Good question
Michael Phillips in Monday’s Wall Street Journal:
If there’s one message the Bush administration has been trying to hammer home to Chinese leaders, it is this: A major country with a huge trade surplus and rising prices should let its currency strengthen with market forces. So why is the administration nearly silent about the fixed exchange rates of Saudi Arabia and other Persian Gulf oil fiefdoms? After all, like China, the big powers in the Gulf — Saudi Arabia and the United Arab Emirates — link their currencies to the U.S. dollar, export far more than they buy abroad, and now face inflation imported from overseas.
The US policy right now is that China shouldn’t peg to the dollar but the Gulf should. In reality, neither should. Kristin Forbes — who I briefly worked for — has this right.
“Given the huge current-account surpluses and reserve accumulation in the Gulf states, it’s getting harder and harder for the U.S. Treasury to justify putting pressure on China, but not the Gulf states, to have more exchange-rate flexibility,” says Kristin Forbes, an economist at the Massachusetts Institute of Technology and former adviser to President Bush.
Dollars pegs are both inflationary and an impediment to effective balance of payments adjustment. The currencies of the countries with huge surpluses need to appreciate; the currency of a country with huge deficit not so much. And it is hard for say Chinese renminbi — let alone the Saudi riyal — to appreciate if it is tied to the US dollar.
Charles Says:
Brad, a long time ago, if I recall correctly you said that you doubted that there was any dollar level at which the US could reach trade balance. First, is that your assessment now? Second, what key steps should the US take to reduce the imbalances? Third, what magnitude of impact would those steps have on the balance?
It strikes me that our second largest problem is very difficult to resolve, namely demographics. People on average do not live near work. (Our largest problem, health care costs, are relatively easy to resolve, but don’t directly impact the CA balance).
bsetser Says:
I have actually always thought that a large enough fall in the dollar would bring the US into rough trade balance. Another 10-20% in real effective terms, ball park, would likely bring the US close if (and it is a big if) oil falls back to the 50s. However, the fall against europe has been larger than needed and the fall v other places hasn’t been big enough.
What can the US do? right now i would emphasize energy policy - as the rising oil import bill is the biggest problem right now. the dispersed housing stock and lengthy commutes that result is part of that, and hard to change in the short-term. but over time, the US could do things to help.
Over time, higher national savings would help — i.e. bringing the fiscal deficit down. in the short-term tho the bigger risk is that US households would face such large constraints after the crisis that demand would falter;i am not opposed to the stimulus so long as it is effective and temporary. Over time though the US government shouldn’t be a big drain on the United STates (meager) private savings.
dmg555 Says:
Brad : correct me if im wrong but if the Saudi Real goes up in value, hence the US dollars goes down in value, does not the price of oil in dollars increase,.. putting further pressure on the american consummer,.. seems to me that at the current time, from the Bush administrations point of view, higher oil prices would translate into fewer republican office holders
Pallj Says:
Aren’t we effectively talking about the Saudis & Co to effectively start pricing oil in their own currency?
Or the Chinese saying OK, from now on you pay for our stuff in RMB, we’ll pay for what we buy of you in USD?
Short term situation would be total chaos, I could imagine.
Twofish Says:
bsetser: So why is the administration nearly silent about the fixed exchange rates of Saudi Arabia and other Persian Gulf oil fiefdoms?
Because there aren’t any domestic groups that would immediately benefit from a Persian Gulf revaluation. There are two groups that would benefit from an RMB revaluation. Textile workers that want trade protection, and Wall Street bankers who are less interested in the exchange rate than in freeing up capital controls.
There is also the fact that the Saudis have much more leverage to hit back at the United States than China does. If the US complains too much about Saudi behavior, then the oil minister reduces production and drives up the price of oil, and legislators hear from angry SUV owners. There’s no equivalent switch that China can pull, and so this is why the US government complains about China a lot more than it does about Saudi Arabia on things like human rights and governmental structure. Finally, there is this belief among lots of people in the government (and in my view a dangerously incorrect belief) that having the Communist Party of China collapse would bring in a more pro-US government, whereas having the House of Saud collapse won’t.
