The Atlanta Fed's macroblog provides commentary and analysis on economic topics including monetary policy, macroeconomic developments, inflation, labor economics, and financial issues.

Authors for macroblog are Dave Altig, John Robertson, and other Atlanta Fed economists and researchers.

December 16, 2016

The Impact of Extraordinary Policy on Interest and Foreign Exchange Rates

Central banks in the developed countries have adopted a variety of extraordinary measures since the financial crisis, including large-scale asset purchases and very low (and in some cases negative) policy rates in an effort to boost economic activity. The Atlanta Fed recently hosted a workshop titled "The Impact of Extraordinary Monetary Policy on the Financial Sector," which discussed these measures. This macroblog post discusses the highlights of three papers related to the impact of such policy on interest rates and foreign exchange rates. A companion Notes from the Vault reviews papers that examined how those policies may have affected financial institutions, including their lending.

Prior to the crisis, central banks targeted short-term interest rates as a way of influencing the rest of the yield curve, which in turn affected aggregate demand. However, as short-term rates approached zero, central banks' ability to further cut their target rate diminished. As a substitute, the central banks of many developed countries (including the Federal Reserve, the European Central Bank, and the Bank of Japan) began to undertake large-scale purchases of bonds in an attempt to influence longer-term rates.

Central bank asset purchases appear to have had some beneficial effect, but exactly how these purchases influenced rates has remained an open question. One of the leading hypotheses is that the purchases did not have any direct effect, but rather served as a signal that the central bank was committed to maintaining very low short-term rates for an extended period. A second hypothesis is that central bank purchases of longer-dated obligations resulted in long-term investors bidding up the price of remaining longer-maturity government and private debt.

The second hypothesis was tested in a paper  by Federal Reserve Board economists Jeffrey Huther, Jane Ihrig, Elizabeth Klee, Alexander Boote and Richard Sambasivam. Their starting point was the view that a "neutral" policy would have the Fed's System Open Market Account (SOMA) closely match the distribution of the stock of outstanding Treasury securities. In their statistical tests, they find support for the hypothesis that deviations from this neutrality should influence market rates. In particular, they find that the term premium in longer-term rates declines significantly as the duration of the SOMA portfolio grows relative to that of the stock of outstanding Treasury debt.

The central banks' large-scale asset purchases not only took longer-dated assets out of the economy, but they also forced banks to increase their holdings of reserves. Large central banks now pay interest on reserves (or in some cases charge interest on reserve holdings) at an overnight rate that the central bank can change at any time. As a result, these purchases can significantly reduce the average duration (or maturity) of a bank's portfolio below what the banks found optimal given the term structure that existed prior to the purchases. Jens H. E. Christensen from the Federal Reserve Bank of San Francisco and Signe Krogstrup from the International Monetary Fund have a paper  in which they hypothesize that banks respond to this shortening of duration by bidding up the price of longer-dated securities (thereby reducing their yield) to restore optimality.

The difficulty with testing Christensen and Krogstrup's hypothesis is that in most cases central banks were expanding bank reserves by buying longer-dated securities, thus making it difficult to disentangle their respective effects. However, in 2011 the Swiss National Bank undertook a series of three policy moves designed to produce a large, rapid increase in bank reserves. Importantly, these moves were an attempt to counter perceived overvaluation of the Swiss franc and did not involve the purchase of longer-dated bonds. In a follow-up empirical paper , Christensen and Krogstrup exploit this unique policy setting to test whether Swiss bond rates declined in response to the increase in reserves. They find that the third and largest of these increases in reserves was associated with a statistically and economically significant fall in term premia, implying that the increase did lower longer-term rates.

Although developed countries' monetary policy has focused on their domestic economies, these policies can have significant spillovers into emerging countries. Large changes in the rates of return available in developed countries can lead investors to shift funds into and out of emerging countries, causing potentially undesirable large swings in the foreign exchange rate of these emerging countries. Developing countries' central banks may try to counteract these swings via intervention in the foreign exchange market, but the effectiveness of sterilized intervention is the subject of some debate. (Sterilized intervention occurs when the central bank buys or sells foreign currency, but then takes offsetting measures to prevent these from changing bank reserves.)

Once again, determining whether exchange rates are influenced and, if so, by what mechanism can be econometrically difficult. Marcos Chamon from the International Monetary Fund, Márcio Garcia from PUC-Rio, and Laura Souza from Itaú Unibanco examine the efforts of the Brazilian Central Bank to stabilize the Brazilian real in the aftermath of the so-called "taper tantrum." The taper tantrum is the name given to the sharp jump in U.S. bond yields and the foreign exchange rate value of the U.S. dollar after the May 23, 2013, statement by Board Chair Ben Bernanke that the Federal Reserve would slow (or taper) the rate at which it was purchasing Treasury bonds (see a brief essay by Christopher J. Neely). Chamon, Garcia, and Souza's paper  takes advantage of the fact that Brazil preannounced its intervention policy, which allows them to separate the impact of the announcement to intervene from the intervention itself. They find that the Brazilian Central Bank's intervention was effective in strengthening the value of the real relative to a basket of comparable currencies.

All three of the studies faced the difficult challenge in linking specific central bank actions to policy outcomes, and each tackled the challenge in innovative ways. The evidence provided by the studies suggests that central banks can use extraordinary policies to influence interest and foreign exchange rates.

December 16, 2016 in Exchange Rates and the Dollar, Interest Rates, Monetary Policy | Permalink


The assumption of your analysis ignores the excess bank reserves globally. For the first time in modern history since the Great Depression, the supply of excess bank reserves is greater than 0, currently at $2 trillion in the US. When excess bank reserves are greater 0 the interest rate paid on cash naturally goes to 0%. During the Great Depression and after 2008, the lack of demand for capital causes monetary policy to find new tools. Quantitative easing was advertised as stimulative but in reality was meant to act as a buyer last resort protecting the banking system from illiquidity. The unintended consequence is the weakening of the currency as the monetary base increases.

In the past, monetary tools were used to influence interest rates when the supply and demand of excess bank reserves were in an equilibrium at 0. A central bank could easily disrupt the equilibrium to affect interest rates with a very small balance sheet. Currently, the Fed must use its historically large $4 trillion balance sheet to pay interest on excess bank to raise interest rates. No longer can central bank influence interest rates without dealing with the excess bank reserves and lack of demand for capital.

Monetary policy must find the path for the greatest economic growth with low inflation and moderate long-term interest rates. When viewed through the lenses of excess bank reserves; the behavior of interest rates, the creation of capital and the mathematics, all fall into place. When the supply of cash is greater than demand the interest rate paid for cash naturally trades at 0% without central bank intervention. When cash trades near 0%, a small move in interest rates has a large nonlinear impact due to the effect of leverage on capital. During this period, global competition for good jobs and the lack of demand for capital keeps inflationary pressures at a minimum. Any interest rate paid or charged on the excess cash by the central banks is artificial and runs the risk of harming the economy or even worse creating asset bubbles. When central banks allow interest rates on cash to naturally be at 0%, this stimulates the economy until demand picks up again and interest rates naturally rise.


