Currency Wars: Global Money in 2010 Jeffrey Frankel Harpel Professor of Capital Formation & Growth, Harvard University Currency Wars Chronology, Fall 2010

Currency Wars: Global Money in 2010 Jeffrey Frankel Harpel Professor of Capital Formation & Growth, Harvard University Currency Wars Chronology, Fall 2010

Currency Wars: Global Money in 2010 Jeffrey Frankel Harpel Professor of Capital Formation & Growth, Harvard University Currency Wars Chronology, Fall 2010

Cox, Nicole, News Director has reference to this Academic Journal, PHwiki organized this Journal Currency Wars: Global Money in 2010 Jeffrey Frankel Harpel Professor of Capital Formation & Growth, Harvard University Macquarie Securities Boston, December 8, 2010 Currency Wars Chronology, Fall 2010 September 15 Japan buys $20 b, as long as ¥, after a 6-year absence from FX markets; thereby joining Switzerl in addition to , the other floater to have appreciated in 2008-09 GFC in addition to to have fought it by FX intervention. September 27: warning from Brazil’s Finance Minister Guido Mantega: “We’re 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 & employment, a goal that is not globally consistent. Currency Wars chronology, continued

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Renewed flows to emerging markets in 2010 have met with $ purchases in FX intervention Brazil, Korea, Thail in addition to , India & others must manage inflows: Appreciation Buying $ to prevent appreciation Capital controls Currency Wars chronology, continued Currency Wars chronology, continued October 15: U.S Treasury postpones semi-annual report to Congress on currency manipulation although there has clearly been little appreciation of the RMB since China announces more flexibility in June. (All a repeat of 2005.) November After inflation rises to 4.4% in October, China raises i & reserve requirements in addition to adopts new price controls. US core inflation falls to 0.6% as long as year, the lowest since 1957. => fears of deflation trap. Currency Wars chronology, continued

Nov. 17 As European sovereign debt crisis resurfaces in Irel in addition to , € hits 7-week low (1.3 $/€). Nov.20-21 Fed announces QE2 (signaled since August): will purchase $600b. Short-term market reaction: $ depreciates Immediate attacks on Fed action – Palin & conservatives: “debauching the currency” German & China: $ depreciation is a deliberate salvo in currency wars Currency Wars chronology, continued The reactions of most emerging markets show they learned two lessons from the 1990s currency crises: Advantages of holding as long as ex reserves: Lower frequency & severity of crises. Advantages of floating: Speculators don’t have a target to shoot at; Accommodate shocks; Discourage unhedged $ liabilities. Such currency mismatch leads to bad balance sheet effects when devaluation comes. How did these lessons fare in the global crisis of 2008-09 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).

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. Frankel & Saravelos (2010). Aizenman (2009) in addition to Obstfeld, Shambaugh & Taylor (2009) Vs. Blanchard (2009) in addition to Rose & Spiegel (2009) This had also been the most common finding in the many studies of Early Warning Indicators in past emerging market crises. EWIs: The variables that show up as the strongest predictors of country crises in 83 studies are: (i) reserves in addition to (ii) currency overvaluation Source: Frankel & Saravelos (2010) Best in addition to Worst Per as long as ming Countries – F&S (2010), Appendix 4

F & Saravelos (2010): Bivariate F & Saravelos (2010): Multivariate Floating Most medium-income Emerging Market countries reacted to the currency crises of the 1990s by increasing exchange rate flexibility with the major exception of Eastern Europe. The flexibility has helped.

