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Surplus countries depreciating when they should be appreciating

by Brad Setser
April 17, 2008

Most Asian currencies have depreciated significantly against Europe since 2003.

And don’t get me started about the Gulf. It remains wed to the depreciating dollar even as oil soars. Following the dollar as it fell from 0.85 or 0.9 to close to 1.60 against the euro as oil went from 20 to 115 doesn’t make economic sense. The Gulf’s currencies should be appreciating along with the price of their main export.

As a result, exchange rate moves, broadly speaking, haven’t helped to facilitate global adjustment. Don’t take my word. The IMF, in the WEO, comes to much the same conclusion:

“Bilateral and multilateral exchange rate movements since 2006 have born little semblance to the distribution of current account surpluses, in contrast to past episodes of dollar depreciation in the 1980s when the currencies of the major surplus countries all went through larger appreciations than other currencies. In the current episode, a number of countries with large current account surpluses have linked their currencies tightly to the dollar, thereby hindering adjustment. A continued mismatch in this regard could result in a reallocation of – rather than a reduction of – global imbalances.

The dollar has moved v Europe, but Europe isn’t the world’s big surplus region. Indeed, so long as the surplus countries link their currencies to the dollar, dollar weakness against the euro only pushes the currencies of big surplus countries down more. Visual evidence that surplus countries have tended to depreciate can be found here.

The IMF deserves a round of applause for its direct language — and, for that matter, also having the courage to forecast a more prolonged US slump than the Fed formally expects.

My read of the WEO’s long-term balance of payments forecast is that the IMF is expecting more of a reallocation of the world’s imbalance than a reduction. To be sure, the IMF expects that a sustained US slump will help bring down the US deficit. Over time, however, the IMF expects the European Union’s deficit to rise. And once the oil shock wears off and the oil exporters surplus starts to fall, the IMF also expects a further rise in Chinas surplus, at least in dollar terms.

That is reasonable. China still hasn’t let its exchange rate adjust in nominal terms. The renminbi has been remarkably stable against a trade weighted basket of the currencies of China’s trading partners. Unless China wants to experience sustained inflation like the Gulf, it won’t experience a sustained real appreciation without a change in policy.

The failure of key exchange rates to adjust is one reason why I am a lot less confident than Dr. Johnson that the IMF’s multilateral consultation has identified the policies needed to reduce the long-term vulnerability associated with persistent imbalances. The Saudis made no commitment to allow exchange rate adjustment during this proces – and the IMF isn’t encouraging the GCC to move off the dollar either. If anything, the IMF is encouraging the Saudis to implement a fiscal contraction to avoid the inflation that is required to bring about real appreciation in the absence of nominal appreciation. That hardly is a policy that supports adjustment.

And other countries haven’t shown much willingness to change either. China has yet to allow a broad-based nominal RMB appreciation — just look at the RMB v the euro. The US hasn’t exactly shown much commitment to reducing its fiscal deficit either, though in the case of the US, there is a plausible argument that circumstances have changed. The recession and all.

Update: I love Alphaville’s pithy summary of my post “Brad Setser isn’t appreciating the depreciating.”   And I think Michael Pettis is right.  Asia’s enormous depreciation against Europe is just shifting the US deficit to Europe.  That seems to be what the IMF is forecasting as well.   Now that China trades more with Europe than the US, shouldn’t the euro-RMB get more attention than the dollar-RMB?

33 Comments

  • Posted by Guest

    import prices from china are up 4% y/y, doesn’t that help with the REER? http://www.bls.gov/news.release/ximpim.t07.htm

  • Posted by Anonymous

    Hi Brad,

    A great blunt comment. Based on simplistic facts that the world refuses to face.

    The IMF deserves a round of applause for its direct language CERTAINLY NOT!

    All currencies are currently spiraling their way down in terms of "buying power". The buying power of say the Euro is even reducing by the day. Do not get me started on the subject… what is the buying power of other currencies, starting with the dollar, yuan and others.

    INTEREST RATES ARE ALL NEGATIVE IN REAL TERMS. ALL AROUND THE GLOBE.

    I am old enough to have lived through various economic periods including the inflationary 70s. Negative real interest rates in the 1-2% range are certainly not business adverse. Current ones are now VERY significantly below this range.

    A banking and credit system is not about bananas or even gold but about money, paper money and money making money (aka interests).

