Posted on Wednesday, June 18th, 2008
By bsetser
I did a podcast for cfr.org that presents my thinking on this topic.
The simplest reason why oil is up and the dollar is down is that the world economy has been far stronger than the US economy. Weakness in the US economy translates into a weak dollar. Still solid global growth translates into strong demand for oil at time when supplies are a bit tight.
It is also striking, at least to me, that the countries that subsidize oil consumption the most also tend to peg to the dollar or manage their currencies against the dollar. US economic weakness consequently has translated into low US interest rates — and low US rates have translated into low nominal rates - and even lower real rates — in the other, booming dollar zone economies. See Martin Wolf. Combine low real rates with subsidized (or at least below-world-market-prices) oil and there has been a big increase in demand for oil in many countries that peg to the dollar or manage their currencies against the dollar.
I also was persuaded by the analysis of Goldman’s fx team. They argue that there are fundamental reasons to think that a rise in the price of oil should be bad for the dollar. The US economy is energy and oil intensive. The US has the largest existing external deficit of any major oil-importing region. The US exports relatively little to the oil-exporting economies. And the oil-exporting economies seem a bit less inclined to hold dollar-denominated financial assets than in the past.
That said, I wish I had concluded by noting that there are two clear paths that could end the current “oil up, dollar down” pattern.
Weakness in the US economy could drag down global oil demand, pulling both the dollar and oil down. Asia’s 1997-98 crisis led both Asian currencies and the price of oil to fall.
Or a rebound in the US economy could push up the dollar while adding to oil demand. In 2000, a booming US pushed up oil prices and the dollar.
The dollar isn’t always weak when oil is strong. And the dollar isn’t always strong when oil is weak. But so long as global growth is far stronger than US growth, there is reason to think that oil prices will respond to global demand while the dollar will reflect conditions in the US.
Posted in Exchange Rate, oil | 36 Comments »
Posted on Friday, June 13th, 2008
By bsetser
The rising cost of transportation makes goods produced closer to their final market cheaper relative to the goods produced a long ways away. Today’s Wall Street Journal reports that rising transportation costs are having an impact: DESA LLC has decided it makes more sense to produce heaters in Kentucky than in China; Breman Castings Ince is getting “work back from China” and Craftsman Furniture (now Chinese owned) is scaling back plans to shift its furniture production to China.
Adjustment in action. Good news too, even if consumers have to pay a bit more. Adjustment doesn’t always work to the benefit of consumers at the expense of domestic producers.
The Journal reports that Jeff Rubin of CIBC in Toronto estimates that the rise in transportation costs has raised the effective “cost of shipping” tariff on imported US goods from 3% to 9%. DESA reports that the 15% increase in the cost of shipping goods from China contributed to its decision to produce more in Kentucky.
Makes sense.
I rather suspect that the close to 20% rise in the Chinese renminbi against the dollar (together with higher inflation in China than in the US) has also played a role in these decisions. A rise in the renminbi has the same effect as a rise in the cost of shipping. Production in the US starts to look more attractive if the cots of producing goods in China goes up.
Indeed, I was a little surprised that Timothy Aeppel’s story focused so much more on rising transportation costs than on the exchange rate: exchange rate changes were mentioned, but only in passing after the beak. The focus was on rising transportation costs
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Posted in China, Exchange Rate | 26 Comments »
Posted on Sunday, June 8th, 2008
By bsetser
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.
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Posted in Exchange Rate, oil | 13 Comments »
Posted on Friday, June 6th, 2008
By bsetser
Tim Duy, with rather impressive timing, says yes. Rising inflation in China and the Gulf, the key regions in today’s “dollar zone,” now have a large enough impact on prices in the US to limit the Fed’s ability to cut rates further. Rather than setting monetary policy for the US, Duy — who had an office next to mine at the US Treasury back when we were both very junior new hires ten years ago — claims the Fed has to set policy for the entire dollar zone. Duy writes:
Years of academic research led Bernanke to conclude that the Fed’s best response to the financial crisis is that which should have been deployed during the Great Depression. Fine on paper, but in practice he is using 1930’s monetary policy in the economy of 2008. And that 70+ year gap is exceedingly important in many respects, but perhaps none is more important than the current status of the US Dollar as a reserve currency, a status that allows the US to run a gaping current account deficit. The concern is that the Fed treats the external sector with something of a benign neglect when setting policy, effectively ignoring the reserve currency function of the Dollar. Hence, in a bow to Wall Street, policymakers unwittingly created an overly stimulative environment that feeds back to the US in the form of higher inflation.