Posted by: Peter del Rio | December 22, 2016 at 01:41 AM

Monetary policy must find the path for the greatest economic growth with low inflation and moderate long-term interest rates. When viewed through the lenses of excess bank reserves; the behavior of interest rates, the creation of capital and the mathematics, all fall into place. When the supply of cash is greater than demand the interest rate paid for cash naturally trades at 0% without central bank intervention. When cash trades near 0%, a small move in interest rates has a large nonlinear impact due to the effect of leverage on capital. During this period, global competition for good jobs and the lack of demand for capital keeps inflationary pressures at a minimum. Any interest rate paid or charged on the excess cash by the central banks is artificial and runs the risk of harming the economy or even worse creating asset bubbles. When central banks allow interest rates on cash to naturally be at 0%, this stimulates the economy until demand picks up again and interest rates naturally rise.


Posted by: Peter del Rio | December 22, 2016 at 01:49 AM

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July 26, 2007

Why Central Bankers Worry About Fiscal Policy

Today I again hand the keys to Mike Bryan -- now a fellow adjunct faculty member in the University of Chicago's Graduate School of Business -- who provides us with a contemporary example of why it behooves central bankers to speak out when a nation's fiscal situtation gets out of whack:

The reports from Zimbabweover the past year and a half are the stuff that makes for good Money and Banking lectures. It seems that inflation in that country, as officially reported, topped 1,300 percent last year and may now exceed 3,700 percent, with some unofficial reports putting the country’s inflation rate even higher.  Let’s put this inflation in perspective.  If the last reported inflation number can be believed (the country’s Central Statistical Office recently stopped reporting the inflation numbers as it reviews its methodology), prices in Zimbabwe are doubling every month. Inflation of this magnitude renders the government-issued money virtually worthless, wrecking trade and financial institutions in the process.   

While the rate of inflation in the African nation isn’t known for certain, there is little doubt it is extraordinarily high.  Also not in doubt is its cause.  All inflations originate from the same phenomenon—too much money chasing too few goods.  In this case the Reserve Bank of Zimbabwe is rapidly printing Zimbabwe dollars in order to “pay” for a large fiscal shortfall. 

In a recent IMF paper on the Zimbabwe situation the author argues that the Reserve Bank of Zimbabwe’s (RBZ) inflation problems stem not from the usual monetary or fiscal laxness that has triggered other “hyperinflations,” but rather “quasi-fiscal” losses incurred by the central bank itself.  Still, the report concludes that these losses, which stem from some combination of credit subsidies, realized and unrealized exchange losses, and losses from open market operations, were nevertheless incurred to support government policies, and the failure to address these losses has interfered with the monetary management, independence, and credibility of the RBZ.

The immediate “solution” to the Zimbabwe inflation has been the imposition of price controls, an approach that has been attempted by governments ancient and modern, including our own.  I can think of no better source on this topic than economist Hugh Rockoff of RutgersZimbabwe’s controls are actually retroactive, in the sense that merchants have been asked to reduce prices to earlier levels.  Predictably, the problem seems to have gotten worse—now there are even fewer goods for the Zimbabwe dollar to chase.  When and where will the Zimbabweinflation end?  I certainly don’t know.  But I’ve got a pretty good idea how it will end, by a sharp curtailment of their currency expansion.  And that’s the Money and Banking lesson.  If a central bank wants to end inflation, either they better start producing goods, or stop producing money. 

And that, I would add, will be a hard row to hoe unless the fiscal house is put in order.

July 26, 2007 in Africa, Deficits, Exchange Rates and the Dollar, Federal Reserve and Monetary Policy, Inflation | Permalink


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July 05, 2007

Roubini On The Symmetry Of Exchange Rate Misalignment

This post is a bit geeky, but I've been mulling over some comments Nouriel Roubini offered a few days back in an email to RGE Monitor subscribers:

Today we look at how Asian Financial Crisis changed Asia and the world...

Policy makers throughout Asia clearly are determined not to return to the IMF.  In Stephen Jen's words the Asian Financial Crisis taught Asian central banks to never be caught without enough foreign exchange reserves...

Asia's crisis generated an international consensus that emerging economies need to hold sufficient reserves to cover their short-term debt.  No comparable consensus emerged, though, over the right exchange rate regime.   The G-7 and the IMF argued that Asia's crisis showed the risks of currency pegs, at least those currency pegs not backed up by an institutional commitment like a currency board.   But it isn't clear that Asian policy makers drew the same lesson many seem to have concluded the real problem was not pegs, but an over-valued currency.

In a simple cut at the issue, there is a distinction between pegging an exchange rate below its freely-floating value -- the case of an under-valued currency -- and pegging the exchange rate above its freely-floating value -- the case of an over-valued currency.  In the case of an over-valued currency, the central bank has to trade from its holdings of foreign currency reserves to "soak up" the excess supply of its own currency.  The ability to do this is obviously limited by its reserves, which can become seriously depleted in the event of a persistent misalignment between the pegged value and where the market would take the exchange rate in the absence of the peg.  And if market participants get a sniff of the possibility that the government lacks sufficient reserves to support the peg, a speculative run is all but guaranteed.

The situation is a bit different when the currency is under-valued.  In this case a central bank would react to upward pressure on the exchange rate by expanding its own money supply to buy foreign currencies, thus eliminating the excess supply of those currencies.  Since there are no inherent resource restrictions in creating fiat money, there is no obvious limit to the government's ability to play the game.  Money supply expansion may eventually be inflationary, but that would itself tend to drive down the freely-floating value of the currency.  But therein, according to Nouriel, lies the problem:

... reserves are not an unmitigated blessing. Sterilizing the region's huge reserve growth poses growing difficulties.  In some countries - notably China - strong money and credit growth has fueled inflationary pressures, stock market bubbles and housing bubbles.  Nouriel Roubini argues that current Asian exchange rate and financial policies have left Asia vulnerable to new kinds of crises. See "Have Asia's Sterilization and Reserve Accumulation Policies Shielded It From Another Crisis Or Have Led To Increased Vulnerabilities?"

I confess that I have been used to thinking like the Asian policy makers in assuming that the impact of pegging an exchange at too low a level is more benign than pegging at too a high level.  Because inflation reduces the value of a currency relative to others, there is a sense in which the actions of a central bank attempting to damp currency appreciation are consistent with moving the exchange rate closer to the unfettered equilibrium value. 

The same argument, however, ought to hold for a currency that is over-valued.  When a central bank buys back its own currency with foreign reserves it is contracting the domestic money supply.  That in turn should reduce the domestic rate of inflation and result in a nominal appreciation, moving the exchange rate's fundamental value toward the peg.  If there are problems, then, they must arise because the necessary price adjustments are too slow when the pressure on the currency is persistent.

