Fixing the exchange rate

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Plan

1. Exchange rate and protectionism

2. International reserve currencies

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Exchange rates & protectionism

• “Currency manipulator” ??

• Should the WTO be involved in regulating the exchange rate?

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Brazilian President Dilma Rousseff referred to unstable capital flows as a “liquidity tsunami”

11 Apr 2012: http://www.aljazeera.com/indepth/opinion/2012/04/20124894553253392.html

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Or are capital controls the solution?

Brazilian exports getting crushed by currency appreciation

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Do trilemma solutions need to be compatible across countries?

• Brazil is complaining now

• Used to have a fixed XR

• Then East Asian Financial Crisis hit

• Currency value collapses under speculation (Dec 1998/ Jan 1999)

• MERCOSUR?

• Argentina’s exports become uncompetitive over night

• Argentina’s currency collapses in 2002

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Do the world’s 2 largest economies have compatible solutions to the trilemma?

• US “shock absorber”:– Floating exchange rate

• China opts for:– restrictions on capital flows– fixes its currency to the dollar

• How can the dollar adjust if China fixes to it?

• If this is the current monetary system…

• We’re all doomed7

What can China do?

• Gradual appreciation?– A one-way road to “hot money” and a scary bubble

• A one-off revaluation?– Catastrophic economic dislocation– Politically possible given the export-oriented sector

strength?

• Status quo?– Unsustainable in the long-run

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http://www.ft.com/intl/cms/s/0/7e010a5a-8324-11e1-9f9a-00144feab49a.html#axzz1rjqaPoVT

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• Complaints from Mexico• But even as their currency appreciated, it was far below where it

was before the crisis

http://www.bea.gov/newsreleases/international/transactions/transnewsrelease.htm

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So, are global imbalances the fault of the United States?

• How can the US get away with running Current Account deficits year after year?

• Capital Account surpluses

• Why?

• Are we really a great place to invest?

• International Reserve Currency– The world has coordinated on the dollar

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The Euro

• The ultimate commitment

• So, if it’s credible, will it overtake the dollar as the international reserve currency?

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Good Will Hunting

• SKYLAR: Maybe we could go out for coffee sometime?

• WILL: Great, or maybe we could go somewhere and just eat a bunch of caramels.

• SKYLAR: What?

• WILL: When you think about it, it's just as arbitrary as drinking coffee.

• SKYLAR: (laughs) Okay, sounds good.• http://www.imsdb.com/scripts/Good-Will-Hunting.html

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Is the euro an alternative?• Coordination game

• The NY meeting game…– The Dollar is “noon, Grand Central information booth”

• Present distribution of reserve currencies:– Dollar: ~60%– Euro: ~25%– Pound: ~4%– Yen: ~4%– Swiss franc: ~0.1%– Other: 5%

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Obstacles

• A focal point: The more people who use an international currency, the more effective it is (increasing returns to scale)

• No equivalent to the US treasury bill @ the EU level

• Leadership – who do you trust?

– US track record v. EU (…Greece?)

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Is the renminbi an alternative?

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Dollar retreats on stimulus speculation (4/9/2012)

• “The dollar continued its retreat against the yen yesterday …

• “after last week’s US employment data showing a slowdown in the pace of job creation stoked speculation about further stimulus measures to keep economic recovery on track.”

• Yen is a safe-haven

• And it’s killing Japanese exports

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Japan

• How would you describe the Japanese Diet?

a) Low in poly-saturated fats

b) A parliament

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Japan’s Diet rejects central bank pick

• Japan’s parliament has rejected a government nominee to the policy board of the central bank, in a sign of tensions over the pace and scale of monetary easing needed to revive the world’s third-biggest economy.

• If the parliament selects the Prime Minister / Government, why would they reject the government?

• Bicameral!

– House of Representatives

– House of Councillors

• Both houses of parliament must approve nominees. The 4 biggest opposition groups have a combined 122 seats in the upper house (104 seats for the ruling Democratic Party of Japan). 23

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Prime Minister Noda must enjoy the confidence of the House of Representatives to remain in office

?

Japan’s Diet rejects central bank pick• The opposition-controlled House of Councillors on Thursday (4/5/2012) voted

127 to 111 against the appointment to the central bank’s highest decision-making body.

• The cabinet’s nomination ... had been seen as a tacit endorsement of the bank’s basic view on the limitations of monetary policy in banishing Japan’s persistent state of deflation.

• In February the BoJ surprised markets by expanding its asset-purchasing programme - its key monetary policy tool, with interest rates near zero - while adopting an inflation “goal” of 1 per cent.

• AND: Last month “took various measures to ensure a smooth supply of funds for the nation’s small to medium-sized enterprises”

• BUT: “refrained from increasing asset purchases”

• Opposition view: "the BoJ has not done enough to spur a rebound in an economy that shrank in 3 of the past 4 years and continues to experience falling prices.“

• “This is democracy in action,” said Robert Feldman, senior economist at Morgan Stanley MUFG Securities in Tokyo. “There’s a genuine policy debate going on right now about the role of the central bank in fighting deflation.”

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Other “safe havens”?

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Why have the Swiss been more successful in bringing down the franc than the Japanese have been in bringing down the yen?

Is the SDR an alternative?

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Be careful what you wish for…

• Benefits of international reserve currency– finance fiscal deficits– enhance international prestige– debt denoted in your own currency

• Costs of international reserve currency– Monetary policy autonomy is hindered - vast

quantities of your currency held abroad– Overvaluation leads to uncompetitive

export-oriented/import-competing sectors

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Take-homes on Euro

• Solves the old problem that the IMF failed to solve

• Still limited as a currency– No EU level bond

• Will it become the new international reserve currency?

– Not any time soon

– Coordination game

– The Dollar is still “noon, Grand Central information booth”

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Thank youWE ARE GLOBAL GEORGETOWN!

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