Pol in addition to , 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 Source: Cezary Wójcik, 2010 (de facto) % change in GDP Depreciation boosted net exports; contribution to GDP growth > 100% Contribution of Net X to GDP: 2009: 2,5 3,4 3,2 3,4 GDP growth rate: 1,7 Source: Cezary Wójcik kroon / $ Estonia Latvia lats / $ zlotys / $ The Polish exchange rate increased by 35%. Capital flows to emerging markets, especially Asia, recovered quickly from the 2009 recession. These countries again show big balance of payments surpluses Goldman Sachs

Although China continues the most salient case, Korea, Singapore & Taiwan are also adding heavily to reserves. GS Global ECS Research Others, such as India & Malaysia, are currently taking the inflows in the as long as m of currency appreciation, more than reserve accumulation. GS Global ECS Research less-managed floating (“more appreciation-friendly”) more-managed floating In Latin America as well, inflows have returned, less-managed floating (“more appreciation-friendly”) more-managed floating GS Global ECS Research but as appreciation in Chile & Colombia. reflected mostly as reserve accumulation in Peru,

Fear of non-cooperative “competitive devaluation” is an argument as long as fixed exchange rates rooted in the 1930s. That 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 don’t care about regimes; they just want a stronger RMB vs. $. Is the currency war metaphor appropriate Economic historians have decided competitive devaluation under 1930s conditions was not a problem after all. True, countries couldn’t all devalue against each other, But they could in addition to did all devalue against gold which worked to ease global monetary policy, just what was needed. Is the currency war metaphor applicable continued The same is true today: The Fed’s QE2 won’t just raise the money supply in the US; it will also loosen globally, to the extent that as long as eign central banks react by buying $ to prevent their own currencies from appreciating. which is what much of the world needs. For those who don’t need it, because they are already in danger of overheating, they can allow appreciation, in addition to so calibrate however much expansion they want. Multilateral cooperation is not necessary as long as this. Is the currency war metaphor applicable continued

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Indeed, the currency war critics seem to have as long as gotten the point of a global floating system: In some places (US), unemployment is high & inflation low, calling as long as easy monetary policy; In other places (China, Brazil, India ), economies are overheating, calling as long as tight monetary policy. The point of a floating system is to accommodate such inevitable macro divergences smoothly. No international cooperation is needed. Would this put unfair pressure on China to choose between inflation, if it continues to keep the RMB down, in addition to appreciation No. Perhaps China can continue to sterilize inflows awhile longer, e.g., raising bank reserve requirements. True, eventually it will have to give that up. But there is nothing unfair about making China choose between inflation in addition to appreciation. Monetary expansion by the US is perfectly legitimate especially at a time of deflation danger. If it puts pressure on China, that is far more clearly within the “rules of the game” than threatening tariffs. Other kinds of international cooperation are needed; the 1930s currency war 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 as long as non-appreciation. 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. Is the currency war metaphor applicable continued

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 dem in addition to . Meanwhile, the US would ideally also take responsibility. Even while prolonging expansionary policy this year, including fiscal expansion designed with high bang- as long as -the-buck, 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. Ideally the US & China would reach agreement on how to address current account imbalances: Will Unsustainable Current Account Deficits Lead to the End of Dollar Hegemony Some argue the US current account deficit is sustainable indefinitely. They believe that the US will continue to enjoy its unique “exorbitant privilege,” able to borrow unlimited amounts in its own currency because it is the dominant international reserve asset. “Bretton Woods II” Dooley, Folkerts-L in addition to au, & Garber (2003) : today’s system is a new Bretton Woods, with Asia playing the role that Europe played in the 1960s—buying up $ to prevent their own currencies from appreciating. More provocatively: China is piling up dollars not because of myopic mercantilism, but as part of an export-led development strategy that is rational given China’s need to import workable systems of finance & corporate governance.

Gold Gold was seen as an anachronism just a few years ago: the world’s central banks were selling off their stocks. Gold re-joined the world monetary system in 2009: The PBoC, RBI, & other Asian central banks bought gold, to diversify their reserves. Even in advanced countries, central banks appear to have stopped selling. Special Drawing Rights The SDR has made a surprising comeback as a potential international money, from near-oblivion. The G20 in 2009 decided to create new SDRs ($250b). Shortly later, PBoC Gov. Zhou proposed replacing the $ as lead international currency with the SDR. The IMF is now borrowing in SDRs. The proposal has been revived as long as an international substitution account at the IMF, to extinguish an unwanted $ overhang in exchange as long as SDRs. The SDR has little chance of st in addition to ing up as a competitor to the € or ¥, let alone to the $. Still, it is back in the world monetary system.

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