So the US government is quiet about Saudi currency policies in part for the many of the same reasons it tends to be quiet about democracy and human rights abuses in Saudi Arabia.
Twofish Says:
I think we are far beyond the point where the situation can be “fixed”.
1) don’t make the situation worse
2) manage the situation so it doesn’t become a crisis
The situation as it is is manageable, but if the US gets into a major war with either Iran or North Korea or if the Taiwan situation spins out of control, then things will get really bad. Wars (either hot or cold) tend to be budget-busters.
SC Says:
Twofish:There is also the fact that the Saudis have much more leverage to hit back at the United States than China does. If the US complains too much about Saudi behavior, then the oil minister reduces production and drives up the price of oil, and legislators hear from angry SUV owners.
I think that is looking at it the wrong way - it is surely unequivocally in the interest of the GCC to increase the value of their currencies (sticking to economic reasons for the moment) vs the dollar given a) their inflation problems would be reduced and b) the relatively inelasticity of demand for oil means that their income isn’t going to be reduced (much).
So the question is - why do they continue to peg?
gillies Says:
why should china heed the advice of rival powers who openly speculate upon its collapse ? and how can china ignore the way that the economy of the old soviet union was looted, when it might have been more appropriate for russia to have been eased into capitalist mode, by contriving a ’soft landing’ for her ?
china may also find it hard to forget the opium wars, an earlier encounter with western strategies. a proud country would rather fail in its own way, than succeed as the lap dog of some other power.
and does anyone else have the sense that the peg has the reverse effect - of holding the dollar up - equal and opposite to holding the r m b etc. down ?
gillies Says:
my comment on an earlier thread deserved brad’s criticism. let me revise it :
there is a danger inherent in ‘excess’ money creation that the money has to end up somewhere. money lent into existence in ‘helicopter attacks’ in support of markets, is bound to lead to recurring ‘ponzi bubbles’ as gamblers or ‘investors’ find newer and more fashionable places to put it. the result can only be a flight from all currencies and inflationary spikes which make and break millionaires, world wide.
only then when the prices of basic commodities are driven beyond the reach of those who make their living in the ‘real’ economy will a deflationary contraction begin. the basic recipe of scarce resources and abundant labour is in place for a slump.
adjustment of interest rates can stimulate, but cannot control, the u s or the global economy. no doubt i am not putting this well - but nor has anyone made out a convincing case that the policy of currency debasement code named ‘helicopter ben’ can have anything other than a disastrous long term outcome. this is not a ‘downside risk.’ it is a direct and inevitable consequence of loosing a tide of dollars upon the world. money is spent more than once and once issued it has to go wherever trade and speculation send it.
less dollars = smaller and less destructive bubbles. that’s not an unreasonable observation, is it ?
.
Eduardo Guelman Says:
Also worth noticing that China has a 400 MLN, and growing, potential consumer market…
oscar Says:
couple of thoughts:
1. A nice shiny new home Brad
kudos to you good sir, ive had many many hours digesting your thoughts over the years, good to see it will continue.
2. I fail to see the point in reiterating how US is trying to pressurize china into revaluing. i think that wheeled out argument goes in the filing cabinate beside the (ex kinda) stong dollar policy mandates. besides i believe china will plough its own path, rightly or wrongly im not gunna judge (currently noone can judge imo).
3. personally i think a rebalancing is occuring, part of that realization is that actually stuff is not that cheap (however you measure it, dollars, RMB, Molds. perception is the metric thats changing)
4. Central banks are only one aspect of a country, think what you may of the actions of the FED, personally i reckon the US will always be a safe store of Value, becuase its the overall leglistative framework of laws and rights that ensures the value.
5. (Off topic) Greatest Financial Crisis Since the Depression (TM Macro man) looks like most crisis i’ve read or experienced (not many tbh). (insert initial starting parameters here) > Insecurity, people buy less stuff > less stuff gets sold, profits down> rising unemployment > people buy less stuff. repeat …. admittedly subprime and leveraging does represent significant scale, but at the same time its more hidden within the overall economic framework, im confident investment appetite will remain, tho how it gets allocated may change.
