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2. What are currency wars? Review of the last 6 months.Is the currency war metaphor appropriate? Which emerging markets are intervening the most to dampen the appreciation of their currencies?What is the right way to measure it?What should they be doing? Lessons from recent crises. . 3. Curre
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1. 1 Currency Wars Jeffrey Frankel Harpel Professor of Capital Formation & Growth, Harvard University MAS Sponsored Public Lecture, Singapore, 8 March, 2011
2. 2 What are currency wars?
Review of the last 6 months.
Is the currency war metaphor appropriate?
Which emerging markets are intervening the most to dampen the appreciation of their currencies?
What is the right way to measure it?
What should they be doing? Lessons from recent crises.
3. 3 Currency Wars chronology
September 15, 2010
Japan buys $20 b for Ľ,
after 6-year absence from FX markets;
thereby joining Switzerland, the other floater to have appreciated in 2008-09 GFC and to have fought it by FX intervention.
4. 4 September 27 warning from Brazils Finance
Minister Guido Mantega:
Were in the midst of an international currency war, a general weakening of currency. This threatens us because it takes away our competitiveness.
I.e., countries everywhere are trying to push down the value of their currencies, to gain exports and employment,
a goal that is not globally consistent.
5. 5 Currency Wars chronology, Nov.2010 As European sovereign debt crisis resurfaces in Ireland, euro hits low (1.3 $/ Nov.17).
Chinese government, responding to 4.4% inflation in October
raises interest rate,
reserve requirements,
& price controls.
US core inflation falls to 0.6% for year,
the lowest since 1957.
6. 6 G20 Summit in Korea was the first chaired by a non-G8 country
7. 7 Currency Wars chronology, Nov.2010 Nov. 12: G-20 Summit in Seoul was judged a failure, at least for Obama:
Rebuff of US proposal for cap on Current Account surpluses at 4% of GDP.
No pledge to refrain from competitive undervaluation
A suggestion to countries with widely used currencies like the $ to be vigilant against excess volatility, a warning against loose monetary policy.
8. 8 Currency Wars chronology, Nov. 2010 Nov.21: Fed announces QE2 decision --
Will purchase $600b in bonds.
Short-term market reaction -- $ depreciates.
Critiques --
Sarah Palin & John Taylor: US is debauching its currency.
Germany, China & Brazil: $ depreciation = deliberate salvo in currency wars.
9. 9 Jan.14, 2011: Secy. Geithner notes that -- including Chinas higher inflation -- RMB is appreciating in real terms.
That suggests (appropriately) lower USG priority on the currency issue
than on IPR, North Korea & other issues
in Jan.19 Obama-Hu summit. Currency Wars chronology, Jan. 2011
10. 10 5% nominal appreciation per annum + 5% inflation differential 10% real appreciation per annum over last half-year
11. 11 Currency Wars chronology, 2011 Feb. 4, 2011
In biannual report to Congress, U.S. Treasury calls RMB "substantially undervalued."
But it once again refrains from naming China a currency manipulator,
and points out real appreciation is running at 10% per annum.
12. 12 Feb. 15, 2011: US Treasury Secretary Geithner fails to convince Brazil to jointly pressure China.
13. 13 Feb. 18-19, 2011: First meeting of G20 ministers in Frances year as host.
Sarkozy no longer talking of a new Bretton Woods.
But G20 goes ahead with a system of indicators,
including real exchange rates, current account balances, budget deficits and sovereign debt levels.
14. 14 Fear of non-cooperative competitive devaluation is an argument for fixed exchange rates
rooted in the 1930s.
It is why the architects of the post-war monetary order chose fixed exchange rates at Bretton Woods, NH, in 1944.
But it is now used to argue that China should move from fixing to floating.
US Congressmen dont care about regimes;
they just want a stronger RMB vs. $.
15. 15 Meanwhile, fear of competitive devaluation is also used as an argument against US monetary expansion.
But monetary expansion is not a beggar-thy-neighbor policy:
Although in theory it should depreciate $,
at the same time it boosts US growth & so imports.
The net of the two effects on trade balance is ambiguous in theory and 0 in practice.
Do other countries want a U.S. double dip ?
16. 16 Economic historians have decided competitive devaluation under 1930s conditions was not a problem after all.
True, countries couldnt all devalue against each other,
But they could and did all devalue against gold
which worked to ease global monetary policy,
just what was needed.
The same was needed in 2008-09
and Fed easing supplied it.
17. 17 The currency war talk -- especially the criticism of US monetary policy -- seems to forget the point of floating rates:
Different countries will generally have different needs at any point in time
e.g., high unemployment in US & European periphery,
while China & Brazil & India are overheating.
