Currencies Aren't The Problem

Link: http://www.foreignaffairs.com/articles/67515/raghuram-g-rajan/currencies-arent-the-problem?page=show

Currencies Aren't The Problem

i.e. the long-term solutions to economic stability/resilience are all related to a country's domestic policy, and can't be achieved through exchange rates

(Opening Section)

The central bank declared that it would buy $600 billion in long-term Treasury bonds in an attempt to push down long-term interest rates.

Which would lead to (deflation?) devaluation of currency, increase in amount of dollars leaving U.S., decrease in imports/U.S. consumption, and increase in U.S. jobs (motivation)

China has continued to hold the yuan steady against the dollar

Japan intervened to prevent yen from rising too quickly

Intervention is zero-sum game: for one currency to depreciate, another has to appreciate

Question: are these same as currency depreciations in 1930's "race to the bottom"?

The relationship between currency depreciation and trade imbalance is... what?

exports		imports
INCREASE	(weak) depreciation undervalued	DECREASE
DECREASE	(strong) appreciation overvalued	INCREASE

Most countries today are not trying to gain a short-term advantage through currency actions; instead, they are following domestic economic policy strategies that have allowed them to grow easily in the past. For developed countries such as the United States, this has meant an emphasis on consumption; strategies in China and other emerging markets, meanwhile, have emphasized exports.

These strategies: lead to significant trade imbalances around the world

Sustained trade imbalances: lead to financial and political instability

If domestic policy does not change, trade imbalances will persist

(so... global economic stability is based on equal trade balances? this makes sense, since imbalances can't last forever... can't be sustained forever... and so aren't a good basis for long-term economic strategies)

Global stability not dependent on grand agreement between countries; dependent on sustainable domestic policy agendas

Goal of G-20 and IMF: don't coordinate policies among countries; instead, insert international dimension into domestic policy debates of countries

Easing Ain't Easy

not easy because easing currency that is tied inextricably to all other currencies...

Fed setting policy for whole world, can lead to negative repercussions elsewhere

i.e. what the author is really saying is that the U.S. should not rely on manipulating exchange rates, but should not rely on manipulating exchange rates, but should focus on domestic policy instead...

and this section explains why should not focus on exchange rates

exchange rates affect international price of that country's goods; by keeping currency undervalued, country's market share can be expanded; this is viewed as direct manipulation by governments

a country's currency weakens when it leaves that country

lower interest rates = increased domestic demands, more household/company spending

b/c dollar is worth more (this is confusing... this means we can produce more, which means we can export more, but why don't we import more? and why would it "take demand from other countries"?)

In the end, monetary easing does not simply take demand from other countries; it also creates demand overall. Monetary easing, of which quantitative easing is just an extreme form, is therefore typically viewed as a perfectly legitimate economic policy. But the circumstances under which the Fed embarked on the second round of quantitative easing made the move questionable.

point: interest rates were nearly 0; unlikely that corporations were not borrowing/households were not spending because interest rates were too high

other countries: quantitative easing would make dollar bonds unattractive, bond yields would fall below investor expectations (anticipating higher inflation)

this would cause capital to flee U.S. (thereby weakening dollar/lowering its value)

inflation relationship with interest? inflation = too much economic production...

lower interest rates put more purchasing power and borrowing power in consumers' hands, creating inflation; high interest rates limit consumers' purchasing and borrowing power

inflation can lead to economic growth, higher wages, more jobs

CPI (cons. price indx) = inflation indicator

result of quantitative easing was not what was expected... worries about eurozone debt, positive news about U.S. economy led to interest rates raising back up

The rest of the world worries that policy in the United States, with its two-year electoral cycle, is excessively focused on short-term growth and employment. U.S. politicians neglect the damage their policies do to the rest of the world and, in the long run, to the United States itself. (exorbitant privilege)

On the other side, the United States worries that too many countries have become dependent on it to buy their exports and have relied too much on purchasing U.S. financial assets, such as government and corporate bonds, to keep their currencies stable.

increasing and maintaining trade deficits, and leading to financial and political instability...

Although the Fed does not recognize it, it sets monetary policy not just for the United States but also for the world.

i.e. U.S. monetary policy imitated by other countries

this leads to problems, because policies good for the U.S. can be bad for other countries, lead to inflation/bubbles

over the medium/longer term, U.S. cannot continue to spend and spend and spend...

continually increasing spending will lead to other countries losing confidence in the U.S.'s ability to... continue spending?

they will then stop financing U.S. spending by buying U.S. financial assets

Gold Rush

the rush for U.S. gold led to Triffin dilemma: 1971 (wikipedia:Nixon shock), fixed conversion rate between dollars and gold was abandoned

post-WWII, US had strong economy, deep financial markets, large gold reserves

dollars very liquid (i.e. easy to convert to gold at a fixed rate)

today, private capital flows into US at much higher rates, so solutions are different between then and now

early 1960s: Robert Triffin: with everyone wanting dollars, US would eventually have to run large deficits and issue IOUs

Triffin dilemma: increased holdings of dollars around the world leads to decreased confidence in dollars (due to decreased confidence in liquidity of dollar, i.e. that US could provide set amt of gold for each dollar)

In [1971], the overhang of dollars outside the US became so large that the US had to abandon convertibility and the fixed gold price of $35 an ounce.

critics: exorbitant privilege: US was neglecting role in world monetary policy

US: currency undervaluation in France, Germany, Japan led to shrinking US trade surpluses

i.e. the Nixon shock led to a decrease in US exports, and led to the increase in US imports of French/German/Japanese goods

then: trade deficits small, world not dependent on US spending and on purchasing US financial assets

difference in private capital flows into richer countries don't come from governments/IMF/World Bank; come from private sources

Sick with Consumption

covers reason for high US spending (consumption)

fallout of increasing spending: increasing foreign dependence on US spending

growth strategies of export-oriented countries: reliant on US demand, rather than on domestic demand

US consumption increased from about 67 percent of GDP in the late 1990s to about 70 percent of GDP in 2007, financed largely with debt.