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LinkedInChristopher Swann of Bloomberg noticed the line in the IMF’s most recent Article IV report indicating that senior US officials objected the IMF’s conclusion – based on their model for equilibrium real exchange rates – that the dollar is overvalued (hat tip, Naked Capitalism).
Swann quite rightly notes that the US is shooting itself in the foot. The US – led by former Treasury Under Secretary Tim Adams and his deputy for IMF affairs Mark Sobel – spent a lot of time trying to get the IMF’s surveillance to focus more on exchange rates. That was the right thing to do as well.
But if the US government isn’t prepared to accept that the IMF’s assessment that the dollar is overvalued, China certainly isn’t going to accept the IMF’s assessment that the RMB is undervalued.
Now the US will likely argue that it argued that the dollar’s value is determined in the market, while the RMB’s value is not. Thus, the IMF’s model is far more germane for China than the US.
Swann reports
Treasury officials criticized the IMF analysis for relying too much on trade in goods and services and not enough on capital flows. While the U.S. has run record trade deficits in recent years, foreign capital also continues to flow into the country at an even stronger rate. The Treasury also was “skeptical about the notion of overvaluation for a market-determined exchange rate such as the dollar,'' the report said.
But, alas, while the value of the dollar against say the euro is determined in the market – albeit a market shaped by the portfolio decisions of China and a host of oil exporters – the dollar’s value against the RMB and a host of emerging currencies is not set in the market.
And I am pretty sure that if the IMF rejiggered its model to account for fact that the majority of net capital inflows in the US in the first of half of 2007 came from the official sector, it would conclude that the dollar is even more overvalued. The US hasn’t been attracting large enough (net) private capital inflows to finance a 6% of GDP current account deficit for a long time.
Mike Mussa, the IMF’s former chief economist noted:
“The U.S. Treasury has cut the legs from under the IMF before it even started the race … This was foolish and unnecessary when they could have just said nothing.''
I agree.
If the US wants the IMF to conduct surveillance on exchange rates, it needs to give the IMF space to do so. If the US wants the IMF to comment on the level of China’s exchange rate, it should allow the IMF to comment on the value of the buck.
Trying to have its cake (IMF calls out China) and eat it too (IMF doesn’t pass judgement on the dollar)is frankly pretty silly, and the US Treasury would do better just to keeps its mouth shut.
Once again it’s samo samo! boring boring boring!! In other words like MM says, “stay out and don’t stick your nose where it don’t belong” — the US Treasury should focus on the fiscal budget while the IMF should focus on interntional lending to third world countries — it’s as easy ABC.
The US has the same double standard, when it comes to UN resolutions.
dunno if the dollar is overvalued but Trichet is ready to hike, be prepared for next euro rally
I just don’t see why anyone thinks the US Treasury genuinely wants the IMF or anyone else to have any teeth on currency surveillance. A change in the BWII status quo is Wall Street’s greatest nightmare, and the guy running the US Treasury these days ain’t from the labor movement. The kind of populists who are mad about China’s currency policy have some real representation in Congress, but not in George Bush’s Treasury. Treasury officials may talk the talk of forcing change to appease populist voices, but they sure don’t want to walk the walk. The Fed and the Treasury share an interest in short-term stability, with hope as the only plan for the longer term.
So, when the Treasury does something odd that undermines the IMF’s credibility at monitoring exchange rates, I wouldn’t call it “foolish and unnecessary”. I would call it cynical.
Today you have a situation whereby the U.S. admin. is saying you better buy our bonds and finance our irresponsible deficit spending or we’ll let the dollar go to hell and all the merchandise you export to us will be devalued and our exports will boom. This is the sign of a very sick government administration who treats the country like a chess board. If the U.S. is the greatest country, greatest economy, greatest everything why should its currency be called into question ? Because not even the IMF can accept what a basket case the U.S. finances have become.
For the benefit (?) of new readers, I repeat my argument that, by failing to maintain the adequacy of its reserves, the US is to some extent, responsible for currency manipulation by omission (of the dollar sales this would have involved).
RebelEconomist on 2007-08-24 02:40:11
Can you be more specific?
How much reserves should the US have? What would be the quantitative criteria roughly?
re: along with supporting evidence from ‘Nicolas’ or any other like minded commenters substantiating their views about “irresponsible deficit spending” – surely some of that money is ‘invested’ and for that which is not, why is it ‘spent’ without the prospect or promise of an appreciable return?
I don’t think *anyone* is really mad about the Chinese exchange rate. People are mad about things that are related to the Chinese exchange rate, but part of politics is to figure out what people are really mad about (which is often quite different from what they say they are mad about).
In the case of organized labor, what people are mad about are jobs, and the AFL-CIO doesn’t give a whit about the rate of the RMB if it doesn’t affect jobs. The issue here is that by talking about the RMB, Schumer and Graham have been able to get trade agreements with China which limit the amount of textile imports.
