2000-02 than since the Volker years? Perhaps the answer is simply that in a benign global environment with plenty of liquidity, investors buy the bond with the highest number under the 'yield' column. RE, if the moral hazard/Greenspan put argument is correct, how and why did credit spreads widen further in 2000-02 than since the Volker years? Perhaps the answer is simply that in a benign global environment with plenty of liquidity, investors buy the bond with the highest number under the ‘yield’ column.

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