18. 18 Inflation has recently crept up in many of the major emerging markets
19. 19 In the advanced economies, by contrast, inflation is still low
20. 20
21. 21 Meanwhile, US core inflation is the lowest in 50 years
22. 22 The point of a floating rate system: the US can choose its easy monetary policy and Brazil its tight monetary system,
with appreciation of US $ vs. Braz. real accommodating the divergence.
Multilateral cooperation is not necessary for this.
23. 23
But other kinds of international cooperation are needed;
the war & 1930s metaphors are not totally misplaced:
Currency war could turn into trade war
if Congress follows through on legislation to impose (WTO-illegal) tariffs on China as punishment for non-appreciation.
Protectionism is a beggar-thy-neighbor policy
unlike monetary expansion.
Until now, the US & G20 have held the line on protectionism
compared to the milder recessions of 1991 & 2001,
let alone the Smoot Hawley tariff of 1930.
24. 24 China would take some responsibility
to reallocate its economy away from exclusive reliance on exports & manufacturing
toward domestic consumption & services,
health, education, housing, environment, insurance & other services.
How? By allowing the RMB to appreciate,
but also by increasing domestic demand.
Meanwhile, the US would also take responsibility.
The US should take steps today to lock in a future return to fiscal responsibility,
e.g., by putting Social Security on a firm footing.
25. 25 Bottom line on currency war metaphor The metaphor is not fully appropriate.
Yes, China finds uncomfortable the pressure of capital inflows,
which is indeed increased by US monetary ease.
But this is a far more legitimate way to let China feel the pressure to appreciate
than are US threats of WTO-illegal tariffs.
26. 26 Intervention in emerging markets to fight currency appreciation Who is doing how much?
It is not enough to look at increases in FX reserves.
The question: for a given increase in Exchange Market Pressure (EMP), how much does the central bank absorb as an rise in the value of currency (exchange rate) versus how much as an increase in the quantity (reserves).
How much should it intervene, vs. appreciate?
What can we learn from recent crises?
27. 27 Capital flows to emerging markets, especially Asia, recovered quickly from the 2009 recession. These countries again show big balance of payments surpluses
28. 28 The 4th wave of inflows was reflected as an increase in Exchange Market Pressure on all Asian countries in 2010, Singapore & Korea the most.
29. 29 Singapore has taken the inflows heavily in the form of reserves,
30. 30 China gets the most attention, partly because it is so large in trade and partly because it absorbs most of its Exchange Market Pressure as FX intervention, rather than appreciation
31. 31 Korea (& Singapore & Taiwan PoC) are also adding heavily to reserves.
32. 32 In Asia since 2008, India, followed by Indonesia, have had the greatest tendency to float, given EMP; Hong Kong & Singapore the least, followed by Malaysia & China.
33. 33 India, Indonesia, & China are in danger of overheating
34. 34 In Latin America, renewed inflows
35. 35 If a country faces an increase in exchange market pressure, should it appreciate? Or intervene? It is the old debate over floating versus fixed exchange rate.
What can we learn about the answer from recent crises?
36. 36 Two lessons from the 1990s emerging market currency crises Advantages of floating:
Speculators dont have a target to shoot at;
Accommodate shocks;
Discourage unhedged $ liabilities.
Advantages of holding forex reserves
Reduces danger of crisis.
How did these lessons fare in the 2008-10 crises?
37. 37 The variables that show up as the strongest predictors of country crises in 83 pre-2009 studies: (i) low reserves and (ii) currency overvaluation
38. 38 Best and Worst Performing Countries -- F&S (2010), Appendix 4
39. 39
40. 40 Reserves Even though many developing & emerging market countries described themselves as floating,
most took advantage of the boom of 2003-2008 to build up reserves to unheard of heights,
in the aftermath of the crises of 1994-2001.
in contrast to past capital booms (1975-81, 1990-97).
41. 41 When the 2008-09 global financial crisis hit,
those countries that had taken advantage of the 2003-08 boom to build up reserves did better.
E.g., Obstfeld, Shambaugh & Taylor (2009)
Frankel & Saravelos (2010),
This had also been the most common finding in the many studies of Early Warning Indicators in past emerging market crises.
42. 42 Poland, the only continental EU member with a floating exchange rate, was also the only one to escape negative growth in the global recession of 2009
43. 43 Depreciation boosted net exports; contribution to GDP growth > 100%
44. 44 New lesson regarding exchange rate regimes Old conventional wisdom: The choice was between
fixing (changes in reserves; not in exchange rate) vs.
floating (changes in exchange rate; no reserves).
Now it appears that:
Intermediate regimes are indeed viable.
Holding reserves and floating are both useful.
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