What Wall Street cares about is capital mobility. With an undervalued RMB, China has to keep capital controls in order to manage the Chinese economy, and capital controls means that the trillions of dollars of Chinese savings can’t effectively be invested overseas by Wall Street bankers. Here again, what people really care about is important, because if the RMB rises but it is in a context where there are restrictions on capital movement, it does Wall Street no good. Also if the RMB appreciates, and the Chinese eeconomy falls apart, it does Wall Street no good.
As far as cynicism and hypocrisy, this is politics. Cynicism and hypocrisy is standard operating procedure, and I’ve found it to be somewhat useless to coomplain about hypocrisy unless you can get something you want from complaining about it, which isn’t the case in this situation.
or shed some light as to why the ‘tax is good’ crowd tend to be part of the ‘irresponsible government spending’ crowd
“…With the few exceptions, the absence of well developed capital markets in the surplus countries is one of the factors, which forced central banks to play the role of global institutional investors for which they are not fully prepared…” http://www.nbp.pl/en/publikacje/lectures/slawinski_112006.pdf
over the past few years the development of local capital markets hasn’t exactly slowed reserve accumulation. if market development helps bring say Chinese offshore savings home and it increases global demand for say Chinese securities and the central bank still resists appreciation, the net effect is more reserve growth. that is one of my least favorite arguments.
it works better in theory than in practice; the development of strong local currency markets — a sign of market development — throughout the emerging world has coincided with big net private capital inflows and rapid reserve growth, not the opposite.
if china wanted, it could say encourage foreign firms to raise money in rmb by issuing rmb denominated bonds to absorb some of china’s surplus — but that would imply allowing a lot more capital account liberalization than china has been willing to accept.
For the benefit (?) of new readers, I repeat my argument that, by failing to maintain the adequacy of its reserves, the US is to some extent, responsible for currency manipulation by omission (of the dollar sales this would have involved)
? indeed
Why is the value of the dollar in question ? why is the dollar depreciating against the Euro and other currencies. Why does Jim Rogers say get out of the dollar ? Is it because the U.S. finance are honky dory or is it because the U.S. government finances are a mess. The Fed is a printing press billions here billions there anyway the Chinese will pay. The U.S. needs to reform/modify its approach. A country is only as good as its currency. If the currency turns to crap it means the country is going to hell. It’s plain and simple
It’s really quite simple if you follow the money….
You have:
1) a major war in Iraq
2) unwillingness to raise taxes
3) loose monetary policy
4) dropping dollar
1) means that wealth is being consumed. 2) means that the wealth isn’t coming from taxes. 3) means that the US isn’t making the bonds it issues attractive which means that 4) the wealth to finance the war is coming out of the value of the dollar.
I do have this disturbing feeling that fifty years from now, the war in Iraq will be a “what the hell were they thinking” example. One thing about looking at history is that you realize that great, stupid blunders looked a lot less stupid when people made them.
What is going to be the case is that Iraq is going to be a massive drain on the United States for at least the next decade if not longer……
re: “major war in Iraq” what if history’s most privatized war generates a profit? are taxes and money printing/ currency ‘manipulation’ (the US) government(‘s’) only means for generating wealth?
“I do have this disturbing feeling that fifty years from now, the war in Iraq will be a “what the hell were they thinking” example. One thing about looking at history is that you realize that great, stupid blunders looked a lot less stupid when people made them”
o twofish !
do we have to wait for fifty years ?
this blunder looked stupid when it was made. in fact it looked stupid before it was made. a page in geo bush senior’s co-authored book with ?snowcroft set out clearly why the tanks stopped short of baghdad in the first gulf war, and every reason that they give still holds good today.
sophisticated tanks do well manoeuvering against poorly equipped opponents in open desert. such wars can be won. but occupied cities become rubble filled rat holes – like stalingrad – and occupations are never won, only ended.
history tells a simple story. kings raised taxes to go to war. the current resident lowered taxes and went to war. that’s financially dyslexic. kings also tended to debase the currency in time of war. the iraq war has to be paid for some way, but the oil did not flow and the currency trick does not work properly while the chinese and people are virtually pegged to debasement.
the iraq occupation is threatening eventually to exceed the second world war in its cost. the intended objective is to prevent any medium sized country in the middle east becoming a regional power through a combination of energy reserves and strategic position. so chaos and poverty in iraq is a victory of sorts – unless the contagion of chaos and poverty, like mortgage backed securities, starts to pop up in unexpected places. then you have an unintended result.
Guests who query (the lack of) US reserves policy:
There are various reasons for holding reserves, some of which have led to rules of thumb for reserves adequacy. The traditional measures are import based, the standard being 3 to 6 months of import cover. Short term foreign debt cover is a more modern measure, with 100% of foreign debt due within one year being the recommended level. Then there are capital flight inspired money stock standards, with, say 10% of M2 being the standard. Other measures of reserves adequacy could be reserves to GDP, reserves to foreign exchange flows etc, etc.
