Brad Setser

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Ken Rogoff is also confused by the US policy towards dollar pegs

by Brad Setser
June 8, 2008

It is nice to be in good company. Ken Rogoff is as confused by US policy toward dollar pegs as I am. Rogoff:

Does it make sense for the United States Treasury Secretary, Hank Paulson, to be touring the Middle East supporting the region’s hard dollar exchange-rate pegs, while the Bush administration simultaneously blasts Asian countries for not letting their currencies appreciate faster against the dollar? Unfortunately, this blatant inconsistency stems from the US’s continuing economic and financial vulnerability rather than reflecting any compelling economic logic. Instead of promoting dollar pegs, as Mr Paulson is, the US should be supporting the International Monetary Fund’s efforts to promote the eventual de-linking of oil currencies and the dollar.

The macroeconomic logic of the US position is hard to decipher.

If the US thinks monetary flexibility would help China – and the rest of Asia — limit inflation, why wouldn’t monetary flexibility help the Gulf do the same? The Gulf certainly has an inflation problem. Saudi inflation is now over 10%. Qatar’s inflation is just under 15%. I would bet the UAE’s inflation rate, honestly calculated, is just as high, if not higher.

The Gulf’s peg the dollar — which is likely to depreciate in the face of the oil shock — certainly has complicates both the Gulf’s own adjustment to higher oil prices and the broader process of global adjustment. Menzie Chinn has calculated that a 10% rise in the price of oil implies a roughly 2% real depreciation of the currencies of most oil-importing economies, including the US.

In Chinn and Johnston (1996), a 10 percentage point rise in the real price of oil induces a 2 percentage real depreciation in a typical OECD country real exchange rate.

A real depreciation in the oil-importing OECD implies an a real appreciation of the oil exporting economies. Yet so long as the Gulf pegs its currency of the oil-importing economy with the largest pre-existing current account deficit (at least among the major economies), the only way this real adjustment can happen is through inflation. In that sense, inflation isn’t a problem — it is the way the Gulf has chosen to adjust.

Perhaps China too.

I agree with Dr. Rogoff’s critique of US policy. But I wonder if has let his colleagues at the IMF off the hook a bit too easily.

Rogoff argues that they are working behind the scenes to help the Gulf move off its dollar peg.


But in public, they continue to support the peg. The IMF’s plan for global imbalances embraces the Saudi peg. The IMF’s Article IV surveillance of individual Gulf economies has also embraced their pegs. Just look at what the IMF board said about the UAE’s peg: “Directors agreed that the current peg of the dirham to the U.S. dollar has served the U.A.E. well.” Finally, the IMF has publicly argued that the Gulf should adopt a contractionary fiscal policy to try to reduce inflationary pressures rather than consider moving off the peg.

All in all, it is hard to see how the IMF’s approach differs from that of the US.


  • Posted by Michael


    What is the common element in your recent discussions about China’s paradoxical accumulation of dollar reserves (given that they are depreciating in value) and today’s discussion about the Gulf petro-exporters holding onto the dollar peg (given that it increases inflation in their countries)?

    They both represent the supremacy of political process over “pure” economic process. The self-contradiction of the U.S. positions attacking China on the one hand for holding to a dollar peg while encouraging the Gulf States to hold to the dollar peg is the same thing: the political process in operation.

    Trade and financial theory always postulates consistent behavior by economic actors in response to various measurable conditions. However, the one thing Keynes, Friedman, Minsky, Krugman and all the rest of us agree upon is that consistency and straightforward response to specific conditions are only theoretical and they always disappear as soon as the economic actors in question are sovereign political leaders.

  • Posted by algernon

    “inflation isn’t a problem — it is the way the Gulf has chosen to adjust. ”

    Given that prices are the language of economic interaction & that inflation represents distortion of that language, the Gulf will in time find it intolerable & change.

    Michael, your point is right on: Pecksniffian political leaders–ie, 95% of them–inveterately attempt to reduce the benefits of voluntary exchange. We too readily allow them to expand their power to do so.

