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Title: The Renminbi - Dollar Issue


1
The Renminbi - Dollar Issue
  • Jeffrey Frankel
  • Harpel Professor
  • Spring Exercise, April 23, 2010

2
Topics to be covered
  • (I) Historical timeline of exchange rate
    diplomacy
  • (II) What is in Chinas interest?
  • (III) What is in the US RoW interest?
  • (IV) Shifting power relationships
  • Addendum The current account imbalances

3
Historical timeline
I have listened to both sides of this debate.
Here is what I think. I think those who call
for a fixed exchange rate are right in the short
run. And those who call for a floating exchange
rate are right in the long run. How long is
the short run, you ask? You must understand.
China is 8000 years old. So when I say, short
run, it could be 100 years.-- Li Ruogu,
Deputy Governor, Peoples Bank of China, Dalian,
May 2004
4
Historical timeline of currency diplomacy
  • 1973 End of Bretton Woods era.
  • Major currencies switch from fixed to floating.
    The rest keep their pegs.
  • 1977 IMF members agree that each shall
    avoid manipulating exchange rates in order
    to prevent effective balance of payments
    adjustment or to gain an unfair competitive
    advantage over other members. Principle (A)
    of the 1977 Decision on Surveillance over
    Exchange Rate Policies, and Sect.1, Clause 3, of
    Article IV amended in 1978.
  • In practice, the IMF almost never pressures
    countries to revalue their currencies upward
  • It just pressures deficit countries to devalue.
  • 1983-84 / Agreement. 1985 Plaza Accord.
  • Japan, US others cooperate to bring down
    overvalued , esp. vs.
  • 1987-89
  • Louvre Agreement depreciation halted.
  • Big bubbles in Japans equity real estate
    markets,
  • followed by crash, severe Japanese stagnation
    in 1990s.

5
Timeline, continued
  • 1988 The Omnibus Trade Competitiveness Act
    mandates the US Treasury report to Congress
    biannually on whether trading partners were
    manipulating currencies.
  • Section 3004 requires the Treasury to consider
    whether countries manipulate the rate of exchange
    between their currency and the United States
    dollar for purposes of preventing effective
    balance of payments adjustments or gaining unfair
    competitive advantage in international trade.''
  • The US must hold talks with governments deemed to
    be breaking rules.
  • In the first Reports to Congress on
    International Economics Exchange Rate Policy,
    Korea Taiwan PoC were found to be guilty of
    manipulation,
  • while Singapore Hong Kong SAR got off with a
    warning.
  • China was named in early 1990s.

6
  • Analysis of the Treasury Departments
    biannualReport to Congress on International
    Economics and Exchange Rate Policy
  • -- Frankel Wei (2007)

7
Two hypotheses regarding determinants of US
Treasury decisions whether partnersare
manipulating currencies
  • (1) Legitimate economic variables
  • the partners overall current account/GDP,
  • its reserve changes,
  • the real overvaluation of its currency vs.
  • (2) Variables suggestive of domestic American
    political expediency
  • the bilateral trade balance,
  • US unemployment,
  • an election year dummy .

8
Two hypotheses regarding determinants of US
Treasury decisions whether partnersare
manipulating currencies
  • (1) Legitimate economic variables
  • the partners overall current account/GDP,
  • its reserve changes,
  • the real overvaluation of its currency vs.
  • (2) Variables suggestive of domestic American
    political expediency
  • the bilateral trade balance,
  • US unemployment,
  • an election year dummy .