    The currency system is currently setup on a very dangerous framework with two majors actors (US and China) playing an inflationary scenario and most others following up.

    Monetary expansion. For opposite reasons. The US is buying short-term consumption credit. China is buying its long-term infrastructure à la XIXth century. Both on junk credit anyway (look at Chinese rates…).

    Noone should expect the "credit crunch" to stop when interest rates are very significantly negative. Noone should expect correct long-term capital allocations in (look at spanish building investment) such a monetary framework. Noone should expect the international trade to trend up anymore.

    Expect a contraction in global trade no later that by the end of this year.

    Monsieur Strauss Kahn IMF is certainly not doing his job. Except by US monetary standards.

    The Euro is the only currency in the world which is managed to support decent price stability (within the Eurozone). The price of the Euro is just reflecting that all majors currencies are getting down the loop. Nothing else. No political bias, nothing that strictly relates to its financial rectitude.

  • Posted by Anonymous

    Hi Brad,

    The "preview" function was working fine. Still a nasty problem with "blank lines". On top of being non-native and possibly a bit rude, my prose gets quite unpleasant to read. Sorry:(

    Call your web-application support. Cutting those extra lines is certainly a need here and on Roubini’s blog as well.

  • Posted by bsetser

    Guest — China’s RER is appreciating due to domestic inflation. Its nominal exchange with the US is appreciating. its real exchange bilateral exchange rate with the US is appreciating even faster (b/c of higher inflation in China than in the US). The variable that isn’t adjusting is China’s broad nominal exchange. China is depreciating v the euro most notably. If you say plot movements in the RMB v the $ v the movements of most other currencies v the $, the RMB is among those that have appreciated the least since 2002 — which implies a depreciation v much of the world.

    the rise in US imports from China is a reflection of the real bilateral appreciation, and yes, over time, it should encourage adjustment. the pace of growth in us imports from china has already slowed noticeably — tho that is mostly due to the US slump.

  • Posted by Judy Yeo

    Or if they are desperate enough, they could try the US path, steep plunge and suddenly everyone else is revaluing upwards; but the ECB isn’t that brave/sorry foolhardy. Given the strengths of Germany France etc the EU may just be able to carry the problematic economies, the question is when the very uneven nature of eurozone economies will erupt publicly. One point of worry, if Spain sinks further into trouble, there’s no telling what will happen to those huge services firms that Spahish concerns have been buying in recent years? Those firms provide services across Europe, will there be problems ahead?

  • Posted by NICOLAS

    Right now the U.S. economy is a house of cards. Why would China change its policy when it doesn’t know what the U.S. is up to ? Two things are clear A) Not even Central Bank intervention can budge the dollar from these levels B) Now even U S. exports are softening therefore soon the currency debasement is not serving a justifiable purpose. But can the U.S. dollar rally and appreciate from these levels? Why should any country make any move based upon such uncertain conditions?

  • Posted by bsetser

    Nicolas — there hasn’t been any g-7 central bank intervention. emerging market central banks — per macro man — are still selling usd for eur, but that isn’t what I think you were driving up. a communique expressing concern falls well short of intervention. tho there is the fact that the fed is easing and the ECB isn’t.

  • Posted by DC

    Asian CB are NOT recycling surpluses into US Dollars anymore

    http://www.telegraph.co.uk/money/main.jhtml?xml=/money/2008/04/18/cneuro118.xml

    BNP Paribas said Asian surplus countries and commodity exporters have accumulated $1,160bn in reserves over the last year alone. US Treasury data shows that only 19pc of this was invested in dollar assets. This is a sharp break with past practice. A large chunk of the money was invested in euro-zone securities. The question is whether China, Saudi Arabia, and others, have now reached euro saturation.

  • Posted by DC

    Every fiat currency in entire world history has always ended in the trash dump. The Euro, Dollar, Yen, and Yuan are all devaluating in "real" purchasing power, but the US Dollar will be in fiat hell very soon, or next to worthless at its current rate of decline within a couple years. Although European and Chinese monetary authorities are a bit more disciplined, real interest rates remain negative worldwide. I’m not sure why anyone would want to own the seriously flawed US Dollar currency anymore. It is unprecedented that former Fed Chairman Paul A. Volcker would directly criticize the Bernanke Fed for irresponsible and incompetent management of US monetary policy. We should all take Paul Volcker’s criticism at face value, except for my 401K pension fund which prohibits me from diversification into foreign currencies and precious metals, I have diversified my entire personal asset holdings into energy stocks, foreign currencies, and precious metals in the past several years. I put my money where my mouth is. It is my vote of "NO CONFIDENCE" for the Bernanke Federal Reserve.