But if prices are slow to adjust, why not on the upside as well as the downside?  And though depleting reserves are no problem in the case of an under-valued exchange rate, the misallocation of resources associated with excessive monetary creation could be, which I believe is exactly Nouriel's point.  I'm still not sure that such misallocations have as sharp a destabilizing potential as running out of reserves and losing the capacity to intervene all together, but I'm convinced Nouriel's argument is worth thinking about.

July 5, 2007 in Exchange Rates and the Dollar | Permalink


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Dr. Altig -- I wouldn't assume that every RGE email is written by Nouriel himself. If the email comes directly from Dr. Roubini, it probably was. But a lot of different people contribute to the biweekly note. That particular passage was written by Christian Menegatti and myself, though in part we were summarizing an argument Dr. Roubini made.

Posted by: bsetser | July 07, 2007 at 08:55 PM

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July 02, 2007

Bad News Bulls

From the Wall Street Journal (page A2 in the print edition):

Economic growth in the U.S. is likely to recover as the year goes on, but that might not be an entirely good thing, according to the latest Wall Street Journal survey of forecasters.

The Journal's seers are feeling rather chipper about the near-term prospects for economic growth... 

Having run a veritable gantlet of threats to its health, the nation's economy is in a better place than it was just a few months ago...

The 60 economists who took part in the survey, conducted in mid-June, offered a mostly upbeat outlook for an economy that has recently sustained declines in both manufacturing and business investment, and that still faces a deepening housing slump.

With consumer spending holding up, a weaker dollar propelling U.S. exports and a pickup in production and investment, they expect real gross domestic product -- a broad measure of economic activity, adjusted for inflation -- to grow at an annualized rate of 2.6% in the second half of this year and 2.9% in 2008. That is down from 3.3% in 2006, but much better than the 0.7% pace of the first quarter of 2007.

... but worry that the Fed might ruin the party:

Forecasters, however, also see a mounting risk: Thanks to longer-term shifts in the U.S. and global economic landscapes, even a little growth could lead to a resurgence of inflation, which would be painful for American consumers and could cause the Federal Reserve to ride the brakes by keeping short-term interest rates higher.

The real-side rationale is pretty straightforward:

With consumer spending holding up, a weaker dollar propelling U.S. exports and a pickup in production and investment, they expect real gross domestic product -- a broad measure of economic activity, adjusted for inflation -- to grow at an annualized rate of 2.6% in the second half of this year and 2.9% in 2008. That is down from 3.3% in 2006, but much better than the 0.7% pace of the first quarter of 2007.

It is probably worth pointing out that the survey was conducted over the period from June 8th through  the 18th, before last week's run of negative news in the housing market.  And looking at the most recent spending data, Calculated Risk -- not a member of the survey panel as far as I know -- is skeptical that consumer spending is "holding up":

You can use the monthly series to exactly calculate the quarterly change in PCE [Personal Consumption Expenditures]. The quarterly change is not calculated as the change from the last month of one quarter to the last month of the next (several people have asked me about this). Instead, you have to average all three months of a quarter, and then take the change from the average of the three months of the preceding quarter...

... in general, the two month estimate is pretty accurate. Maybe June was exceptionally strong, or maybe April and May will be revised upwards, but the two month estimate suggests real PCE growth in Q2 will be about 1.5%.

That seems entirely plausible, but month-to-month and quarter-to-quarter changes in specific categories of spending tend to jump around:

Pce    :

Thus, to CR's initial question on perusing the May PCE numbers...

Is this just a one quarter slowdown? Or is this the beginning of a housing related slump in consumer spending?

... I'd side with those saying not slumpy enough to cause real problems -- at least not so far as we can tell at this point.  No, what the Journal's experts really seem concerned about is the price picture:

An increasing number of economists worry that the battle with inflation isn't over, despite the benign message sent by recent data. As of May, the Fed's preferred measure of inflation -- the "core" index of personal-consumption prices, excluding food and energy -- was up only 1.9% from a year earlier. That compares with 2.4% as recently as February.

It seems to me that The Skeptical Speculator has about the right take on the issue:

The Federal Reserve Bank of Dallas publishes two other measures of inflation based on personal consumption expenditures. The first is the overall personal consumption expenditures price index that is already reported by the Commerce Department. The other is the trimmed-mean price index that excludes components of personal consumption expenditures that have the highest and lowest rates of change.

The latest data provided on the Dallas Fed website show that these other measures of inflation remain above the Federal Reserve's comfort zone. The 12-month inflation rate based on the overall PCE price index was 2.3 percent in May and the inflation rate based on the trimmed-mean measure was 2.2 percent...

Based on this observation the Skeptical One draws this conclusion...

...  with the economy expected to recover from the second quarter onward, further moderation is likely to be limited. In fact, many economists think inflation will re-accelerate as the level of resource utilisation in the economy remains high despite the recent slowdown.

... an opinion that is shared by the WSJ panel:

In the survey, one in five forecasters saw a resurgence of inflation as the greatest risk facing the economy. That is more than twice the proportion who saw it as the No. 1 risk six months ago. As a result, they now see little chance that the Fed will lower its target for short-term interest rates from the current 5.25% by December. They do, however, lean toward a cut to 5% by June 2008. Six months ago, they were betting the Fed would cut rates to 4.75% by December.

December is, of course, a long way away.

July 2, 2007 in Exchange Rates and the Dollar, Federal Reserve and Monetary Policy, Forecasts, Inflation | Permalink


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Maybe we need to ask the question, what does a 2.5% growth forecast mean?

Is it a forecast of sub-par growth?

Or is a forecast that given weak productivity and sluggish labor force growth that this is the best the economy can do?

I'm not sure, but lean towards the later case. If so it implies that the system will not have sufficient excess capacity to prevent wages, unit labor cost and inflation from accelerating. If so it implies that the fed will not ease and that we are just seeing a pause before fed funds start climbing again.

Do others disagree that 2.5% probably is the best the economy can do right now?

Posted by: spencer | July 03, 2007 at 07:30 AM

Spencer -- "is that the best the economy can do right now?" is a tricky question. I have a real business cycle heart beating deep within, so I make a distinction between short-run potential growth and long-run potential growth. I do think that 2.5% is below the long-run potential -- the 2.9% forecast for 2008 is getting closer. However, I'm less certain about the balance of the year. I suspect that there is still a fair amount of resource reallocation to pass through as a result of the housing market travails -- that could certainly damp potential growth in the short-run. On the other hand, I lean against the rote assertion that higher-than-expected growth necessarily brings inflationary pressure. Given the stance of monetary policy, I suspect that any acceleration in economic activity will be associated with a productivity pick-up, which I would lose no sleep over at all.

Anyway, darn good question.

Posted by: Dave Altig | July 03, 2007 at 11:33 AM

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June 11, 2007

One Savings Glut That Carries On

From the Wall Street Journal:

China's monthly trade surplus soared 73% in May from a year earlier, a state news agency reported Monday, amid U.S. pressure on Beijing for action on its yawning trade gap and the possibility of sanctions.