9
Timeline, continued
  • Those countries named as manipulators, or given
    warnings, have always been Asian.
  • What political economy determines Treasury
    findings?
  • Econometric analysis
  • Domestic political variables are as important as
    global manipulation criteria

10
Explaining findings of Treasury Department
biannualReport to Congress on Int.Ec. Exchange
Rate Policy
  •   All countries
    15 Asian economies
    Excluding oil exporters
  • US bilateral TB -0.92
    -0.99
  • 0.0655 0.1548
  • Partners 0.014
    0.028
  • CA/GDP 0.002
    0.007
  • Partners Real -0.18 -0.23
    Exchange Rate 0.0291 0.1115
  • Change in 0.003 -0.012
  • reserves/GDP 0.003 0.009
  • US unem- 0.022 0.08
    ployment 0.010 0.037

statistically significant at 99 level
11
Findings suggest the domestic US variablesaffect
the Treasury decision more than the legitimate
global manipulation criteria
  • weak role for partner reserve accumulation,
  • very high significance of bilateral balance,
  • significance of US unemployment, and
  • significant (borderline) extra effect of
    unemployment in election years.

12
Implication
  • If the IMF were interpreting Article IV,
    rather than the Treasury interpreting the 1988 US
    law,
  • the criterion of consistent uni-directional forex
    intervention would receive more emphasis,
  • and US-specific variables such as the bilateral
    trade balance would not appear at all.

13
Some sympathy for the Treasury
  • It walks a fine line.
  • An additional finding
  • Treasury is eager not to single out one country
    for unique opprobrium.
  • No single country is left exposed on its own.
  • the top-ranked country is less likely to be named
    than if it had some other country to hide behind,
    while
  • the 2nd- 3rd-ranked countries are more likely
    to be moved up, to give the leader company.

14
Timeline, continuedExchange rate
  • Jan. 1994 China devalues its official rate,
  • unifying its dual exchange rate system.
  • 1997-98 East Asia crisis.
  • China wins plaudits for keeping RMB (yuan)
    fixed
  • while all its neighbors are devaluing.
  • 1995-2005 China continues to peg
  • for 10 years
  • at 8.28 RMB/.

15
Timeline, continuedUS pressure
  • Oct. 2003 Treasury Secretary Snow begins to
    browbeat China to allow appreciation.
  • Report RMB merits concern talks
  • Speculators in financial markets start to bet
    appreciation.
  • as reflected in either capital flows (residual
    see Prasad Wei)
  • or non-deliverable forwards (see appendix
    graph).
  • Feb. 2005 Senators Schumer Graham propose
    first of bills to impose (WTO-illegal) tariffs of
    27.5 against all Chinese goods if China does
    not substantially revalue its currency.
  • Subsequent versions, by Baucus-Grassley and
    others substitute the phrase currency
    misalignment in place of unfair manipulation
    to ease standard of proof.

16
Timeline, continuedChinas macroeconomy
  • 2004- Rapid growth puts China into Excess
    Demand condition.
  • 2005-06 Despite large balance of payments
    surpluses, PBoC sterilization of reserve inflows
    prevents excessive money growth inflation.
  • 2007-08 Sterilization finally falters Money
    growth becomes excessive.
  • Inflation becomes a serious concern.
  • Shanghai stock market experiences a bubble.
  • Mid-2008 early 2009 Worst of the global
    recession hits.
  • China loses 26 of exports
  • Growth rate slows down danger of overheating
    disappears.
  • Mid-2009 mid-2010 China resumes blistering
    growth
  • In response to domestic demand stimulus renewed
    exports
  • China is now a major engine of growth in world
    economy.
  • Danger of overheating returns esp. asset market
    bubbles.

17
Timeline, continuedExchange rate
  • July 2005 China announces a new policy,
  • Immediate 2.1 revaluation,
  • Followed by managed float controlled
    appreciation, supposedly against an unspecified
    basket of currencies.
  • But, as often, de jure exchange rate regime ? de
    facto.
  • Econometric estimation of true regime reveals
  • link did not even begin to loosen until 2006.
  • By 2007, implicit basket had shifted some weight
    onto other currencies, especially the .
  • RMB appreciates against the from 2006 to 2008,
  • But only because does.

18
The magnitude of daily movements vs. increased
in the spring of 2006,
19
Estimating the weights
  • A problem made-to-order for OLS regression.
  • Regress changes in value of RMB against
    changes in values of candidate currencies.
  • ? log RMBt
  • c a ?log t ß1?log t ß2 ?log
    t
  • The coefficients are the basket weights.
  • Can impose a S ß j 1.

