Competitive Nonappreciation*

Geithner Call for Global Cooperation on Currency by Sewell Chan

As finance officials from around the world gather here this weekend for the annual meetings of the I.M.F. and the World Bank, American officials are concerned that the degree of cooperation in the recent financial crisis is eroding. In particular, the Obama administration is looking to the I.M.F. to help bring about what months of negotiations have failed to achieve: greater exchange-rate flexibility by China.

Instead of the "competitive devaluation" of the 1930s, which exacerbated the Depression, the world faces a threat of "competitive nonappreciation," Mr. Geithner said, citing a term coined by Edwin M. Truman, a former official at the Treasury and the Federal Reserve.

That was a reference not only to China but also Japan and Brazil, which have taken steps recently to prevent their currencies from rising in value.

I'm pretty sure the competitive devaluations of the 1930s helped ameliorate the Depression.

Financial Shock and Awe by Barry Eichengreen

(via Mark Thoma and Brad DeLong)

First, it is a misunderstanding to believe that the policies pursued by the BOJ, the Fed, and the Bank of England come at one another's expense. What we are seeing, in all three cases, is not exchange rate manipulation but what is known as quantitative easing, actual or incipient. The evolution of BOJ policy makes this clear. What two weeks ago started as a modest foreign exchange market intervention has now turned into an explicit program of purchasing 5 trillion yen of Japanese treasury bonds and bills, commercial paper, exchange traded funds, and real estate securities. The Bank of England has made no bones about its continued commitment to quantitative easing. The Fed is moving slowly, slowly in the same direction.

This, of course, is precisely what is needed in a world where deflation has again become a problem and fiscal policy, for better or worse, is off the table. It is not a "beggar thy neighbor race to the bottom." If anything it is a race to the top.

Eichengreen sees the Fed employing "shock and awe" methods in the data, but wishes they would be more explicit. (Krugman notes that the markets appear to believe in QE2) He hopes China sees reason as well, but I doubt they will.

 The Fed needs to stop dithering and make precise the extent of the quantitative easing it intends. Uncertainty about whether it will move in increments or adopt a policy of shock and awe is contributing to the erratic behavior of the dollar exchange rate.

Not only would more clarity help that exchange rate settle down, but in addition it would make it easier for other central banks to calibrate their own policies. In particular, a Fed policy of shock and awe which, recent data increasingly suggest, is what is called for will make it easier for China to calibrate an appropriate response. With China experiencing inflation rather than deflation, looser credit conditions are the opposite of what it needs. Its challenge is to continue to modestly cool off its economy. Delinking from Fed policy by delinking from the dollar is the obvious way of achieving this result.

 Eichengreen believes the European Central Bank is still fighting the last war, but will eventually come around.

The ECB, for its part, needs to start planning for the next battle instead of incessantly fighting the last. If it ends up with an exchange rate of $1.50 to the euro, the European economy tanks, and in the absence of growth the Greek, Irish, and other fiscal austerity programs will collapse. It will only have itself to blame.

Here's a prediction: Contrary to what the markets currently assume, the ECB will eventually join the quantitative easing bandwagon. The only question is whether by the time it does it will already be too late.

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* what often happens in marriage. Spouses compete on who can not appreciate the other the most. (sad trombone sound - wah wah)