This simply implies that the Fed does not sufficiently consider the reaction functions of other central banks when setting policy. Should they? In a world with limited capital flows, no. But in today’s globalized financial environment, the answer is increasingly yes. In effect, by encouraging open capital flows, the US has ceded some amount of domestic policy control.
It is an intriguing argument.
Once upon a time, Nouriel Roubini and I postulated that central banks would be unwilling to add ever increasing sums of depreciating dollars to their portfolios, and that the need to attract international capital to finance the (large) US external deficit could become a constraint on US macroeconomic policy autonomy. In such a scenario, US long-term rates would rise — and the Fed might need to raise short-term rates — even during a US slowdown. Rather than being able to adopt counter-cyclical policies designed to support domestic economic activity during a slowdown, the US might be forced to adopt pro-cyclical policies designed to assure access to sufficient external financing.
This scenario hasn’t materialized. US fiscal policy is now expansionary and the fiscal deficit is rising rapidly. US monetary policy is also expansionary. US policy rates are low, especially in real terms. Long-term rates are low too — though no longer quite as low as they once were. All this has been possible, in some sense, because of an absolutely extraordinary increase in central bank reserve growth (supplemented by big flows into sovereign funds). My analysis suggests central banks and sovereign funds are on track to add over $1.5 trillion dollars to their portfolios this year (after adjusting for valuation gains). The huge rise in custodial holdings at the New York Fed strongly suggests that central banks remain the key sources of financing for the US.
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Posted in Exchange Rate, Monetary policy | 44 Comments »
Posted on Saturday, May 31st, 2008
By bsetser
That at least seems to be the Treasury’s policy.
Krishna Guha of the FT reports that the US believes that dollar pegs can help countries manage commodity price volatility.
Mr McCormick said that oil producers were not in the same position as large manufacturing exporters such as China. “A commodity-driven economy with a lot of volatility in commodity prices could be a beneficiary of a pegged regime,” he said.
So much for the notion that the Treasury is open to a change in the Gulf’s peg.
And so much for any illusion that I might have some influence over US policy.
In my Peterson institute policy brief, I argued that commodity price volatility is a reason not to peg to the dollar. A peg assures that fluctuations in the dollar price of a commodity (say oil) will translate one for one into volatility in countries local currency revenues from commodities. By contrast, a currency that appreciated when commodity prices appreciated and depreciated when commodity prices depreciated would tend to stabilize a country’s local currency revenues.
And I am not quite sure how pegging to a currency that has depreciated in real terms even as oil has appreciated in real terms has helped smooth out macroeconomic volatility in the oil-exporting economies; it seems to have produced high levels of inflation, negative real interest rates and a wildly pro-cyclical macroeconomic policy mix.
It isn’t hard to see why Paulson is intent to signal that the US remains open to foreign investment from sovereign wealth funds — and why he is pushing the Gulf to allow more foreign investment in its oil sector. A sharp fall in financing for the US would be disruptive, US investment banks are keen to do business with sovereign funds and the Bush Administration is keen to spur more investment in oil production in the big oil-exporting economies. The Wall Street Journal reports (in an article that was perhaps buried a bit more than it should have been) that the big oil exporters are exporting less this year than last.
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Posted in Exchange Rate, oil | 14 Comments »
Posted on Friday, May 23rd, 2008
By bsetser
That more or less is the conclusion of this week’s Economist.
I agree.
Back in 2003 when the dollar started to depreciate, many emerging economies opted to maintain dollar pegs and follow the dollar down. The resulting increase in their reserves — and holdings of US Treasuries — altered the monetary transmission mechanisms in the US. The dollar was stronger than it otherwise would have been, notably against the Asian currencies. And US rates were lower than they otherwise would have been.
Moreover, long-term rates didn’t rise when the Fed started raising rates, keeping financial conditions looser than they otherwise would have been. And as the revised data from mid-2004 to mid-2006 comes out, it is increasingly clear that ongoing central bank purchases of Treasuries and Agency bonds are part of the explanation for the persistence of low long-term rates. The Economist:
“Emerging economies shared some responsibility for America’s housing and credit bubble. As Asian economies and Middle East oil exporters ran large current-account surpluses, they piled up foreign reserves (mostly in American Treasury securities) in order to prevent their currencies from rising. This pushed down bond yields. At the same time, cheap imports from China and elsewhere helped central banks in rich economies hold down inflation while keeping short-term interest rates lower than in the past. Cheap money fueled America’s bubble.”