F Wei (2007), Frankel (2009)
20
Has US pressure pushed the pace of increased
flexibility?
  • We searched an electronic database of news
    reports (FACTIVA/NewsPlus) , recording the number
    of US news reports of US officials asking China
    to speed up RMB flexibility/revaluation.
  • Two separate time series on the cumulative
    numbers of complaints
  • from US Treasury and
  • from officials of other government agencies (e.g.
    the White House, Congress and Fed)

21
Complaints Treasury other US
22
We added complaints as a regressor (Table 19)
  • No evidence that U.S. official complaints are
    associated with RMB appreciation relative to the
    currency basket.
  • There is evidence that cumulative complaints are
    associated with a reduction in the RMBs weight
    on the US dollar.

23
Timeline, continuedExchange rate
  • May 2008 Chinese leaders hear exporter
    complaints of competitiveness difficulties.
  • Mid-2008-April 2010 yuan repegs 6.84 RMB/
  • 20 stronger, vs. , than 2005.

24
The RMB rose against the for 2 years, but
returned to peg in mid-2008
/RMB
/RMB
/
25
Timeline, continued
  • Oct. 2006 -- IMF Article IV consultation finds
    RMB undervalued.
  • 2007 US Treasury temporarily passes hot potato
    of exchange rate complaints to IMF,
  • which gets mandate for exchange rate
    surveillance.
  • 2008 Though financial crisis originates in US,
    flight to quality temporarily raises demand
    for .
  • 2009 Chinese leaders, for the first time,
    express concerns that their vast holdings of US
    treasury bills may not be well-invested.
  • Pres. Obama Secy. Geithner seek to reassure.

26
2009 Chinese warnings
  • Premier Wen worries US T bills may lose
    value.Urges the US to keep its deficitat an
    appropriate size to ensure
  • the basic stability of the (again on
    11/10/09).
  • PBoC Gov. Zhou, proposes replacing as
    international currency, with the SDR (March 09).

SDR
27
Timeline, continued2010
  • Winter 2010 Pressure mounts --
  • International pressure on Beijing to appreciate
  • Congressional pressure on US Treasury to find
    China guilty of currency manipulation in its
    biannual report due April 15.
  • But Chinese say they will never bow to pressure.
  • US-China relations deteriorate
  • on other fronts as well.

28
April 1-9 Collision is averted at the last
minute -- or at least postponed
  • April 1 China announces Hu Jintao trip to DC
  • to attend April 12-13 summit.
  • April 2 Beijing hints it may adjust pegging
    policy
  • if visit goes smoothly.
  • April 3 Treasury announces manipulation report
    postponed
  • from mid-April deadline,
  • probably until the summer
  • after Strategic Economic Dialogue in May,
  • G-20 Summit meeting in June.
  • Implication The two governments must have come
    to a face-saving understanding.
  • April 9 Geithner makes surprise stop in Beijing.

29
(II) From Chinas viewpoint,
  • Countries should have the right to fix their
    exchange rate if they want to.
  • True, the IMF Articles of Agreement and the US
    Omnibus Trade Act of 1988 call for action in the
    event that a country is unfairly manipulating
    its currency.
  • But
  • Almost no countries have been forced to
    appreciate.
  • Pressure on surplus countries to appreciate will
    inevitably
  • be less than pressure on deficit countries to
    depreciate.
  • It is time to retire the language of
    manipulation.
  • Usually, it is hard to say when a currency is
    undervalued.
  • Dont cheapen the language that is appropriate to
    WTO rules.
  • China should do what is in its own long-term
    interest.

30
What is in Chinas interest?
  • My view mutually-beneficial bargain, between
    equals
  • E.g., China agrees that
  • its exchange rate is part of the problem,
  • it will cooperate to lower the RMB/ rate in a
    gradual manner,
  • and of course it wont dump US treasury bills.
  • In exchange, US agrees that
  • its low national saving rate is part of the
    problem,
  • it will cooperate to reduce the budget deficit,
  • and of course it wont close off the US market to
    Chinese goods.
  • But perhaps a bargain isnt even necessary
  • It is in Chinas own interest to begin
    appreciating the RMB.