Estragon Says:
Twofish,
I generally agree with your thoughts, bar one. There certainly is a “switch” China can use to tune up noisy US politicians.
If they were to stop buying US debt for a period, they’d certainly demonstrate the popular appeal of letting sleeping dogs lie.
DR Says:
I agree with TwoFish also but I would like to add that the US might see a RMB revaluation as a move towards lowering the US trade deficit where as a Gulf revaluation would have little effect on the deficit due to Opec’s cartel pricing ability.
David Says:
Ya know, the US spends way to much time saying what other countries should or shouldn’t be doing, in stead of what the US SHOULD
David Says:
Ya know, America spends way to much time saying what other countries should or shouldn’t be doing with their currencies, instead of what America SHOULD be doing in response to what China, Saudi Arabia, etc. ARE doing. If China doesn’t want to raise the value of its currency, then we need to respond to THAT….not to develop plans to what they SHOULD be doing - or whining about what they ARE doing - and then move forward from there. At some point, the US has to develop its own game plan in response to what China, etc. ARE doing. And, if we aren’t in a position to do anything constructive for ourselves — God knows they’re taking care of themselves — then we need to address that. I have a rule, respond to what people ARE doing, not to what they say they’re going to do, or what I think they SHOULD be doing.
Charles Says:
I hope you’re right about 10-20% devaluation resulting in trade balance, Brad. The dollar has fallen a lot more than that with only a small decrease of the trade imbalance. But of course, as you point out, that’s mostly been against the Euro.
don Says:
I would like to expand on the point made by Twofish. Saudi Arabia is not supporting its exports by fixing its currency. The price of crude is set in dollars and is determined by the global market. Whatever Saudi Arabia does to its currency will have virtually no effect on oil prices or oil exports. The policy may be subtracting a bit from global aggregate demand by discouraging Saudi consumption, but the amount is surely negligible. It will simply take them time to absorb the windfall in income caused by the oil price increase. To say it is somehow inconsistent for the U.S. to criticize China’s pegged currency regime and not the Saudi’s is to draw a false (and silly) analogy.
bsetser Says:
Charles —
Have faith:
a) the fall in the non-oil trade balance is actually a bit bigger than the fall in the overall balance (and the possibility that oil could be a bigger offset does worry me)
b) there are long lags in trade adjustment. the slow reaction in 04 and even 05 may reflect the dollar’s strength in 01 and 02. the $ didn’t really fall til 03. and it only really got objectively weak in 07 — 03 brought it back down to its normal range after its earlier strength.
bsetser Says:
dmg555 –
An appreciation of the riyal means each $ of oil revenue buys fewer riyals (supposedly one reason why the Saudis resist appreciation). but each riyal buys more dollars, so the external purchasing power of the Saudis oil revenue stream is unchanged. that suggests to me that there should be no impact on the price of oil —
moreover, if the price of oil is determined by demand — as the supply is fixed in the short-run — an appreciation of the riyal shouldn’t have any impact. it would only matter if the saudis had pricing power and tried to raise the $ price (and could do so) to they to keep their riyal revenue the same. and if they were able to do so, they would effectively be increasing the real price of oil — as they would be getting the same number of riyal, but each riyal would buy more. and if they could do so, why wouldn’t they do that now.
2fish — you are only 1/2 right. There isn’t a constituency in the us that is hurt by the peg, so there is less pressure. But the coalition that dislikes chinese intervention is broader than just textiles. Furniture makers for example. and some auto parts makers (The small guys) as well as most auto parts workers. The street isn’t really for appreciation in my jdugement. Paulson in my judgement wanted more market access for financial services firms more than he wanted appreciation — and that probably reflects the general view of the street. The street isn’t hurt by massive chinese demand for safe assets/ cheap Chinese goods. Some statesmen worry, but there is at least as much angst over adjsutment as there is over continued inflows.
bsetser Says:
i would have more sympathy for the argument that china should be able to determine its own exchange rate and its own pace of adjustment if:
a) it wasn’t also setting the exchange rate for the US
and
b) its choices only impacted China not the rest of the world.
the spillovers from the Gulf’s peg are less obvious; the gulf’s own residents are biggest losers — at least those who cannot borrow in rapidly depreciating dinar and riyal. But here the US role goes beyond not pushing for change. The US supposedly has encouraged the Gulf states to remain pegged — i.e. it is actively resisting change. and that strikes me as a policy error.
full disclosure: I am personally long gulf currencies as well as being intellectually long the idea that the Gulf shouldn’t be pegged to the $.