Exports exceeded imports by $22.5 billion, the Xinhua News Agency said, citing data from China's customs agency. That figure, close to the all-time record high monthly surplus of $23.8 billion reported in October, came despite repeated Chinese pledges to take steps to narrow the gap by boosting imports and rein in fevered export growth. The report gave no details of imports or exports.

The U.S. government has been pressing Beijing for action, especially steps to raise the value of the Chinese currency. Critics say the yuan is kept undervalued, giving Chinese exporters an unfair advantage and adding to the country's growing trade gap.

Apparently, the U.S. Senate is about to officially jump into the yuan-peg fray.  From Bloomberg:

The U.S. Senate will introduce a bill this week to pressure China to strengthen its currency, the Financial Times said today, citing unidentified people close to the situation.

The market, on the other hand, suggests that maybe things aren't so straightforward:

The gap may increase pressure on China to let the yuan appreciate to reduce tensions with trading partners and cool the world's fastest-growing major economy. The currency today had its biggest decline in 10 months and has reversed gains made in May when Chinese and U.S. officials met for trade talks in Washington...

The yuan declined 0.2 percent to 7.6691 against the U.S. dollar at 4 p.m. in Shanghai today, the biggest one-day fall since Aug. 15.

The currency has strengthened 7.9 percent since China scrapped a 10-year peg to the dollar and revalued the currency in July 2005. The 0.74 percent monthly gain in May was the biggest since the end of the fixed exchange rate.

I'm not sure what the story is there, but Nobel Prize winner Robert Mundell warned this weekend that too much pressure on the Chinese may not imply an appreciating yuan.  From the Wall Street Journal (page A9 in the weekend print edition):

... in the unlikely event that the yuan were suddenly made fully convertible, Mr. Mundell predicts that the value of the currency would fall, not rise. Many Chinese savers would want the security of keeping at least some portion of their wealth in foreign currency and would convert quickly, worried that the government might slam the door shut. This might become a self-fulfilling prophecy. In the U.K. in 1947, the Bank of England saw its reserves evaporate in a matter of weeks, and reinstated capital controls. The movement to full convertibility is fraught with danger and must be approached cautiously.

Meanwhile, yet another Nobel Prize winner, Michael Spence, suggests there is something much deeper in play than mere currency policy.  From China Daily:

China has been in a high growth mode since it started economic reforms in the late 70s. Its almost three decades of high growth is the longest among the 11 high-growth economies in the world and part of "a recent, post-World War II phenomenon". And the Chinese economy will sustain its fast growth for at least two more decades...

The high levels of savings and investments both in the public and private sectors, resource mobility and rapid urbanization are the important characteristics of China's high growth, says Spence, who is also the chairman of the independent Commission on Growth and Development. The commission was set up last year to focus on growth and poverty reduction in developing countries. China's saving rate of between 35 to 45 percent is among the highest despite the relatively low level of income of its people. Resource mobility has generated new productive employment to absorb surplus labor in a country where 15-20 million people move from the rural areas to the cities every year.

The most important feature of sustained high growth is that it leverages the demand and resources of the global economy, says Spence. All cases of sustained high growth in the post-War period have integrated into the global economy because exports act as a major high-growth driver.

Enumerating the reasons why the Chinese economy will sustain its high growth rate for another two decades, he says: "There are basically two reasons. One is that there is still a lot of surplus labor in agriculture. The engine for high growth is still there. The second is that the Chinese economy has diversified very rapidly. It's quite flexible and entrepreneurial."

Spence clearly believes that the Western complaints of too low a value for the Chinese currency and too high a surplus in its trade balances will self-correct, with a little help from government policy:

The only way to stop China's high growth would be to shut the economy off from the rest of the world. "It's just not going to happen." Even 20 years later, China will continue to grow because its currency will appreciate, helping raise the income level and increase the wealth of the people...

... To balance the huge trade deficit, Spence hopes China would boost domestic consumption and bring down the saving rate.

He acknowledges, though, that the relatively high-income younger generation is spending more despite the fact that East Asians traditionally are good at saving. A solution to the trade imbalance could also be found by increasing social security and the pension system, making them available to everybody, improving the medical coverage in the rural areas and making education at all levels affordable.

Meanwhile, the move to liberalize domestic financial markets in China took another step forward this weekend.  From Reuters, via China Daily:

China Export-Import Bank (EximBank) is set to issue 2 billion yuan (US$261 million) in yuan-denominated bonds in Hong Kong this month, making it the first Chinese lender to do so, sources told Reuters on Monday.

Exim Bank is to sell the 3-year bonds only to institutional investors, an investment banking source said, adding that the bank would decide on the yield later.

Never boring, is it? 

June 11, 2007 in Asia, Economic Growth and Development, Exchange Rates and the Dollar, Trade , Trade Deficit | Permalink


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Mundell's comments make no sense to me. Why would chinese citizens convert a rising Yuan to a falling USD or falling Euro? Security? If chinese citizens are so concerned with security, why are they pumping money into equities at an alarming rate?

Those who think the Yuan is undervalued can never explain why the PBoC have to excahnge an awful lot of Yuan for USD to keep the currency peg. It's never the other way around.

Posted by: Charlie | June 11, 2007 at 07:38 AM

Mundell may be right about short term allocation issues, but comparing a relatively declining UK do a relatively ascending China isn't analogous.

Posted by: cb | June 11, 2007 at 01:17 PM

Mundell also went for the "everything all at once" approach. It doesn't have to be that way. The yuan can be allowed to float without allowing full convertability. That has been done before, has it not?

Posted by: kharris | June 11, 2007 at 01:47 PM

"Even 20 years later, China will continue to grow because its currency will appreciate, helping raise the income level and increase the wealth of the people..."

by correlation: the US currency will continue to fall helping to reduce the income level and decrease the wealth of the people ....

Posted by: zinc | June 11, 2007 at 10:38 PM

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May 22, 2007

Too Much Ado About The Yuan Peg?

Over at Angry Bear, pgl provides a rundown on a bit of a blogworld dust up over the consequences of Chinese exchange rate policy.  The first fighting words were issued by Dartmouth's Matthew Slaughter. From the Wall Street Journal Online:

... the dollar-yuan peg are misplaced. Economic theory and data are very clear here on two critical points. Controlling a nominal exchange rate is a form of sovereign monetary policy. And monetary policy, in turn, has no long-run effect on real economic outcomes such as output and trade flows.

Gotta say that makes an awful lot of sense to me, but Brad DeLong nonetheless takes exception:

... Matthew Slaughter's assertions are based on his assumption that full long-run monetary and price-level adjustment has already taken place, yet the pace and magnitude of China's reserve accumulation (and Japan's) are very strong signs that the PBoC and the BoJ are blocking monetary and price-level adjustment--and that is the problem.