31
Five reasons China should let RMB appreciate, in
its own interest
  • Overheating of economy
  • Reserves are excessive.
  • It gets harder to sterilize the inflow over
    time.
  • Attaining internal and external balance.
  • To attain both, need 2 policy instruments.
  • In a large country like China, expenditure-switch
    ing policy should be the exchange rate.
  • Avoiding future crashes.
  • RMB undervalued, judged by Balassa-Samuelson
    relationship.

32
1. Overheating of economy
  • Bottlenecks. Pace of economic growth is
    outrunning
  • raw material supplies, and
  • labor supply in coastal provinces
  • Asset bubbles.
  • Shanghai stock market bubble in 2007.
  • Inflation 6-7 in 2007
  • gt price controls
  • shortages social unrest.
  • All of the above was suspended in late 2008,
  • due to global recession.
  • But it is back again now skyrocketing real
    estate prices.

33
Attempts at sterilization, to insulate domestic
economy from the inflows
  • Sterilization is defined as offsettingof
    international reserve inflows,so as to prevent
    them from showing updomestically as excessive
    money growth inflation.
  • For awhile PBoC successfully sterilized
  • until 2007-08.
  • The usual limitations finally showed up
  • Prolongation of capital inflows lt
    self-equilibrating mechanism shut off.
  • Quasi-fiscal deficit gap between domestic
    interest rates US T bill rate
  • Failure to sterilize money supply rising
    faster than income
  • Rising inflation (admittedly due not only to
    rising money supply)

34
2. Foreign Exchange Reserves
  • Excessive
  • Though a useful shield against currency crises,
  • China has enough reserves 2 ½ trillion by April
    2010
  • US treasury securities do not pay high returns.
  • Harder to sterilize the inflow over time.

35

The Balance of Payments
rate of change of foreign exchange
reserves rose rapidly over last decade
Source HKMA, Half-Yearly Monetary and Financial
Stability Report, June 2008
36

The Balance of Payments
rose rapidly in China over past decade, due to
all 3 components trade balance, Foreign Direct
Investment, and portfolio inflows
Source Prasad Sorkin
37
Not only has the level of fx reserves risen,but
the rate of change (BoP surplus) shows
acceleration
Source Prasad Sorkin
38
Attempts to sterilize reserve inflow
Successful sterilization in China 2005-06
High reserve growth
gt steady money
offset by cuts indomestic credit
While reserves (NFA) rose rapidly, the growth of
the monetary base was kept to the growth of the
real economy even reduced in 2005-06.
were remarkably successful in 2005-06.
39
In 2007-08 China had more trouble sterilizing the
reserve inflow
  • PBoC began to pay higher interest rate
    domestically, receive lower interest rate on
    US T bills gt quasi-fiscal deficit.
  • Inflation became a serious problem.
  • True, global increases in food energy
    priceswere much of the explanation.
  • But
  • Chinas overly rapid growth itself contributed.
  • Appreciation is a good way to put immediate
    downward pressure on local prices of farm
    energy commodities.
  • Price controls are inefficient and ultimately
    ineffective.

40
Sterilization faltered in 2007 2008
Monetary baseaccelerated
Growth of Chinasmonetary base, its components
Source HKMA, Half-Yearly Monetary and Financial
Stability Report, June 2008
41
In 2008, domestic Chinese interest rates when
above US T bill ratesgt quasi fiscal deficit
Source Prasad Sorkin
42
Chinas CPI accelerated in 2007-08 Inflation
2002 to 2008 Q1
Source HKMA, Half-Yearly Monetary and Financial
Stability Report, June 2008
43
3. Need a flexible exchange rate to attain
internal external balance
  • Internal balance demand neither too low
    (recession) nor too high (overheating).
  • External balance appropriate balance of
    payments.
  • General principle to attain both policy targets,
    a country needs to use 2 policy instruments.
  • For a country as large as China, one of those
    policy instruments should be the exchange rate.
  • To reduce BoP surplus without causing higher
    unemployment, China needs both
  • currency appreciation, and
  • expansion of domestic demand
  • gradually replacing foreign demand,
  • developing neglected sectors health,
    education, environment, housing, finance,
    services.