Twofish Says:
bsetser: Furniture makers for example. and some auto parts makers (The small guys) as well as most auto parts workers.
RMB appreciation won’t help auto parts makers or furniture makers. If you appreciate RMB, then the factories will relocate to Mexico. Textiles are unique since China has some comparative advantage there for reasons I don’t fully understand.
bsetser: The street isn’t really for appreciation in my judgment.
True, but they are for removing capital controls, and you just can’t remove capital controls without unpegging the currency.
bsetser: The street isn’t hurt by massive chinese demand for safe assets/ cheap Chinese goods.
It’s not but you don’t make much money selling treasury bonds. The way you make money in finance is M&A, high value consulting, etc. etc. All of which you can’t really do right now in China because of capital controls.
bsetser: i would have more sympathy for the argument that china should be able to determine its own exchange rate and its own pace of adjustment if: it wasn’t also setting the exchange rate for the US
Actually it’s not. The US is perfectly able to change the dollar exchange rate. Just either reduce the amount it borrows by cutting the deficit, or increase interest rates which will send the economy into a recession. The fact that the US government is unable and unwilling to make tough choices is hardly the fault of Beijing.
In fact there is a irony, in that during the 1990’s, the IMF and most economists argued that fixed exchange rates were a good thing *because* they forced governments to make tough choices. It’s very hard for anyone outside the US who has undergone an “austerity program” to have much sympathy for the United States.
In any case, China can only be expected to do what is in the Chinese national interest just as the US can only be expected to do what is in the US national interest. Discussions about what is “fair” or not seem to be rather irrelevant.
bsetser: b) its choices only impacted China not the rest of the world.
Everyone choices affect everyone else’s. It’s part of the globalized world that we live in. Rather than complain about how badly China choices affect people in the United States, I think one can start by asking the question of what the US *can* do if it doesn’t like the choices China is making. Once you start asking that question, I think it will become obvious that the options that the US has really are less appealing to large numbers of people in the US than the status quo. Let’s not forget that the current state of affairs in which we are all embedded in a global economic system in which everyone has to be somewhat nice to everyone else is one that people consciously put into place in the 1990’s.
I just can’t help but think of the proverb “be careful what you wish for since you might get it.”
Let’s think ahead. Suppose you get everything you wish for. RMB appreciates drastically. Trade deficit goes into balance. What happens next? (One obvious thing is that US companies become very cheap.)
Laurent GUERBY Says:
Twofish, excellent summary.
If RMB moves up USA companies that decided in the first place to go to China to screw their USA workers will just go somewhere else and it will not solve USA problems at all.
Only USA fixing its own problems (well identified by now) will change anything.
bsetser Says:
Laurent and 2fish — while I agree that the US can and should do more to address its own problems, an imbalance reflects policy choices in both the deficit and the surplus country — i was struck by the fact that the US current account deficit didn’t adjust as much as might have been expected when the fiscal deficit fell from 04 through 07 (tis rising again in 08), largely b/c low interest rates (thanks to policies in china and the oil exporters) helped encourage household borrowing (and yes, us households are bit easier to persuade than some others).
the notion that the location of produciont of autoparts and furniture are not a function of the exchange rate strikes me as off. Auto assembly too. Look at German manufacturers new found desire to set up shop in the US. That has something to do with the euro-dollar. Chinese export growth to Europe in a host of products seems linked to the euro-renminbi. The notion that production shifts to China no matter what the exchange rate and thus the deficit is not shaped by the exchange rate doesn’t seem to fit the facts.
Eur-RMB move had an impact.
the recent $-RMB move seems to have contributed to the slowdown in US import gowth from china.
Menzie chinn found that the real exchange rate impacts US export growth.