Brad and pgl both cite the cogent analysis of knzn:

What the People’s Bank of China is doing is... attempting to cool the economy by raising interest rates.... It is trying to keep exports strong by keeping the currency weak, and at the same time, it is trying to reduce domestic demand by tightening domestic monetary policy. As a result, it is accumulating a huge, huge, huge quantity of dollar-denominated assets, and this rate of accumulation is clear evidence of a policy conflict.

The conflict might be a bit more obvious if things were going in the other direction. If China were trying to peg the yuan too high rather than too low, while at the same time trying to stimulate, rather than cool, its domestic economy, it would be losing reserves rapidly. The process couldn’t continue, because it would run out of reserves. Then it would be forced either to abandon the peg or to tighten the domestic money supply dramatically. Because the process is now going in the opposite direction, there is no “crisis”, but otherwise what we are seeing is the exact inverse of conditions that would normally have led to a foreign exchange crisis.

Good stuff, from both Brad and knzn.  But I'm somewhat puzzled why they are so exercised by Slaughter's comments.  Says Brad:

To state that if we assume that the problem doesn't exist then we conclude we don't have a problem is just not very helpful. And not one in a hundred readers of the WSJ op-ed page will be able to diagnose just how Slaughter's piece is a misleading tautology.

Adds knzn: 

Of course, when a country does have a foreign exchange crisis, we don’t read economists saying that it is just “sovereign monetary policy” and nothing to worry about. When the process happens in reverse, though, apparently central banks can find plenty of apologists for their unsavory policies.

I'm failing to see as much conflict as all the spilled typing suggests.  I would not myself characterize an exchange regime, fixed or otherwise, with a word like unsavory -- or distasteful, yucky, stinky, or with any other such value-laden language.  knzn makes the point that is worth making which is, if markets are allowed to work, unsustainable pegs won't be sustained.  In the case of an overvalued currency, the whole scheme ultimately collapses for want of foreign currencies with which to intervene.  In the case of an undervalued currency, monetary creation results in the inflation that depreciates the value of the currency, which solves the under-valuation problem. I think Matthew Slaughter agrees.

Furthermore, I certainly agree that there may be lots of ups and downs along the road to long-run neutrality of monetary policy, as Professor DeLong indicates. But I don't see anything suggesting that Professor Slaughter has it wrong in the larger scheme of things.  Writes the former:

This policy conflict could end in one of several ways:

    1. A sudden large burst of inflation in China, as the PBoC finds that it can no longer maintain both the current exchange-rate peg and a stable effective money stock, and sacrifices the second to the first.
    2. A sudden large rise in the value of the yuan, as the PBoC finds that it can no longer maintain both the current exchange-rate peg and a stable effective money stock, and sacrifices the first to the second.
    3. Slow and gradual versions of (1) and (2) as holders of nominal yuan assets in the first case and nominal dollar assets in the second let their wealth be gradually but substantially be eroded without ever taking steps to cut their losses.
    4. Something more unpleasant.

Items 1-3 on that list sound to me an awful lot like the nominal adjustments emphasized in the Wall Street Journal piece.  What's more, I don't think Matthew Slaughter is quite as sanguine as suggested by either knzn or Brad DeLong:

Put it this way: In a counter-factual world where over the past decade China allowed the yuan to float against the dollar, the U.S. would still have run a large and growing trade deficit with China. The real economic forces of comparative advantage that drive trade flows operate regardless of which nominal prices central banks choose to fix.

This week the U.S. government hosts Chinese officials for the second round of the Strategic Economic Dialogue. Treasury Secretary Henry Paulson and Chinese Vice Premier Wu Yi have framed the SED as a forum to address complex policy issues associated with the links between our two countries. In China, further capital-market reform is needed to support economic growth via better risk management and capital allocation throughout all sectors of the economy. Here at home, the large aggregate gains the U.S. has realized from freer trade and investment with China have also generated hardship, too. Many American workers, firms and communities have been hurt, not helped, by Chinese competition.

Issues like these are legitimate and real. But focusing on the dollar-yuan peg is a misplaced and counterproductive way to address them. Instead, let China continue to conduct its sovereign monetary policy and let the SED continue to engage the real challenges. Stop fixating on the fix.

I may be completely misinterpreting things, but it seems to me that the point is simply that the peg alone cannot be the biggest issue in the discussion.  I guess the disagreement here may be that the Slaughter piece puts more emphasis on the strains that trade-related adjustments in resource allocation inevitably bring, while pgl (and DeLong and knzn, I guess) are more concerned about distortions in resource allocation associated with questionable trade restrictions, capital controls, bad economic policy in the U.S., and so on.  Fair enough.  But none of that is about the yuan peg per se, and I think Matthew Slaughter was right to say so.   

May 22, 2007 in Asia, Exchange Rates and the Dollar | Permalink


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Well, Matthew seems to slide from the assumption "in the long run, money is neutral" to "we are in the long run" to "that China is getting its monetary policy wrong doesn't matter." And both Friedman and Keynes would disagree: monetary policy does matter a lot, and to analyze it in a model in which you have assumed it doesn't matter is not terribly productive.

Posted by: Brad DeLong | May 23, 2007 at 09:32 AM

The problem is not so much that the policy is unsustainable as that it is sustainable for an awful long time before it collapses. Because much of the intervention is sterilized, the real exchange rate adjustment can be put off for many years (and won’t necessarily take the inflationary form associated with Hume). The risk that it will take some unpleasant form increases with time. The yuan peg, partly sterilized as it is, is causing China to supply a credit junkie (the US) with cheap credit, and one has to be concerned about what the withdrawal symptoms will eventually be like.

Posted by: knzn | May 23, 2007 at 02:12 PM

I second knzn's point. I was also agitated by the argument that the SED should be about things other than the exchange rate peg. I personally think it should be mostly about the exchange rate. It seems to me that the need to maintain the exchange rate peg (and the myriad of policies that support it) limits China's ability to engage in say true banking reform, since it needs the banks to absorb its sterilization bills, and limits China's ability to stimulate consumption since stimulating consumption when exports are contributing so positively to growth would lead to overheating.

I also worry a bit that focusing on what slaughter calls the "real issues" will lead to over-emphasis on gaining market access for US financial firms -- and thus support a political economy where the existing winners from trade with china get even more w/o doing much more to help those who aren't winning.

finally, i objected to Slaughter's argument that China's growing trade with Europe over the past ten years proves the XR doesn't matter for trade flows. it seems to me that the strong acceleration in Chinese export growth to europe (and the rise in China's bilateral surplus with europe) after the rmb fell v the euro suggests that the nominal Xr matters. neither the RMB/ euro not the pace of Chinese export growth to europe has been constant since 97.

Posted by: bsetser | May 23, 2007 at 03:07 PM

Those "accumulations" from Brad's remark stir me to spillover:

"... Matthew Slaughter's assertions are based on his assumption that full long-run monetary and price-level adjustment has already taken place, yet the pace and magnitude of China's reserve accumulation (and Japan's) are very strong signs that the PBoC and the BoJ are blocking monetary and price-level adjustment--and that is the problem."