44
4. Avoiding future crashes
  • Experience of other emerging markets suggests it
    is better to exit from a peg in good times, when
    the BoP is strong, than to wait until the
    currency is under attack.

Introducing some flexibility now, even though not
ready for free floating.
45
5. Longer-run perspectiveBalassa-Samuelson
relationship
  • Prices of goods services in China are low
  • compared at the nominal exchange rate.
  • Of course they are a fraction of those in the
    U.S. lt ¼ .
  • This is to be expected, explained by the
    Balassa-Samuelson effect
  • which says that low-income countries have lower
    price levels.
  • As countries real income grows, their currencies
    experience real appreciation approx. .3 for
    every 1 in income per capita.
  • But China is one of those countries that is cheap
    or undervalued even taking into account
    Balassa-Samuelson.

46
The Balassa-Samuelson Relationship 2005
Source Arvind Subramanian, April 2010, New
PPP-Based Estimates of Renminbi
Undervaluation and Policy Implications, PB10-08,
Peterson Institute for International
Economics Undervaluation of RMB in the
regression estimated above 26. Estimated
undervaluation averaging across four such
estimates 31. Compare to Frankel (2005)
estimate for 2000 36.
47
Does the Balassa-Samuelson relationship have
predictive power?
  • Typically across countries, gaps are corrected
    halfway, on average, over subsequent decade.
  • gt 3-4 real appreciation on average per year,
    including effect of further growth differential.
  • Correction could take the form of either
    inflation or nominal appreciation, but
    appreciation is preferable.

48
The conclusion that it would be in Chinas
interest to allow RMB to appreciate --
  • has long been shared by top economic officials in
    China, it is believed.
  • But the decision is a political one
  • It is a matter of Hu and Wen !

49
Solving the problem of current account imbalances,
(III) What is in the global interest?
  • in particular, the US CA deficit Chinas
    surplus.
  • Both have widened, on long-term trends.
  • Imbalances narrowed sharply in 2009
  • the US deficit fell by almost ½
  • Chinas CA surplus fell by almost ½.
  • Its trade surplus actually dipped to 0 in March
    2010.
  • Problem solved?
  • The imbalances will now resume widening.

49
50
50
51
The US trade current account balances have been
on a downward path for 50 years.They improved
sharply in 2008-09, falling by half but this
reversal was temporary, attributable to US
recession,
Trade current accounts, in billions per
quarter
52
Dangers of the U.S. trade deficit
  • Shorter-term dangers
  • Protectionist legislation
  • A possible hard landing for the .
  • Long-term dangers
  • Dependence on foreign investors
  • US net debt to RoW now 3 trillion,
  • and rising.
  • Will lower our childrens standard of living.
  • When the US cuts its deficit, that will mean the
    rest of the world losing its surplus
  • The longer adjustment is postponed, the harder it
    will be.

53
Policies to reduce the US CA deficit
  • Reduce the US budget deficit over time,
  • thus raising national saving.
  • After all, this is where the deficits
    originated.
  • Depreciate the more.
  • Better to do it in a controlled way
  • than in a sudden free-fall.
  • The already depreciated a lot against the
  • other currencies
  • from 2002 to 2007.
  • Who is left?
  • The RMB is conspicuous as the one major currency
    that is still undervalued against the dollar.

54
(IV) Changing power relationships
  • It has never worked well for the US to make a
    dozen different demands on China,
  • IPR, human rights, help on N.Korea, Iran
  • when we only have one carrot / stick
  • keeping our markets open.
  • As the worlds largest debtor, with China our
    primary creditor, our ability to make demands is
    diminished.
  • There is a particular tension between hoping
    China will continue to buy our Treasury bills,
    while asking it to stop buying our Treasury bills
  • i.e., to stop buying / selling RMB,
  • which is what keeps its currency from rising.