  • Posted by Guest

    Chinese Central Bank Vice Director Xiu Jian said that his country is planning to shift much of its $1.4 trillion national currency reserve from dollars to more stable currencies, such as the euro or Canadian dollar. China has divested approximately 5 percent of its $400 billion holdings in the U.S. Treasury and established a $200 billion fund to help diversify its investments in equities and stocks around the world. "We will favor stronger currencies over weaker ones, and will readjust accordingly," said Cheng Siwei, vice chairman of China’s National People’s Congress.

    http://www.globalresearch.ca/index.php?context=va&aid=8718

  • Posted by Nicolas

    It would be nice to know what the FED really thinks about the U.S. dollar. I don’t believe that Central Bank intervention can alter the course of the currency. it would just provide a temporary blip as in the past.

    Therefore it should be made clear what the fundamental condition of the U.S. dollar is. If not, then one is to surmise there are other plans behind the scenes. The world is starting to see clearly beyond the obfuscation.

  • Posted by Fabio

    Written by Judy Yeo on 2008-04-18 07:37:13: if Spain sinks further into trouble ..

    I do not understand these continuous calls for eurozone breakup.. they have been proven consistently wrong in the last ten years.

    If Spain is in trouble with a 3.8% gdp growth in 2007 and a forecast 1.9% growth in 2008, what of France or the UK?

  • Posted by bsetser

    DC — the TIC data is a bad guide to dollar reserves growth, as I think my repeated posts here have shown. the torygraph story has a grain of truth, but it ignores some offsetting evidence — not the least the ENORMOUS growth in the fed’s custodial holdings this year. note that the fed’s custodial holdings sometimes show a bigger increase that suggested by the TIC data, and also note how the survey data leads to revisions to the US data over time. i need to look at the BNP work, but it seems likely they missed this …

  • Posted by Anonymous ibid.

    Today is a fascinating data point. Citigroup is cutting jobs and Google made some money even if no one quite understands why, so the dollar, energy, and most world markets spike while precious metals fall.

    I certainly hope Nouriel’s analysis is correct, Brad, and that phase II of the credit crunch is on the horizon. I wouldn’t want to have too many fascinating days like today.

  • Posted by Guest

    "The Chinese economy continues on an exciting trajectory, a path considerably different from the sorry events that have shaken the U.S. financial system and sent tremors around the world."

    We explicitly dismiss a common fear about China: that its banking system is suspect. "The reality is that Chinese banks are healthier and more profitable than they have ever been. The final word on the subprime crisis goes to the president of China Merchants Bank, Ma Weihua. He said, ‘A bank’s bottom line is to never provide loans to candidates short of credit, and the subprime crisis is just the result of the violation of this bottom line.’

    "Who would have thought the Chinese bankers would one day be giving reminders about the basics to their American colleagues? Amazingly that day has come."

    http://money.cnn.com/news/newsfeeds/articles/djhighlights/200804170110DOWJONESDJONLINE000017.htm

  • Posted by DC

    Anonymous ibid,

    I have it on good word that the next round of musical chairs for the banking industry will come this June when a large number of lines of credit will expire for subprime corporate debtors. All of the US Banking industry thinks that there will be enough chairs for everyone with the liquidity hose coming from the Bernanke Fed. The Fed has already burned through $600 billion of its $800 billion capital base accepting subprime garbage for US Treasury bonds. What’s Bernanke going to do? I believe a special place in "fiat" hell has already been reserved for Ben Bernanke by permanent Fed governor Satan.

  • Posted by Guest

    Anonymous wrote: "The Euro is the only currency in the world which is managed to support decent price stability (within the Eurozone)"

    And fails. Raising prices on all fronts are currently the greatest concern of most European citizens.