And the facilitating role of the transnational companies that allow GM (to pick the obvious durable good one, but there is also the larger and quieter carry traders in the case of Japan) to post significant profits from their Chinese plants? A role that appears may outlast the US consumer as the trade shift to the underfed European consumer may be long term.

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May 18, 2007

China Having Problems With The Peg?

The Financial Times reports:

China’s central bank on Friday widened its daily trading band against the dollar for the renminbi to 0.5 per cent from 0.3 per cent, while raising interest rates and banks’ reserve requirements.

The widening of the trading band is sure to fuel expectations that China will allow the renminbi to rise at a faster rate as its politically sensitive trade surplus soars.

You were expecting the "however", weren't you?

However, People’s Bank of China insisted the move was just a further step in its gradual reform of its currency exchange regime and that it should not be seen as prelude to a revaluation.

"(The widening) is a constructive institutional step, and certainly does not signify that there will be great volatility in the renminbi exchange rate, even less does it signify that there will be a large appreciation,” the central bank said.

The track record suggests you should believe what they say, and some are of the opinion that this is a lot of not much.  From the Wall Street Journal:

The band widening is a "symbolic but laudable" move that will help shift China's economy toward more domestic-led growth, said analysts at Goldman Sachs.

It "means nothing" for yuan appreciation, said a Shanghai-based trader with foreign bank. "We don't even use half of the current band. This is just to impress [U.S. Treasury Secretary] Henry Paulson."

Nonetheless, a report on the policy move from China Daily has a more urgent tone than usual:

... the tightening policies have largely failed to prevent the economy from becoming overheated. The gross domestic product grew 11.1 percent in the first quarter of the year, compared to last year at 10.7 percent, statistics showed.

Total value of the Chinese stocks hit 17.43 trillion yuan (US$2.27 trillion) yesterday and has likely surpassed the total in household deposits, as money continues to flow out of banks and into the stock market.

In April, total household renminbi deposits dropped to 17.37 trillion, a decrease of 167.4 billion yuan (US$21.7 billion) compared with March. Household deposits may drop further in May as investors are rushing to withdraw money from savings accounts and pump them into the stock market, the Shanghai Securities News reported.

It should be noted that, if the claim that the yuan remains undervalued is correct, demand pressures on the economy are inevitable.  From macroblog past:

... abstracting from capital controls, theory would predict an undervalued currency is a problem that should eventually take care of itself.  The reason is that pegging the nominal exchange rate -- the only currency price a central bank can hope to influence in the long run -- requires flooding the world with your domestic currency.  Given enough time, the inflationary consequences of those policies will cause the fundamental value of the nominal exchange rate to fall on its own.

"Abstracting from capital controls" is not, of course, a phrase that ought to be used in discussions of Chinese financial markets.  But the effects of mispricing have to show up somewhere, and it does appear that the yuan peg may have become a bit of a struggle.

May 18, 2007 in Asia, Exchange Rates and the Dollar | Permalink


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So, what happens to interest rates in the U.S. on Monday?

My prediction is Sunday night, the treasuries will sell off a bit more. They have had steady erosion on no news the past couple of days, so information may have been leaked.

Posted by: Jeff | May 19, 2007 at 11:29 AM

with paulson and wu scheduled to meet, bond market likely anticipated some chinese mollification toward u.s. position with bias toward a modest chinese slow down suggesting u.s. may also slow fractionally

Posted by: peter miller | May 19, 2007 at 03:38 PM

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April 15, 2007

Heard This One Before?

The Financial Times reports:

The world’s biggest economies on Saturday strengthened their commitment to reducing global imbalances but stopped short of making these pledges binding.

The “multilateral consultations” undertaken by the International Monetary Fund, included plans by China to make its exchange rate more flexible “in a gradual and controlled manner” against a basket of currencies.

There's not much to suggest that the "gradual and controlled manner" is having any impact quite yet.  Brad Setser puts it about as succinctly as it can be put:

There is just no way to get around the fact that China bought a ton of foreign exchange in the first quarter.

The Treasury is turning up the heat...

U.S. Treasury Secretary Henry Paulson stepped up his push for rule changes that would allow the International Monetary Fund to monitor and disclose cases of countries that manipulate their currencies, calling for action "very soon.''

"Reform of the IMF's foreign-exchange surveillance is the linchpin'' of needed changes in the 63-year-old fund, Paulson said today in a statement to the IMF's semiannual gathering in Washington. "We look forward to action in this important area very soon after these meetings.''

... but the response of the Chinese government sounds pretty familiar:

"We have noted the efforts to strengthen Fund surveillance since the Singapore Meetings, including through possible revision of the 1977 Decision on Surveillance over Exchange Rate Policies," [Hu Xiaolian, deputy governor of the People's Bank of China] said.

"In this regard, we wish to emphasize that, first, revision of the Decision should not proceed too hastily," she said. "In making adequate and careful analysis, the Fund must take the opinions of all concerned parties into account and build broad consensus among all member countries to ensure that it would benefit them all."

Second, in strengthening surveillance, the Fund should be realistic, and not overestimate, the role of exchange rate, Hu said.

"Biased advice would damage the Fund's role in safeguarding global economic and financial stability," she said, while emphasizing that the focus of surveillance should be consistent with the purposes laid out in the Fund's Articles of Agreement.

"Due respect should be paid to the fundamental role of sustaining growth in promoting external stability. External stability can only contribute to overall sustained stability when anchored by domestic stability," she concluded.

Also Saturday, Hu Xiaolian said that China's economic growth model has undergone welcome changes and its economy will continue on path of steady and fast growth.

"The Chinese economy is projected to remain on a fast growth track -- exceeding 8 percent in real terms -- in 2007," she said, adding that the government will give more emphasis to the quality and sustainability of economic growth.

She also said the reform of the China's foreign exchange regulatory framework has steadily deepened. "The RMB exchange rate formation mechanism is being improved and flexibility of the RMB exchange rate has increased significantly," she said.

Sounds like the status quo to me.

April 15, 2007 in Asia, Exchange Rates and the Dollar | Permalink


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"Sounds like the status quo to me."

Yep, but here's an interesting prespective from Latin America, reported by MarketWath's Rex Nutting:

Argentine Economy Minister Felisa Miceli argued that the [IMF]'s problems go far beyond inadequate surveillance of currencies.

"To many in both the developed and developing world, globalization has not brought the promised economic benefits and this is breeding a nasty protectionist sentiment," Miceli said. "Ministers need to be mindful of the political consequences of having the fund advocating for policy changes that breed protectionism and radical political opposition."

Income inequality is growing everywhere. "What is the fund doing about this?" said Miceli. "Well, very little or perhaps even more harm than good."

Miceli said effective currency surveillance would not be easy.