55
China is the largest holderof US Government debt
Source Prasad Sorkin
56
Be careful what you wish for. You might get it !

57
If China gave US politicians what they say they
want...
  • For US output employment to rise,
  • we would first need other Asian currencies to
    appreciate along with RMB.
  • Otherwise, fall in US bilateral trade deficit
    with China would be offset by rise in US
    bilateral deficit with other cheap-labor
    countries.
  • It also depends on excess capacity in US economy
  • and no crowding out of domestic demand via higher
    interest rates.
  • Those conditions are met in 2008-2010. But not
    2007. 2012?
  • Prices for Wal-Mart shoppers would go up.

58
If China gave US politicians what they say they
want...
  • we might regret it.
  • if it included reserve shift out of T bills, to
    match switch in basket weights from .
  • we could have a hard landing for the
  • including a sharp fall of US securities prices.
  • Skeptics argue China will not sell T bills
  • because, as the largest holder, it would be the
    biggest loser when the depreciated.
  • Financial market fears that China might stop
    buying US T bills could send the down in
    themselves.
  • If the is falling, China will not want to be
    the only one left holding the bag.

59
Roughly 2/3 of fx reserves are thought to be held
in
Source Prasad Sorkin
60
Central banks reserve holdings
The share has been on a downward trend since
2000 (also during 1976-1991).
61
Central banks reserve holdings Frankel Chinn
(2007) estimated effects of country size, market
depth, ability to hold value, and network effects
  • Simulation suggests could overtake by 2022.

62
The global monetary systemmay move from
dollar-based to multiple international reserve
currencies
  • The could challenge the .
  • The SDR is again part of the system.
  • Gold in 2009 made a comeback as an international
    reserve too.
  • Someday the RMB will join the roster with
    .
  • a multiple international reserve asset system.

SDR
63
Historical precedent (1914-1956)
A 2001-2020 decline in international currency
status for the would be only one small part of
a loss of power on the part of the US. But
A loss of s role as 1 reserve currency could
in itself have geopolitical implications.
  • With a lag after US-UK reversal of ec. size net
    debt, passed as 1 international currency.
  • Imperial over-reach the British Empires
    widening budget deficits and overly ambitious
    military adventures in the Muslim world.

64
  • Precedent The Suez crisis of 1956 i
  • is often recalled as the occasion on which
    Britain was forced under US pressure to abandon
  • its remaining imperial designs.
  • But recall also the important role played by a
    simultaneous run on the , and Americas
    decision not to help the beleaguered currency.
  • i Frankel, Could the Twin Deficits
    Jeopardize US Hegemony, Journal of Policy
    Modeling, 28, no. 6, Sept. 2006.  At
    http//ksghome.harvard.edu/jfrankel/SalvatoreDefi
    citsHegemonJan26Jul.pdf .

64
65
http//ksghome.harvard.edu/jfrankel/index.htm
66
Addenda
  • Is the US Current account sustainable?
  • The 2003 start of RMB speculation
  • Internal external balance

67
Economists were (are) split between
those who see the US deficit as unsustainable,
requiring a fall,
and those who see no problem.
  • Ken Rogoff
  • Maury Obstfeld
  • Larry Summers
  • Martin Feldstein
  • Nouriel Roubini
  • Menzie Chinn
  • Me
  • Lots more
  • Ben Bernanke
  • Ricardo Caballero
  • Richard Cooper
  • Michael Dooley
  • Pierre-Olivier Gourinchas
  • Alan Greenspan
  • Ricardo Hausmann
  • Lots more

67
Some claim that the financial crisis of 2007-09
fits their previous theories.
68
The events of 2007-09 struck major blows against
both interpretations of CA.
  • Most of us in the unsustainability camp would
    have predicted that something like the US
    sub-prime mortgage crisis would cause a big fall
    in the .
  • Instead , the strengthened.
  • Most of those in the sustainability camp had been
    arguing that the US has uniquely superior assets
    (corporate governance, securities markets, bank
    regulation)
  • Instead, the crisis showed the US system to
    suffer serious flaws
  • of crony capitalism like other countries (Simon
    Johnson, Ragu Rajan)
  • or worse excessive deregulation (Joe
    Stiglitz)
  • The answer, for the moment The and US
    Treasury bills still play unique roles in the
    world monetary system.

