Currency Wars

Draghi Seeks to Ease Talk of Global Currency War

Over the last few years, emerging-market countries like Brazil have openly accused slow-growing advanced countries like the United States of unfairly pushing down the value of their currencies with their aggressive monetary policies. And, for years, the United States has accused export-reliant emerging economies, in particular China, of manipulating their currencies, too. 

More recently, in Japan, stimulus programs backed by the newly elected prime minister, Shinzo Abe, have kept interest rates near zero and flooded the economy with money, which has reduced the cost of Japanese products around the world.

China has capital controls which prevent inflation and "hot money." It has a trade surplus. It intervenes in foreign exchange markets by buying U.S. Treasuries. That's manipulation. This article neglects to mention this info.

The U.S. has a trade deficit and a large output gap. It's reasonable to try to stimulate the economy after a financial crisis. A stronger U.S. economy will be able to buy more exports from countries like Brazil.

Stanley Fischer for Fed Chair? by Dean Baker

Dylan Matthews has an interesting column discussing former M.I.T. professor Stanley Fischer's career in the context of the possibility of him replacing Ben Bernanke as Fed chair in the fall. There are a couple of important items that are not mentioned in this discussion. 

First, Matthews notes the central role that Fischer played in the I.M.F.'s resolution of the East Asian financial crisis. While this discussion might lead readers to believe the resolution was a success, this crisis actually marked a turning point that led to the major imbalances of the next decade. 

Prior to the crisis there were substantial capital flows from rich countries to poor countries, as textbook economics would predict. However as an outcome of the crisis developing countries began to accumulate massive amounts of foreign exchanges reserves, presumably to avoid ever having to be in the same situation as the East Asian countries were placed when they had to deal with the I.M.F. in the crisis. 

This led to a huge rise in the value of the dollar and large trade deficits. The gap in demand created by the trade deficit with developing countries was filled in the United States by the housing bubble. The predictable outcome of this situation was the collapse in 2007-09, which is likely cost the country close to $10 trillion in lost output before the economy fully recovers. 

This raises the more general point that Fischer is one of the pillars of the school of thought that central banks should target 2.0 percent inflation and otherwise do nothing. If it is in principle possible for an economic theory to be refuted by evidence, this view of the optimal monetary policy has been decisively discredited.

These items may affect how people would view Stanley Fischer's qualifications as a candidate for Fed chair. 

The piece also gets one other important item wrong. It contrasts the ability of Israel (where Fischer now runs the central bank) as a small country to devalue its currency with the United States, as the holder of the world's reserve currency. 

"If Bernanke halved the value of the dollar relative to, say, the Chinese yuan, that would dramatically increase U.S. exports and probably economic growth, too, but it would also wreak havoc with the global financial system. Every dollar-denominated asset in the world, including all manner of bonds, would plummet in value." 

Actually this is very far from being the case. Most holders of dollar denominated assets are not hugely interested in the value of their assets measured in yuan. (Quick, how many yuan is your 401(k) worth?) While the repercussions of a large fall in the value of the dollar against one or more major currencies are certainly greater than the fall of the Israeli shekel, it is certainly not obvious that a major reduction in its value would have disastrous consequences. In fact, over time it is virtually inevitable.

The "Currency Wars" Wars Heat Up by Yglesias

Yglesias links to Greg Ip who I linked to below.

The clear implication of the term “war” is that these policies are zero-sum games: America and Japan are trying to push down their currencies to boost exports and limit imports, and thereby divert demand from their trading partners to themselves.

(Not totally clear on this.) China was doing this with its "currency manipulations" because it was buying U.S. Treasuries and has "capital controls." Japan has said it won't intervene in foreign exchange markets to lower its currency. Also Japan is supposedly now in surplus (need to check) while China's currency has strengthened (need to check). In any event emerging markets like Brazil should institute limited capital controls to regulate hot money and make sure they don't end up like Spain.

Part of the problem is the domestic politics of each country. China is allowing the U.S. to borrow cheaply in order to subsidize its exporters. The U.S. should use the cheap money to "invest in the future" and close the output gap. Republicans are blocking this. (But if China didn't have capital controls, money would be flowing in and strengthening their currency and they would get more inflation and would have to borrow more from the U.S. Again not crystal clear on the arguments.)

Should The U.S. Take A Harder Stance On China's Currency? (Part II) by Joe Gagnon

Federal Reserve Chairman Ben Bernanke recently said that Chinese currency manipulation "is blocking what might be a more normal recovery process." In fact, the problem goes beyond China to include many other emerging economies and even a few advanced economies. All together, governments in these economies are spending about $1.5 trillion per year on currency manipulation.

Currency manipulation occurs when governments purchase foreign currency in order to hold up its value relative to their own currency. Manipulation makes a country's exports cheaper and imports more expensive, artificially raising the trade balance. The evidence suggests that currency manipulators jointly have increased their trade balances by about $1 trillion relative to where they would have been in the absence of manipulation. Europe and the United States have suffered the corresponding decline in trade balances.

(via Thoma)

American Republicans (and Fed board members like Lacker), the Chinese Communist Party, and German conservatives are the Axis of fools, all denying the American economy full employment and adequate demand to close the output gap. Germany however is mostly damaging Europe, though. The Chinese are screwing their consumers.

DeLong gives an early sketch of the Brookings paper he's working on with Larry Summers, titled "Fiscal Policy in a Depressed Economy".

Persistent high transitory cyclical unemployment is transforming itself into permanent structural unemployment as the labor market recovery continues to delay its appearance.

Government polices by the American, Chinese and German governments are actively delaying its appearance. Its not choosing to be fashionably late itself.

What Caused The Deficit? A Reply to Megan McArdle by Jonathan Chait

Dean Baker's entire post on the "currency wars" is excellent, so I'll repost the entired thing.

The NYT had a piece on the recent decline in the value of the dollar and effort by other countries to offset its impact. The article noted in particular developing country efforts to reduce capital inflows that are raising the value of their currency.

It would have been worth noting that in standard economic theory, developing countries are supposed to be borrowers. The logic is that capital is relatively scarce in the developing countries, which means that it gets a higher return. Capital therefore should flow from relatively to slow growing rich countries to more rapidly growing developing countries.

This was the direction of flows until the East Asian financial crisis in 1997. The harsh conditions that the IMF imposed on the East Asian countries led developing countries throughout the world to focus on building up reserves so that they would not have to deal with the IMF. This reversal coincided with the "high dollar" policy touted by then Treasury Secretary Robert Rubin. It helped to lay the basis for the imbalances associated with the stock and housing bubbles.

To a large extent, the decline in the value of the dollar would effectively reverse the distortions to the world economy resulting from the IMF-Rubin policy of the late 90s. It is also worth noting the recent decline in the dollar is largely just reversing its run-up as a result of the financial crisis in 2008. Money flowed into the U.S. as a safe haven, pushing the dollar well above its pre-crisis levels. It is now falling back toward the level it was at before the crisis.

What would you call the reasonable reaction of China and others to the harsh conditions imposed by the IMF in the wake of the 1997 crisis? It would be the opposite of morale hazard. Once can be too indulgent and too harsh or strict.

This New York Times piece argues that England's current austerity measures are partly due to memories of the IMF bailing them out in the 1970s.