"If the fund has not been more effective in the surveillance of systemically important countries, it is mostly because these countries do not need to listen to the fund's exhortations," either because they, like the United States, can print all the currency they need, or, like China, have amassed huge currency reserves, Miceli continued.

Posted by: Wayne | April 15, 2007 at 11:26 AM

I agree Dave,

pretty much steady as she goes which after all also is what the data (oh sorry , Setser :)) tells us.

Meanwhile, everybody is looking to the ECB and the Euro-dollar. Indeed it is ticking up but for how long, or should I say for how long can the ECB keep on nudging upwards?

Of course then, the ECB and other European politicians are looking to Japan arguing that it is certainly about time for the Yen to reflect the fundamentals of the Japanese economy.

Now, that we certainly also have heard before :).

Posted by: claus vistesen | April 15, 2007 at 02:50 PM

Non-binding is the way everything is done these days. Like when you say to somebody you have no intention of seeing again, "I'll call you."


Posted by: muckdog | April 15, 2007 at 09:44 PM

China's attitude towards the IMF/G7 is exemplefied by two facts:

1) The PBOC governor and Finance Minister stayed at home;

2) They marked USD/CNY higher today

Posted by: Macro Man | April 16, 2007 at 09:01 AM

As long as China remains such a large buyer of foreign exchange, none of the other great powers will have any leverage to change China's trade behavior.

The US could unilaterally prevent China from buying T-bills, but that would hurt Americans more than the Chinese.

This is only an issue because unions are politically significant.

Posted by: Erasmus | April 17, 2007 at 05:36 AM

a few simple truths:
- The enormous r.e. bubble we've witnessed was NOT caused by low interest rates OR the FED.
- Bubble states, including CA, NV, FLA, have yet to sign on to CSBS' nontraditional mtg. guidance. (It's been five months since CSBS issued the guidance & seven months since the FED directed its national banks on the issue.)
- National Bank owned credit card issuers are STILL aggressively offering 0% interest financing on transfers & purchases for the next YEAR.
- Freddie-Mac & Fannie-Mae are dangerously out of control, as are way too many of our hedge funds.
- Bond market strategists strongly believe BB WILL ease ff rates come fall. (So much for my theory they'd fall into line if BB talked straight to them!)

BB inherited the greatest mess the FED's seen since the 1930s, but BB alone (not Paulson) will be judged on whether we return to responsibile economic decision-making.

It is NOT the FED's job to see we never endure the horror of two successive quarters of negative GDP growth.

Posted by: bailey | April 19, 2007 at 12:32 PM

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March 18, 2007

Inflation Chickens Roosting In China?

From China Daily:

The People's Bank of China, the central bank, raised key savings and lending interest rates from Sunday, March 18, the third time in 11 months in a bid to curb inflation and asset bubbles in the world's fastest-growing major economy.

The one-year benchmark lending rate will be raised to 6.39 percent from 6.12 percent, and the one-year deposit rate will be increased to 2.79 percent from 2.52 percent, according to a statement on the bank's website (www.pbc.gov.cn) .

Time to start up the yuan appreciation clock?  From the Wall Street Journal:

After Saturday's credit tightening, [Goldman Sachs Group Inc. economist Hong Liang] said, she expects authorities in China to continue efforts to pull liquidity from the financial system with technical measures, possibly another interest rate increase and steady appreciation of its currency against the U.S. dollar...

Many economists regard China's tight grip on the value of its yuan as an underlying reason for Beijing's concern about financial system stability. A weak currency helps keep exports cheap and China's strong export growth has pumped U.S. dollars into the country, as evidenced by foreign exchange reserves that top $1 trillion. When that money is moved into yuan, banks are left flush with funds to lend out. Too much lending risks sparking inflation or leaving banks holding bad loans.

The Chinese government, however, continues to suggest that we should not expect too much too fast.  From the Financial Times:

China on Friday sought to reassure global currency markets that a new state investment agency set up to chase higher returns for its $1,000bn-plus in foreign exchanges reserves would not harm the value of the US dollar.

Wen Jiabao, premier, said at a press conference to close the National People’s Congress that investments by the agency “would not have any impact on US dollar-denominated assets”.

Mr Wen’s comments were reinforced by the People’s Bank of China, the central Bank, which said in a report issued hours later that it would not make “frequent, major adjustments to the structure of the reserves in response to market movements”...

Mr Wen’s reassurance on the US dollar is also in China’s self-interest, since any dollar sell-off would leave huge capital losses for Beijing’s existing holdings.

Are an unadjusted yuan, still-strict capital controls, and low inflation compatible goals?  Normally one would would think not, but we shouldn't forget this (again from the Wall Street Journal):

China only reluctantly adjusts base interest rates. Analysts say that reflects how interest rates have less impact on lending and borrowing decisions in China than they do in countries with more highly developed financial systems. Instead, to temper lending and the economy, China's central bank more often relies on moral suasion with state-controlled banks and technical adjustments to capital requirements.

So, the answer is probably "Sure, if the government is willing to institute even tighter controls on the allocation of financial resources."  I doubt, however, that many would be inclined to advise taking that path.

March 18, 2007 in Asia, Exchange Rates and the Dollar | Permalink


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February 24, 2007

The Euro Vs. The Dollar

Although I've not written much about the topic lately, I have been monitoring the debate of the last several months about the rise of the euro, and the related question of whether it will eventually emerge as the world's dominant international money.  The discussion has been prompted in part by the fact that euro appreciated by about 11 percent from December 2005 to December 2006, but also by some really splashy news: The observation that the value of euro notes in circulation has surpassed the value of dollar notesthe reported desire of oil-producing countries to diversify their foreign-exchange reserves,  and the fact that euro-denominated debt has become a larger share of the global cross-border total than dollar-denominated debt.  Yesterday Brad Setser published some ruminations about whether the Japanese yen can ever be the "un-dollar", but the reality is that the euro remains the only real contender for the foreseeable future.

A couple of pictures (constructed by my colleague Owen Humpage) helps to put things in perspective.  To begin with, international currency reserves are still dollar dominated:




There are definitely some problems with those statistics -- see, for example, the picture provided by Brad Setser, provided by Menzie Chinn -- but here is another relevant fact: The overwhelming share of foreign exchange transactions involve dollars:




It seems pretty clear that most of the euro activity is still taking place on the European stage.  That could change -- there is an interesting discussion about the expanding importance of the export sector being conducted at Eurointelligence and at Eurozone Watch -- but my guess is that the "tipping point" for the euro depends critically on whether the eurozone ultimately expands.