69
Critics of the twin deficits view say that the US
current account deficit is sustainable.
  1. Global savings glut (Bernanke)
  2. Its a big world (R. Cooper Al Greenspan..)
  3. Valuation effects will pay for it (Gourinchas)
  4. US as the Worlds Banker (Kindleberger)
  5. The US offers superior-quality assets
    (Caballero, Forbes, Quadrini Rios-Rull, Wei
    Wu )
  6. Dark Matter (Hausmann Sturzenegger)
  7. Bretton Woods II (Dooley, Folkerts-Landau
    Garber)

70
Exorbitant Privilege of
  • Among those who argue that the US current account
    deficit is sustainable are some who believe that
    the US will continue to enjoy the unique
    privilege of being able to borrow virtually
    unlimited amounts in its own currency.

71
When does the privilege become exorbitant?
  • if it accrues solely because of size history,
    without the US having done anything to earn the
    benefit by virtuous policies such as budget
    discipline, price stability a stable exchange
    rate.
  • Since 1973, the US has racked up 10 trillion in
    debt and the has experienced a 30 loss in
    value compared to other major currencies.
  • It seems unlikely that macroeconomic policy
    discipline is what has earned the US its
    privilege !

72
The Bretton Woods II hypothesis
  • Dooley, Folkerts-Landau, Garber (2003)
  • todays system is a new Bretton Woods,
  • with Asia playing the role that Europe played in
    the 1960sbuying 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 Chinas need to import workable
    systems of finance corporate governance.

73
There is no reason to expect better today
  • Capital mobilityis much higher now than in the
    1960s.
  • The US can no longer necessarily rely on support
    of foreign central banks
  • neither on economic grounds (they are not now,
    as they were then, organized into a cooperative
    framework where each agrees explicitly to hold
    if the others do),
  • nor on political grounds (China OPEC are not
    the staunch allies the US had in the 1960s).
  • 3) A possible rival currency to the exists.

74
My own view on Bretton Woods II
  • The 1960s analogy is indeed apt,
  • but we are closer to 1971 than to 1944 or 1958.
  • Why did the BW system collapse in 1971?
  • The Triffin dilemma could have taken decades to
    work itself out.
  • But the Johnson Nixon administrations
    accelerated the process by fiscal monetary
    expansion (driven by the Vietnam War Arthur
    Burns, respectively).
  • These policies produced declining external
    balances, devaluation, the end of Bretton
    Woods.

75
(I) Prices on Non-Deliverable Forwardsshowing
post-2003 speculation on RMB appreciation
76
(II) 3-A Internal and external balance
  • Between 2002 and 2007, China crossed from the
    deflationary side of internal balance (ES excess
    supply, recession, unemployment), to the
    inflationary side (ED excess demand side,
    overheating). And again in 2009.
  • gtMoved upward in the Swan Diagram
  • gt appreciation called for under current
    conditions.
  • Together with expansion of domestic demand
  • gradually replacing foreign demand,
  • developing neglected sectors health,
    education, environment, housing, finance,
    services
  • General principle to attain 2 policy targets
    (internal external balance), a country needs
    to use 2 policy instruments (real exchange rate
    spending).

77
China is now in the overheating surplus
quadrant of the Swan Diagram
Spending A
78
The US is not alone in its path of rising debt.
Other major industrialized economies have the
same problem.
  • A remarkable role-reversal
  • Debt/GDP of the top 20 rich countries
  • ( 80) is already twice that of the top 20
    emerging markets
  • and rising rapidly.
  • By 2014 (at 120), it could be triple.

79
One of the most important developments of
2009the G-20supplantedthe G-7
  • Finally giving some representation to China and
    other large emerging market countries,
  • after years of failed attempts in the IMF
    elsewhere
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