Presentation Transcript

1. Currency Conflicts

   John Driffill Birkbeck College University of London January 2012
2. Global Imbalances Source: Figure 1.20 from the IMF World Economic Outlook, September 2011 Current account surpluses as a percent of world GDP for various groups ofcountries.
3. Recent Issues US/China Japan Switzerland Brazil and other emerging economies
4. From Mourougane, A. (2011), “Explaining the Appreciation of the Brazilian real”, OECD Economics Department Working Papers, No. 901, OECD Publishing. http://dx.doi.org/10.1787/5kg3krcwd27k-en
5. Diagram from www.brazilianbubble.com, based on Credit Suisse research
6. Brazil Monetary Council (CMN) may impose and control financial transaction taxes, or IOF taxes, on dollar derivatives contracts – dollar forwards and futures contracts. CMN can charge as much as 25% in the IOF tax — the limit specified under existing national laws. Amendments to constitutional laws allow a 1% tax on all Forex derivatives transactions that are increasing their short dollar position by more than than$10 million. Mourougane (2011) concludes, “There is evidence of an overvaluation of the real in 2010, but the extent of the misalignment is hard to gauge. FEER estimations point to an overvaluation between 3-10% in 2010. Dynamic simulations of behavioural exchange rate equations generally suggest an overvaluation of the real of between 10-20%. However, these estimations remain subject to large uncertainties.”
7. Financial Times coverage in late 2011 US currency bill passes Senate vote - Oct-11China engineers renminbi jump - Oct-10China currency bill passes US Senate test - Oct-06China tests US with currency move - Oct-05White House voices concern over currency bill - Oct-05Bernanke criticises China over currency - Oct-04US currency bill drama belies grind ahead - Oct-04China warns of ‘trade war’ over US bill - Oct-04US Congress presses China on currency - Oct-02US Senate to vote on China tariffs - Sep-28Brazil fights rearguard action in currency war - Sep-26Emerging markets try to steady currencies - Sep-25Brazil reverses policy in real defence - Sep-22Brazil blames Fed move on fiscal inaction - Sep-22Brazil to seek new arms for currency battle - Sep-19US damps likelihood of joint action on currencies - Sep-08Fears over ‘currency wars’ resurface - Sep-06Renminbi’s rise fuels talk of China policy shift - Aug-11Currency wars not over, says Brazil - Jul-05Currency war fears reignite in Brazil - Jul-01
8. This is taken from IMF WEO Sept 2011, Figure 1.19.
9. IMF, WEO Sept 2011, Figure 1.19. Three month moving averages of exchange rate indices, with 2000 as the base year (index = 100).
10. This is taken from IMF WEO Sept 2011, Figure 1.19. Reserves: index, year 2000 = 100
11. Source of currency conflicts Each country’s exchange rate directly affects all its trading partners, Indirectly, if it is a large economy, it may affect the whole world. The n-1 problem. n countries n(n-1)/2 cross rates, n-1 independent exchange rates. Everybody wants to run a surplus. Current accounts around the world have to add up to zero. n countries, n-1 independent current account surpluses. Wages and prices do not adjust rapidly
12. China vs US Rate pegged too low US gets Ability to run persistent deficits US remains global reserve currency China’s motives Insurance against ‘sudden stops’ Mercantilism: employment growth Narrower income differences Dampen internal unrest Avoids disruption caused by move to floating currency
13. Emerging Market Reserve Accumulation Avoiding falling into hands of IMF Post-1997 experience What is the optimal level of reserves? Depends on length and depth of recession caused by crises or ‘sudden stops’ Around 10% GDP (Olivier Jeanne, 2007) Observed levels only if crises cause massive loss of around 60% of GDP Extreme ‘loss aversion’ may explain things (Miller & Zhang (2007)
14. Self- Correcting? Costs to China of high reserves grows US wealth reduced by deficits US govt has to cut borrowing National Accounts Private surplus + public sector surplus = current account surplus
15. US Deficit Fall in real estate values and stock market induces more saving Deficit does not cut US household wealth by much US net worth ca. 500% GDP, net foreign assets only a fraction of GDP US earns more on its foreign assets than it pays on its liabilities (by 1 or 2 % points)
16. US deficit and debt Source: IMF data, WEO database, Sept 2011
17. From the IMF WEO September 2011, page 9, figure 1.7:
18. Brazil, Japan, Switzerland They have substantially floating exchange rates Excessive appreciation Safe havens Exchange rates do not follow ‘real’ fundamentals Milton Friedman was (partly) wrong ‘The Case for Floating Exchange Rates’ 1953 Smooth adjustment to relative inflation rates Stabilizing speculation Independent monetary policies Insulation against shocks
19. Floating Exchange Rates Defy Theory Are financial asset prices Highly volatile Respond mostly to news about the future and ‘shocks’ Purchasing power parity S = P/P* Only works in long run with very wide margins of error, ±20% or more Very slow adjustment to PPP following shocks (half-life of 3-5 years)
20. Efficient Markets Uncovered interest parity Expected rate of appreciation of exchange rate equals interest differential between two countries Or: today’s exchange rate equals what tomorrow’s is expected to be, less the difference in interest rates Explains only a small fraction of total changes A random walk is hard to beat
21. FEER Fundamental Equilibrium Exchange Rate John Williamson Exchange rate consistent with full employment (equilibrium output and employment and stable inflation) and medium term capital flows Only measurable with wide margins of error Used as a reference for under or overvaluation
22. Brazil
23. European public debt crisis Euro zone countries borrowed too much in the boom years before 2007 Tempted by very low interest rates Ignored the Stability and Growth Pact rules on deficits and debt Led by Germany and France in mid-2000s Rules widely criticised for being arbitrary Fiscal plans sustainable pre-crisis only if growth remained strong Depth of recession, cost of bank bailouts, fall in growth prospects, derailed public finances Portugal, Italy, Spain, Greece, Ireland uncompetitive relative to Germany Real exchange rates ‘overvalued’ Persistent current account deficits
24. Structural Change Needed OECD countries rely increasingly on deficit-financed public spending to maintain full employment E.g., Japan’s debt approaching 250% of GDP Rise in share of GDP taken up by govt spending Progressive increase in size of government Drift towards public deficits Causes Uncertainty about longevity? Low inflation? Add to these – deleveraging, rebuilding balance sheets Ability of governments to take active role may be limited in coming years OECD economies may need to adjust, to rely less on public more on private spending
25. High public debt is not always an obstacle to growth Rapid growth in Europe and US in 1950s and 1960s despite high public debt Debt/GDP ratios fell Long-term finance at low interest rates High private demand Full employment consistent with public sector in balance or surplus. Real growth plus inflation gradually reduced debt/GDP
26. From Clark, Tom, and Andrew Dilnot, “Measuring the UK Fiscal Stance since the Second World War”, Institute for Fiscal Studies Briefing Note no 26, 2002
27. From Clark, Tom, and Andrew Dilnot, “Measuring the UK Fiscal Stance since the Second World War”, Institute for Fiscal Studies Briefing Note no 26, 2002
28. Cottarelli, Carlo, and Andrea Schaechter, “Long Term Trends in the Public Finances of G7 Countries”, IMF Staff Position Note, SPN/10/13, September 2010
29. Conclusions Currency conflicts are one aspect of interdependencies They have been around for a long time Unlikely to go away. China vs US will run and run Coordinated expansion would be useful. A long recession in Europe seems highly likely Debt-financed public spending limited in future Basic accounting identities are inescapable Surpluses and deficits have to add up to zero