Goldman found that the real exchange rate impacts Chinese export growth –
look at my next post. the acceleration in Chinese export growth is very correlated with the RMB’s depreciation.
there are a bunch of things the US should do; its current energy policy is no one’s fault but the US. but China’s policy of spending half a trillion in the fx market to fight RMB appreciation does have an impact on the world, not just China.
2fish — US rates don’t set the RMB/$; the US has lowered rates, creating pressure for appreciation. the market flows reflect that. but the pace of rmb appreciation and thus the value of the $ against the RMB is still set by China’s government. and yes, it is setting the exchange of the dollar v China as well as the china’s exchange rate with the dollar. Tis one price.
don Says:
“Given the huge current-account surpluses and reserve accumulation in the Gulf states, it’s getting harder and harder for the U.S. Treasury to justify putting pressure on China, but not the Gulf states, to have more exchange-rate flexibility,”
As Brad already noted, oil exporter’s currency policies have little effect on the price of their exports (oil), or their trade surpluses. Thus, the apparent parallel in the quote is just plain silly.
If I were finance chief of such a country, I would certainly peg my currency to some foreign currency. Otherwise, what would happen to my domestic non-oil industries when the price of oil makes such large swings? Who could invest in any domestic non-oil enterprises under such circumstances?
Laurent GUERBY Says:
Brad, half a trillion is absolutely nothing.
Just the USA housing bubble is at least ten times bigger nominal wise and at least two order of magnitude bigger risk-wise.
Iraq war is also several time bigger nominal wise, and even more risk wise.
Derivatives loved by USA banks are waaayyy bigger.
Both USA problems and fixable locally by USA political action.
Political action should happen were the payoff is the biggest, and China FX/reserve issues are way down the list. Plus just doing nothing will solve the FX problem in a five year scale given current China FX policy, how long to fix the housing bubble aftermath if nothing is done?
bsetser Says:
$500b intervention in a year (with an expected long-term loss of $150b) is more than the US is spending on Iraq (at least on a flow basis)
i take the point that risk wise invading iraq was bigger, but in terms of $ cost, China is now spending more propping up the $ (or holding the RMB down) than the US is spending in iraq …
the whole point of my next post is that doing nothing implies a bigger problem, as the trend is more intervention not less (just as iraq is getting more not less costly over time)
Laurent GUERBY Says:
Brad, honestly how can you write “with an expected long-term loss of $150b”?
If you know the long term value of any security, you’re the richest man in the world! I envy you!
In the long term (actually not so long in my estimates), the peg will go away all by itself (crossing equilibrium) and CNY will fluctuate as most developped countries currencies.
If you look at EUR/USD it means that FX will vary +/- 50% around long term average.
Here is a prediction with very high probability of being true: at some point in the next 20 years, the write-off for PBoC USD reserves will be exactly zero, no accounting gain, no accounting loss.
You just have to be patient. I guess patience is not a virtue of USA based economists :).
bsetser Says:
Laurent — Please explain to me exactly how the peg will go away all by itself?
the loss comes from an assumption that the RMB is undervalued v a euro/ $ basket by around 33%. That is just an estimate, but given that China has a current account surplus and that is has a capital account surplus, it isn’t unreasonable. Remember, China is buying all these $ to keep its exchange rate from appreciating. if its stops, it takes a loss. that is what gives me confidence; predicting the value of security whose long-term value is being held down by market intervention isn’t hard.
Moreover, over time, one would expect the RMB to appreciate in real terms, as normally happens when a country develops. Look at the yen from 1950 to 1980, or the won over time.
I am quite happy to take your bet … tho I would rather structure it as in twenty years, the PBoC will take a large write off on its $ holdings; a long-term view for a yank.
Laurent GUERBY Says:
Year on year CNY appreciated more than 10% against USD, so 33% is three years of the current regime, less if you take into account the measurable acceleration.
Also 33% might only be 10% as the latest data shows, see Menzie Chinn here:
http://www.econbrowser.com/archives/2008/05/rmb_misalignmen.html
Once some equilibrium is reached, easy to spot for PBoC since it will have to buy much less USD, PBoC might want to release the tightness of the peg.
Your bet terms are substantially different than mine :).