Just to maintain the effectiveness of its reserves on any of these measures, the US should have increased its reserves significantly in the last decade, and by any of them, US reserves are now clearly inadequate, representing about 1 month of imports, 5% of short term foreign debt and 3% of M2. Yet the US has held about the same stock of reserves for the last ten years. There has been no analysis published by the US authorities that indicates that the existing level of reserves was once excessive or that the present level is appropriate. The US appears to have no reserves policy at all other than to do nothing and avoid the issue. Not that this stops the Americans offering their advice to other countries on the size of their reserves!
Brad, you say that “if china wanted, it could say encourage foreign firms to raise money in rmb by issuing rmb denominated bonds to absorb some of china’s surplus — but that would imply allowing a lot more capital account liberalization than china has been willing to accept.”
The Chinese have been slowly encouraging RMB bond issues by foreign entities (mostly ADB/World bank stuff to dat, but recent rule changes have made it easier for others), and even now permit the funds to be converted into dollars and spent offshore, but it is hard to convince anyone that raising RMB to spend offshore is a good idea. Even if you could get sub-4% borrowings, the expected annual RMB appreciation of 4-5%, with the possibility of upside surprises, means that in dollar terms your borrowings will cost at least 8% and probably a lot more. No one is interested. Until they can convince the market that the RMB will stop appreciating (perhaps after a one-off maxi-reval), there is no incentive to take money out of the country. This is part of their curse, and why liberalizing capital restrictions is having such little impact.
Sorry, that last comment was by Michael Pettis
re: “chinese and people are virtually pegged to debasement… the intended objective is to prevent any medium sized country in the middle east becoming a regional power”
“…Unlike its Arab adversaries, Israel is not a member of any of the regional organizations… Military exports and security assistance play an important role in promoting Israel’s foreign policy interests. Israel’s closeness with a country is often correlated to security cooperation. For example, Israel’s emerging close political ties with India and Turkey contain a strong military component, as did its past ties to South Africa. Absent the confidence of other states in Israel’s ability to fulfill contracts, the Jewish state’s strategic outreach might be undercut. At the very least, Sino-Israeli relations would weaken if Israel were prohibited from pursuing the lucrative Chinese arms market…” http://www.meforum.org/article/926
re: “effectiveness of its reserves”? as the world’s largest economy by far, and global reserve currency steward, ‘American’ reserves policy is unique and the ‘advice’ “offered” is sought/ procured by all. “tradition” doesn’t make anything ‘correct’ then, now, here or somewhere else under entirely different circumstances.
Written by RebelEconomist on 2007-08-24 16:19:00
Thanks for response.
Guest,
The weakness of your argument is revealed by the fact that you pick up on a minor word; I just give a range of measures, one of which happens to be traditional rather than being associated with any particular proponent.
Shouldn’t a large economy have large reserves? How long can the US expect to remain the global reserve steward, and does it want to do so? Then what? The US is giving unwanted advice to China about the growth of its reserves, and has complained about Japanese currency policy, even during its prolonged slump. Why does the US lecture other countries about the cost of reserves, and hold three quarters of its own reserves in gold? What is US reserves policy?
There isn’t one? Thought not!
not arguing – only asking for a clearer articulation and substantiation of your argument – along with the term “effectiveness of its reserves” – and additionally whether the sum of the answers to your questions might provide some insight into “What is US reserves policy?”
Guest,
Most countries hold foreign exchange reserves either because of exchange rate policy or to smooth capital flows. Being a relatively closed economy, the US is less exposed to volatile exchange rate movements, but all of the measures of reserve adequacy I mentioned are to provide for capital stops, which usually involve sharp currency depreciation anyway. The US has a large current account deficit, so its consumption depends on a steady capital inflow. If this suddenly stops, reserves allow time for the economy to adjust.
Imports are a measure of the importance of foreign supply in the economy. Overseas debts represent committed external payments which should be made regardless of the capital stop, so it is prudent to set aside a reserve to meet them. Currency depreciation can trigger capital flight, and demand deposits are readily liquidated. Allowing for this protects against financial crisis. The recommended levels are usually based on the experience of countries which have undergone currency crises.
In US case, however, I would also say that as the provider of the reserve currency, it would have been wise to have matched some of the reserve inflows with its own reserve assets – kind of asset-liability matching. The dollar debt sales that this involved would have constrained the private sector consumption boom by keeping long run interest rates up and held the dollar down.
Why haven’t the US done this? Partly because there are a few economists who take an interest in this relatively arcane subject, and those that do tend to have a predilection for floating exchange rates and against state intervention……the US badly needs some RebelEconomists! The operational staff at the FRBNY seem to be regarded as an information-gathering resource rather than an expert source of informed policy advice. And partly because there has been little political interest in putting a dampener on the party that the official capital inflows have allowed the US to throw.
It really does seem that the US has no reserves policy; they let sleeping dogs lie.
thank you again for your reply – I was hoping that someone with more appropriate expertise than I may join in. I’m sure there are many sleeping dogs, but came to the conclusion a while ago that a great deal of ‘policy work’ involves stepping around them and managing (or exploiting or glossing over) the impact of a nasty awakening after the fact!
Guest,
You are welcome…….hopefully you were satisfied by my responses. I am always glad to discuss reserves with those who are interested.