  • Posted by Guest

    "The large trade and current account deficits of the United States cannot continue indefinitely because doing so would constitute a permanent gift to the U.S. economy. The process that will cause this gift to shrink and that will eventually cause it to reverse is a fall in the dollar. The dollar will fall as private investors and governments become unwilling to accept the risk of increasing amounts of dollars in their portfolios, especially in a context in which they realize that the dollar must fall to reduce the trade imbalance. Although a more competitive dollar is the mechanism that will cause the U.S. trade deficit to decline, the fundamental requirement for a lower trade deficit is an increase in the U.S. national saving rate. So a rise will be driven by higher household savings of the coming years as the two primary forces that depressed savings in recent years are reversed: the exceptionally rapid rise in household wealth and the high level of mortgage refinancing with equity withdrawal." http://www.nber.org/papers/w13952.pdf

  • Posted by Guest

    Paul Volcker in his recent speech is arguing so strongly that the FED should be defending the US currency, and preserving price stability and anything else is not its business!.

  • Posted by NICOLAS

    Ha Ha Paul Volcker of all people should know what the

    Federal reserve is all about who owns and controls the currency to the chagrin of many.

  • Posted by Rurik

    Brad:What about Eu’s large trade deficit with Russia, with oil currently at $116 and the ruble(RUB) depreciating vs euro. Will it become a major concern?

  • Posted by PDR Vet

    Quick comment on the EU CA deficit — it was all of $100 billion in 2007, or about 0.6% of EU GDP and it’s actually down in absolute terms from 2006. Not sure your use as a data is particularly compelling. Euro real effective rate appreciation much less than nominal appreciation against USD.

  • Posted by Anonymous

    Forgot to add that the EU CA deficit is accounted for almost entirely by the UK CA deficit. Euro area is actually running a slight CA surplus.

  • Posted by Twofish

    Guest: "The reality is that Chinese banks are healthier and more profitable than they have ever been. The final word on the subprime crisis goes to the president of China Merchants Bank, Ma Weihua. He said, ‘A bank’s bottom line is to never provide loans to candidates short of credit, and the subprime crisis is just the result of the violation of this bottom line.’

    You have to be careful about newspaper articles which mix of different quotes. Ma Weihua was just in NYC as part of a roadshow to raise capital and recruit some overseas Chinese from Wall Street. He often speaks at the Chinese Financial Association and he has a nuanced view of the Chinese banking system (i.e. something that can’t be summarized in about one sentence). China Merchants is a pretty unusual bank in that it isn’t tied to the state (as Ma loves to point out).

    DC: I have it on good word that the next round of musical chairs for the banking industry will come this June when a large number of lines of credit will expire for subprime corporate debtors.

    I haven’t heard anything like this.

    DC: The Fed has already burned through $600 billion of its $800 billion capital base accepting subprime garbage for US Treasury bonds. What’s Bernanke going to do?

    Fed isn’t accepting subprimes as collateral. Only prime mortgages. Also I don’t see the connection between lines of credit expiring and another musical chairs in banking.

  • Posted by Guest

    The new Olympic sport: China bashing

    http://www.timesonline.co.uk/tol/comment/columnists/mick_hume/article3768155.ece

    China is now blamed for everything from human rights abuses, trade imbalances, war and genocide to pollution, abortion and rising food prices (how dare those Asian Olivers want to eat more!). Students of doom-mongering may have assumed that man-made global warming was responsible for every woe. Now it seems that the Chinese are to blame for climate change, too. Those out to humiliate China seem to be recycling toxic old prejudices.

    The Olympic furore is underpinned by fears about the rise of China at a time when, if we did boycott Chinese goods, there really would be a recession on the high street. In a saner world it would surely be seen as a good thing that the Chinese economy is booming – and subsidising the West – and that China is investing in roads, railways and hospitals in Africa; makes a change from UK charities sending the odd goat. But to suggest so today is to risk being seen as mad – or worse.

  • Posted by DC

    "Fed isn’t accepting subprimes as collateral. Only prime mortgages. Also I don’t see the connection between lines of credit expiring and another musical chairs in banking."

    The Fed’s balance sheet is rapidly filling up with garbage loans. From Bloomberg,

    " Wall Street firms may be bundling high-yield, high-risk corporate loans into securities to use as collateral to borrow from the U.S. government, according to a report by Morgan Stanley analysts. Securities firms can borrow against collateralized loan obligations at the Federal Reserve’s Primary Dealer Credit Facility, the analysts said. The Fed set up the facility last month, its first extension of credit to non-banks since the Great Depression.