  • Posted by aim

    “US should be supporting the International Monetary Fund’s efforts to promote the eventual de-linking of oil currencies and the dollar”

    In the past, wasn’t the IMF actually promoting dollar pegs?

  • Posted by bsetser

    the IMF was supporting pegs as a disinflationary tool in the early 1990s. By the late 1990s, pushed by the US among others, it was encouraging emerging economies to allow more flexibility. the pegs of the early 1990s had left many emerging economies with overvalued exchange rates and they had difficulty adjusting to a fall in capital flows (and for some a fall in commodity prices). Most emerging economies then devalued — and in retrospect, far more “repegged” at a lower, depreciated rate than really moved toward greater flexibility.

    the other source of the big swing tho was the dollar — pegging to the dollar in the 90s created problems b/c of the dollar’s appreciation, pegging to the dollar now creates problems b/c of the dollar’s weakness.

    given that oil has been weak when the dollar was strong and strong when the dollar is weak, this has been (in my view) particularly problematic for the oil exporters.

  • Posted by Twofish

    bsetser: The macroeconomic logic of the US position is hard to decipher.

    That’s probably because there is no macroeconomic logic behind it. US wants cheap oil and money for bailouts from the Saudis. It want fewer job losses from China imports.

    Macroeconomics has nothing at all do to with this, and I think we’ll have much more honest and constructive discussions if people stop pretending that it does.

  • Posted by FG

    Surely politicians can ignore macroeconomics, but they can also be victims of the economic consequences of their decisions.

  • Posted by zebla

    “Surely politicians can ignore macroeconomics, but they can also be victims of the economic consequences of their decisions.”


    will the victims no be ordinary people than politicians?

  • Posted by JKH

    Oblique to topic:

    It would be interesting if sometime you could do a time graph on your estimate of CB treasury and agency holdings versus the outstanding float of same. It would show a couple of natural boundary points or limits on CB reserve accumulation.

  • Posted by bsetser

    jkh — it would be an interesting exercise, tis true …

    but remember that supply of treasuries is fairly elastic. the US is issuing a lot more, and the fed’ balance sheet operations are also having an impact by adding more treasuries to the market.

    as for the agencies, well, central banks haven’t gotten close to holding even 50% of the outstanding stock. tis a big market. that number includes the agency pass-throughs tho, and some CBs won’t hold them.

    2fish — methinks you are right. i still think the US policy logic is wrong/ puts too high a premium on cheap saudi financing v other goals.

  • Posted by don

    I don’t see much of a contradiction in the U.S. policy. Chinese and Asian currency pegs are deindustrializing the U.S. economy. The yen carry trade also would probably not be quite so vigorous (and the U.S. auto industry not quite so devastated) if traders thought currency manipulation would not be tolerated if the yen were to rise to trade for fewer than 100 per dollar.
    In contrast, I think the Gulf pegs are doing little to U.S. aggregated demand or to U.S. industries.
    On another note, I wonder if some oil exporters besides Iran are concerned about U.S. expropriation of their U.S. assets. They can hold dollars in other ways (I think the euro-dollar market came into being to allow the Soviet Union and other ‘Iron Curtain’ countries to hold dollars.) But is there any effect on their investments?
    The piece does not seem in keeping with someone of KR’s reputation. For example, he talks about the Administration’s monetary policy, and he makes no clear statement about the effects of the Gulf pegs on the U.S. economy.

  • Posted by JKH

    Re the 2 year treasury yield –

    I guess China delegated bond pricing to the Fed this time 🙂

  • Posted by bsetser

    JKH — yep. the carnage among those trading the shape of the yield curve is really quite stunning. Must be a lot of selling of 2s by folks covering positions. I am not sure that I really think the fed will raise rates this year tho — even tho that is what the market now expects.

  • Posted by s

    The Feds are desperately afraid of a move away from the dollar – can you say franking privalige gone. In agreement with you on rates; if inflation was such a worrey why si the long bond not moving? the short end is anshort term unwind and will eventually wind its way lower, damn the dollar. The banks are in catastrophic shape and a flattening curve is not good to say the least.