As I have noted in the past, the research of Menzie Chinn and Jeffrey Frankel suggests that the wildcard involves the UK's designs on the euro.   But the incorporation of the so-called "accession countries" is at issue as well.  For that reason, this, from the Financial Times, got my attention:

On Monday Standard & Poor’s lowered the outlook for Latvia’s long-term sovereign debt from stable to negative. The country has a huge current account deficit, accelerating inflation and loose monetary policy, just like Thailand in 1997. And, as in Asia a decade ago, the symptoms are not limited to one country. As growth has accelerated in the European Union’s 10 newest central and eastern members, it has become unbalanced, propelled by consumers rather than exports. The results are predictable – worsening trade imbalances, mounting inflation and wage pressures. Only Poland and the Czech Republic currently meet the inflation requirement for euro membership, while current account deficits in six of the EU-10 hover near or beyond 10 per cent of gross domestic product. Meanwhile, credit is expanding dramatically – at more than 50 per cent year-on-year in Latvia, Lithuania and Romania, according to Danske Bank.

The difficulties of integrating new-Europe and old-Europe are also on the radar at The Economist (via Edward Lucas and Claus Vistesen):

If the EU were to fracture, the natural fault-line would be the edge of the euro zone, as Toomas Hendrik Ilves, Estonia ’s thoughtful president, has observed...

The common currency includes most of old Europe, but excludes most of the new democracies (including his). What would happen to the outsiders? It would be nice to think, as a worst-case scenario, that the single market would hang together, and that the baker's dozen of countries outside the euro zone would at least remain part of this thriving free-trade area...

Probably, however, the unraveling would go further. The EU already finds it a huge effort to make the Poles, for example, abide by European competition law. Without a seat at the top table in Brussels, no Polish government would allow foreigners to claim full national treatment, especially when it came to buying the country’s big companies. With that, the single market would unravel too.

That all may be a bit alarmist -- the worst-case scenario is important to think about, but it rarely happens.  The point is that, despite the challenges that undeniably confront policy makers in the United States, there are equal, if not more daunting, challenges elsewhere.  I have my doubts that the "exorbitant privilege" of being the world's dominant currency is likely to pass from the dollar any time soon.

UPDATE: Export activity in Germany (and Japan) is also on the mind of Edward Hugh, at Bonobo Land.

UPDATE II: Claus Vistesen uncovers an article from the Financial Times suggesting that central bankers are chasing yield by by taking on more risk, as well as by diversifying the currencies in their reserve portfolios.  My sense is that this sort of motivation drives "investment" decisions at the margin, but that core portfolio choices are still driven by "fundamentals" related to trade flows, financial market activity, and internal exchange rate policies. But as the FT article notes, central bankers are "a secretive bunch," so there is a lot we -- or at least I -- don't know.

February 24, 2007 in Europe, Exchange Rates and the Dollar | Permalink


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David -- the Humpage chart on the $ share of the fx reserves of emerging economies is based on the COFER data, and to be clear, I have no specific problem with that data. Or no problem with it other than the fact that it is incomplete -- many emerging economies don't report data to the IMF, including China. Personally, I think the countries that do not report (China, a lot in the middle east) have a higher dollar share than those that do. Which reinforces your argument --

the problem here is that we don't know whether the countries that don't report have also been holding the dollar share of their reserves constant. my guess is generally speaking their dollar share is trending down but very, very slowly -- almost imperceptably.

The data that I think is off is the BEA data on official inflows, which, if my argument above is right, significantly understates central bank inflows. moreover, the BEA in principle captures all official inflows -- Temasek of singapore, norway's government fund, the oil inv. funds of the middle east. So when you look at total official asset growth (@$900b in 06, based on the numbers I track), the BEA's recorded inflows (@$300b) look a bit too low.

My critique of the Humpage chart would be a bit different -- it looks at shares, when the real story is the growth in the stock. Emerging economies are holding more reserves of all kinds right now -- and their reserves are growing at an exceptional pace, something which a chart that just shows the share doesn't really capture. the stock of euro reserves held by central banks today is probably far larger than the stock of $ reserves held by central banks ten years ago, simply b/c the overall stock of reserves has gone up so much. incidentally, recent offiical sector inflows into euros and pounds (@$300b in 05, probably more like $200b in 06, based on my estimates which try to flesh out the hidden parts of the COFER data set) are very large absolutely -- they would top $ reserve growth in say 2000 or 2001. they only don't seem big b/c in say 2006, i would bet the central banks added $550b to their dollar reserves (counting SAMA foreign assets and PBoC swaps as part of reserves -- there are a lot definitional issues)

Posted by: brad setser | February 25, 2007 at 10:24 AM

Brad -- Thanks. I should have been clear that the issue with the data is incompleteness. I'm not sure I follow your position concerning shares vs. levels, at least not in the context of the post. Because the share of official reserves held in euro has beem rising, it has to be the case that the growth in euro levels has been greater than the growth in dollars. No argument there. It is also true that the growth in levels is a lot bigger than can be accounted for by a simple cut on the growth in trade -- at which point we may proceed to debates about dark matter, global saving gluts, fiscal deficits, and so on. But for the narrower question of which currency is the dominant reserve vehicle, it seems to me that shares are the appropriate thing to be thinking about.

Posted by: Dave Altig | February 26, 2007 at 08:08 AM

Hi Dave,

Thanks for the plug (both of them that is :))

In terms of central bank management I take your point that this move into riskier assets occurs on the margin as it were on the reserves but then again what are the 'margins' of a reserve portfolio in for example China or any of the other dollar peggers. I guess the question here is to what extent these CB portfolios will end up being major market movers in equity markets too?

As for the dollar v euro question ... well well, that is a question for you is it not :)?

It is very difficult for me to see the Euro taking up the slack of the dollar. This of course has some imminent implications since ...

1. I don't think the dollar is headed for any crash soon at least not so long that the Breton Woods II persists. We won't see any major cb reserve diversification into Euros I think.

2. Even in a long term structural perspective I do not see the Euro replacing the dollar as the global reserve currency, that honour is going to go to the Indian Rupee or the Yuan I think.

Of course this may very well change if the Eurozone expands as you say but then again there are notable challenges associated with such an expansion and in fact even the current Euro zone setup seems to have enough structural difficulties as it is.

Posted by: claus vistesen | February 27, 2007 at 03:21 PM

Claus -- I think we are in agreement on this one. Cheers.

Posted by: Dave Altig | February 28, 2007 at 09:18 AM

The EUR/USD continues to flirt with the 1.440 price handle, teasing the forex market with an initial push higher, only to fall back exhausted in later trading, and today's price action has replicated this once again, promising much in the morning, only to fail to deliver later in the day. However before we assume that this level may prove to be an immovable barrier to any move higher for the euro vs dollar, it is important to note the role of the 40 day moving average, as once again yesterday it provided the platform for a push higher following the wide spread down bar of the previous day, and creating once again a series of lower highers as we edge on up towards this price level. Yesterday's candle also closed above the 14 day moving average, but marginally below the 9 day average. If today's candle holds firm then in my view this will be another in a long series of failures to break through the 1.44 barrier, and each time we see a failed attempt on the daily chart then this adds to the likelihood of a move lower in the medium term.

Posted by: Anna Coulling | September 08, 2009 at 04:45 AM

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