The problem is that getting off a peg is really quite difficult. The second you start moving off of a peg, then you get this positive feedback cycle that causes massive capital flows. Looking at Argentina and Turkey (and China now), it wasn’t so much that they didn’t want to get off the peg, it was that they couldn’t easily move off of their pegs without a lot of turmoil.

it turns out that a low fewer Emerging markets than we thought adopted the kind of policies the US advocated; most decided to peg an undervalued level rather than float. That really was their choice — not one pushed by the US.

I’m curious what you think the responsibility is of economists and international organizations that were encouraging third world nations to peg their currencies to the dollar.

This statement points out the fatal flaw of Bretton Woods I and Bretton Woods II. Under a Bretton Woods system then nation that ends up serving as the reserve currency *does* have an obligation to manage its currency for the benefit of nations that peg to it. The trouble with that as we found out in the early 1970′s and in the early-2000′s, is that the US simply can’t and won’t cause a recession in its domestic economy for the good of the rest of the world.

No it couldn’t. Changing from a system of pegged exchange rates to an system of floating exchange rates is one of the most complex, difficult, and dangerous things that a nation can do with its economy. People have had their hands full dealing with the slow unpeg, and any depeg that was faster than what has happened would have caused huge amounts of economic disruption.

One thing that makes depegging difficult is that it is an all or nothing irrevocable decision. Once you’ve depegged, then it is effectively impossible to move back. There are dozens of examples of botched depegs that have devastated an economy. The examples of successfully depegs in economic history are quiet small, and they have always taken years to undertake.

bsetser: US is under no obligation to manage its currency for the benefit of other countries that unilaterally choose to peg to the $. China is responsible for the consequences of pegging to the dollar at an unchanged rate as its circumstances changed and as the US economy changed.

Who is resposible for what is something in international finance is something is quite unclear right now. If the US view is that international monetary policy should be designed so that what every is good for the US is good, and to hell with the rest of the world, and the US can do whatever it pleases and is not responsible for the consequences then sure, the US isn’t responsible.

However, the post-WWII major efforts that have been made to create an international framework for monetary policy have relied on fixed currency exchange rates to prevent nations from doing precisely what Greenspan did in 2001-2004. Both Bretton Woods I and the Washington Consensus mandated a system of fixed exchange rates precisely so that nations would have to “bite the bullet” and undertake actions that would hurt its domestic economy rather than to run presistent deficits.

The US is really the only country that is able to break these rules because the dollar is used as a reserve currency and because of its huge economic and political power. Any other country that tried what the US did between 2001 and 2004 would have quickly run into a massive currency crisis.

Here is an experiment. Replace the nations involved in your statement, US->Mexico and China->US, and imagine arguing it in front of the IMF in 1995.

The system of fixed exchange rates that China adopted in 1993 was one aspect of the Washington Consensus that it did adopt (and influence from Hong Kong was pretty crucial), and it was willing to uphold the peg through the Asian crisis of 1998.

bsetser: again, if excesses in the us are the sole cause of the big us deficit (and a fall in investment v savings globally), the us deficit should be putting pressure on rates both in the us and globally. didn’t happen.

That’s because the peg and high Chinese savings rates meant that US excesses are being financed by Chinese savers. I don’t disagree that this is happening. Where I do very strongly disagree about is how this situation came about, and the decisions that lead to this situation were made mostly in Washington and not in Beijing. As you yourself have pointed out, most of the costs of the current situation are going to be borne by Chinese rather than Americans, and that strongly suggests that the critical decisions are being made in Washington rather than Beijing.

bsetser: frankly, i had hoped china wouldn’t finance w’s war and tax cuts so their costs would more visible.

Wars and tax cuts are something else that are hard to undo. Once you’ve committed yourself to fighting a war cutting taxes then it takes some rather extreme pressure to undo those.

Also any efforts to make the cost of a policy obvious runs into the fact that you are dealing with politicians whose job it is to hide the costs of any policy. This is in some ways a good thing since it makes politicians very interested in pro-growth policies since it is much easier to hide things in a growing economy than in a stagnant one.

But, by similar logic, as I explain at http://reservedplace.blogspot.com/2008/05/enigma-inside-conundrum.html, if central bank intervention was driving US interest rates, government bonds should have been relatively expensive and spread product relatively cheap. In fact, before the financial crisis, spreads were tight. My conclusion is that US demand to borrow has been as responsible for the US current account deficit as foreign central bank supply of savings.

I have been very impressed that you have been thinking through some of these issues along the same lines that we have. Do you have any published papers or commentaries that you could e-mail me. I can be e-mailed at director@phaa.org.

Howard

I agree with your analysis. Once you figure out where, do let me know. I also hope it won’t be U.S. government debt, but I suspect that that will be part of it. I hadn’t thought of US farmland. Hmmmm….

Howard