    Lehman Brothers Holdings Inc., the fourth-largest U.S. securities firm, last month created the $2.8 billion Freedom CLO, the largest this year, out of loans that couldn’t be readily sold to investors, such as for buyouts of payment processor First Data Corp. and power producer TXU Corp. JPMorgan Chase & Co., Deutsche Bank AG and Barclays Plc also underwrote CLOs in March, according to data compiled by Bloomberg. "

    http://www.bloomberg.com/apps/news?pid=newsarchive&sid=alBrRvnzgSaM

    Now we see CLOs being created for the express purpose of swapping to the Fed. The reason the CLOs are being created is there is no market for the underlying loans. Yet supposedly Moody’s, Fitch, and the S&P are supposed to rate this garbage investment grade so that it can be swapped with the Fed.

  • Posted by Guest

    The FRB should do whatever necessary to avoid a contraction of credit or they will be responsible for causing a depression.

  • Posted by df

    PEOPLE WAKE UP !!!! The dollar is not LOW enough. It ll be low when the US will be running a surplus.

    Bernanke is to blame for one reason : PRINTING HAS NOT STARTED. The FED has swapped good T bills for bad "A" mortgage, it should have printed money instead and handed it to the Tresory. If necessary rates could have been brought to 0 where would be the problem ?

    Inflation due to government printing is right now NOT a threat. THe threat is deflation because of excess in debt and contraction of private creation of money through a credit crunch.

    The IMF is stupid to ask oil exporters to adopt restrictive fiscal policy to avoid ifnlation. Andy reference to the 70′s is plain stupidity.

    In the 70′s the PER was around 10 right now it is over 20. In the 70′s debt GDP ratio was less than half its present value.

    Printing has not started. And it seems no one will have the balls to start it. Volker was bold enough to raise rates when needed ? Who will be bold enough to bring them to 0% now ?

    Of course bringing them to 0% will work only if simultaneously action is taken to curb international movements of K, destroy the present finance industry with new strict regulation, simply put : kill those bankers who brought our global economy in its present mess.

  • Posted by Anonymous

    From Menzie Chinn, may be of interest:

    Prospects for Federal Interest Payments to the Rest-of-the-World

    I was struck at how Federal government interest payments to the rest of the world have risen even as interest rates have fallen.

    http://www.econbrowser.com/archives/2008/04/federal_interes.html

  • Posted by Rachel

    Rurik

    re trade deficit with Russia, with oil @ 115 or anywhere over 100 its probably a concern, especially if Russia keeps the rouble on hold. But Russia is spending a lot of its windfall on EU goods. EU exports to Russia and Imports from Europe are both up by 25-30% from Jan 2007 to January 2008. Though the deficit is widening a lot more with EU27 than the EU15.

    And for 2007 as a whole, exports to Russia rose a lot more than imports – albeit that’s largely before the massive surge in commodity prices. Data comes from Eurostat

    http://epp.eurostat.ec.europa.eu/pls/portal/docs/PAGE/PGP_PRD_CAT_PREREL/PGE_CAT_PREREL_YEAR_2008/PGE_CAT_PREREL_YEAR_2008_MONTH_04/6-17042008-EN-AP.PDF

  • Posted by Rurik

    Rachel, thank you.

  • Posted by Judy Yeo

    I do not understand these continuous calls for eurozone breakup.. they have been proven consistently wrong in the last ten years.

    If Spain is in trouble with a 3.8% gdp growth in 2007 and a forecast 1.9% growth in 2008, what of France or the UK?

    Written by Fabio on 2008-04-18 10:12:55

    Fabio, not calling for breakup of the eurozone (why when it makes travel so much less aggravating!) . Just saying how fractitious the eurozone is, let’s face it, the issue of budget limits, who exceeds, who doesn’t is an annual bickerfest – how an impending crisis will magnify these faultlines is anybody’s guess. As for Spain, not disputing the growth rates of Spain signs are they are heading for problems; the Irish aren’t laggards in terms of growth but they are increasingly antsy with good reason.

  • Posted by bsetser

    PDR vet — I need to go back and check the WEO, but I remember a slightly larger deterioration in the EU deficit for 07. And certainly there was an additional deterioration forecast for 08. In addition to the UK, it is mostly in Eastern Europe. Eurozone is remarkably balanced. Euro’s RER move is smaller than the nominal move v the $ both b/c of china’s appreciation v the $ this year and last and above all b/c of lots of trade with the nordics, uk and the east. but the aggregate move v $ block in us and asia is quite large …