The housing bubble and residential construction boom obviously have ended. The US economy has slowed sharply. And the US has cut rates.
The result is that a host of emerging economies are now importing both a weak currency and loose monetary policy from the US. Countries that peg to the dollar can easily have a looser monetary policy than the US — higher rates of inflation and the same nominal interest rate can produce lower real interest rates — but have difficulty maintaining a tighter policy. Raising rates while maintaining a de facto dollar peg would tend to attract speculative capital inflows. Ask China.
Loose monetary policy globally has helped to offset the US slowdown. Much of the emerging world is booming on the back of negative real interest rates. But it also has pushed up inflation globally. The Economist reports that the average global real interest rates is negative (”global monetary policy is now at its loosest since the 1970s: the average world real interest rate is negative”) largely because of very high rates of inflation in the emerging world.
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Posted in Exchange Rate, emerging economies | 21 Comments »
Posted on Tuesday, May 20th, 2008
By bsetser
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.
Posted in Exchange Rate, oil | 29 Comments »
Posted on Wednesday, May 7th, 2008
By bsetser
The blogosphere’s eyes and ears in the London foreign exchange market — Macro man — thinks so. China has, he thinks, been a net seller of euros over the past few weeks. That is something of a change. It has been a large net buyer for some time — whether to hit its portfolio targets or in an effort to push the dollar share of its reserves down a bit.
If China’s foreign assets are rising at an annual rate of between $600 billion and $700 billion — as Wang Tao, who just moved to UBS, believes — just maintaining China’s existing portfolio targets might require selling something like $200b of dollars for euros a year. That amounts something like $1 billion of sales a business day, minus whatever euros come directly into the central bank from its intervention in the euro/ renminbi market. My calculations assume the central bank intervenes entirely the dollar/ renminbi market.
I find Macro man’s anecdotal evidence plausible because something clearly changed about a month ago.
Once the RMB reached 7, its appreciation against the dollar stopped cold. Over the last month the RMB dollar looks a lot like a tightly managed peg.
That clearly reflects a policy decision inside China. And it possible that China made a two-fold decision, first to slow (or stop) the appreciation against the dollar and second to do what it could to push the dollar up against the euro. Stopping dollar sales is a rather obvious way to support the dollar if you are a big net seller.
The idea behind such a strategy would to be to get real appreciation through dollar appreciation rather than through renminbi appreciation against the dollar. Or to get Europe off China’s back once China decided to slow its own appreciation against the dollar. Or perhaps just to try to profit from a view that the euro has risen to the point where it is likely to fall.
I of course don’t whether China has actually scaled back its euro purchases. I would be curious what other think. And I certainly don’t know if the decision to scale back euro purchases was tied to the decision to slow the RMB’s appreciation against the dollar — that is pure speculation on my part.
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Posted in China, Exchange Rate | 29 Comments »
Posted on Tuesday, May 6th, 2008
By bsetser
Oil is trading above $120.
Saudi Arabia exports more oil than anyone else. It isn’t unrealistic to think the Saudis oil export revenue could approach $400 billion a year if oil stays above $120.
Saudi economic development has lagged the Gulf boom towns of Doha, Dubai and Abu Dhabi. Paul Murphy, quoting Goldman’s Ahmet Akarli:
the Saudi economy has lagged badly behind its peers in the Gulf region in terms of both per capita income and overall living standards – in particular, it lags the rapidly diversifying and prosperous economies of the UAE, Kuwait and Qatar.
The right policy course: a bit of austerity. Yep, spending cuts. Or least slower spending increases.
That at least is what the Saudi central bank governor suggests. The FT reports:
Saudi Arabia’s central bank governor on Tuesday called on the government to fight inflation by curbing public expenditure, warning that economic policies in the kingdom faced “a critical situation” ….
“The Saudi Arabian Monetary Agency [the central bank] has taken steps to reduce domestic liquidity by raising the statutory reserve requirement several times. Given the dominance of fiscal policies on the economy, it is necessary to reprioritise spending and programme it to fit the absorptive capacity of the national economy,” Mr Sayari added.
The IMF – which has been arguing for maintaining the dollar peg and limiting inflation with spending cuts – presumably approves. The IMF’s advice to Oman is presumably not that different from its advice to the Saudis. Not that the IMF’s views matter. The US, which is rumored to have put pressure on the Saudis to maintain their peg to the dollar, presumably does too.
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Posted in Exchange Rate, oil | 4 Comments »
Posted on Thursday, April 17th, 2008
By bsetser
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.
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Posted in Exchange Rate | 33 Comments »
