Currency Wars and (Macro) Competitiveness


With the cover page of the Economist [1] [2] worrying about currency wars, and various analysts arguing whether the US can or cannot win such a “war” (see Naked Capitalism for a discussion), I thought it would be useful to see where we now stand, in terms of “competitiveness”, as understood by open economy macroeconomists.


Open economy macroeconomists typically defined competitiveness as the relative price of traded goods. Below, I’ve plotted the trade weighted value of the dollar against a broad basket of currencies in nominal (blue) and real (CPI deflated) terms (red), as measured by the Federal Reserve. Notice that by this definition, “up” is an appreciation.


Figure 1: Nominal trade weighted value of the US dollar against a broad basket of currencies (blue), and real, CPI-deflated (red). Blue square is for 10/15 observation. An appreciation is denoted by an upward movement. Source: Federal Reserve Board.

What is interesting is that the dollar is weakening against other currencies, including the East Asian currencies. (For calculations regarding the Chinese yuan, see here.) Much of the depreciation has occurred as talk of QE2 has mounted.

The CPI-deflated value of the dollar has also depreciated. It’s important to note that, as I discussed here [paper], the CPI might not be the most appropriate deflator, since it includes many nontradable goods and services; and in fact there is a theory which states that real exchange rates should appreciate over time as productivity rises relative to partner countries (see [3] [4]).

One might be more interested in the cost of produced goods, as opposed to price (see for instance this paper by Golub, as well as this paper). This suggests the use of unit labor cost deflated real exchange rates. In Figure 2, I plot the ULC deflated value of the dollar.


Figure 2: Log real (CPI-deflated) trade weighted value of the US dollar against a broad basket of currencies, from IMF (blue), log real, CPI-deflated from Federal Reserve (red), and log unit labor cost deflated from IMF (green). (1) the ULC deflated series pertains to industrial countries. (2) An appreciation is denoted by an upward movement. Source: Federal Reserve Board, IMF, International Financial Statistics.

Note because it is difficult to obtain ULCs for many emerging market economies on a timely basis, the ULC-deflated index pertains to a narrow basket of currencies, excluding China. This limits the usefulness of the measure, but one can still see how US productivity and wage trends affect the index. Arguments that high labor costs have made US goods uncompetitive (at least relative to a couple years ago) seem unjustified. (One caveat: as pointed out in this post, divisia indices potentially miss out on big level effects.

Limits to Expenditure Switching

I find it interesting that some people have argued that a depreciating currency will not have a large impact on US output. I tend to agree, but arguments based on low price elasticities of trade (as in this post), do not seem entirely convincing to me. In the past, I would have agreed that US trade (particularly import) elasticities with respect to the real exchange rate are low [5]. However, my more recent estimates, based on data going through 2010Q2, indicate the long run elasticity of exports is close to unity, suggesting scope for substantial impact from dollar depreciation [6] [paper].

Just because the US dollar has depreciated does not mean that we can necessarily “win” the currency wars. In fact, I’m not sure what “winning” means in this context. In particular, Barry Eichengreen notes that a far better way to stimulate economies would be in a coordinated fashion, with transparent declarations of what quantitative easing means and goals would be.

On the other hand, I do think the US can influence the US dollar real exchange rate even if other countries (including China) are less than willing to cooperate. Paul Krugman has observed that quantitative easing that involves further purchases of short term Treasury debt will have limited impact on exchange rates given the high substitutability of money and (short term) bonds at the zero interest bound. I have two observations: (i) if long term bonds are purchased, then quantitative easing/credit easing should have an impact, given the lower degree of substitutability. (ii) while no countries are on a classical gold standard right now (in contrast to the interwar years), if quantitative easing leads to more inflation than would otherwise occur, that would induce more rapid depreciation of the dollar. Of course, (ii) incorporates a big “if”.

The Fed has another tool, which it is unlikely to fully utilize, that could have a big impact on the dollar — namely changing the interest rate paid on reserves. That rate influences the money multiplier that links money base to the money supply. And I think few doubt that an expansion of the money supply has an impact on the exchange rate.

A cooperative solution to monetary policy (and macro policy coordination) [7] is clearly more desirable than a noncooperative solution. But in the absence of that, there are actions that can be undertaken to improve the US situation.

Update 9:10pm More on QE2 and currency wars from Alan Taylor, Manoj Pradhan and Joachim Fels in a Morgan Stanley note discussed here. PIIE’s Arvind Subramanian thinks the US alone cannot win the currency war.

The quantitative impact of QE2 depends on the magnitude of the purchases. Chris Neely’s results, discussed in this post, is summarized thusly in a recent Deutsche Bank Global Economic Prospects:

…the St Louis Fed has calculated that a
total of $1.725trn asset purchases resulted in an
accumulated decline in the dollar of 6.5%. On this basis,
a $1 trn purchase of Treasuries might therefore cause the
dollar to decline by 4%. …(Peter Hooper and Torsten Slok, September 29, 2010)

The Neely results are contained in this paper.

31 thoughts on “Currency Wars and (Macro) Competitiveness

  1. Jeff

    I agree with everything in this post. I would only add that people who are upset with the yuan exchange rate should take note that Chinese inflation is picking up, particularly in asset prices. If QE2 is big and effective, the dollar-yuan peg will create even more Chinese inflation. I predict they will give up on the peg, but either way, their real exchange rate rises.

  2. Cedric Regula

    China says “Move along..nothing to see here..”
    U.S. officials are hopeful that China, which projects that its current-account surplus will hover around 4% of gross domestic product in the next few years, will go along. But a spokesman for the Chinese Ministry of Commerce, Yao Jian, said last week, “Other countries have no right to comment on what is a reasonable level for a country’s trade surplus.”
    So the currency war will be confined to G7 countries, and ultimately resolved by the Eurozone and Japan dusting off Smoot-Hawley and translating it into their respective languages.
    The BRICSs will be content with taxing dollar flight from the US.
    All US farm and ranch production leaves the country. The US redevelops it’s horse production base as the solution to $10 gasoline prices. GM closes down US production to focus on it’s China operations. Ford launches a horse farm in Mexico.
    Ok, so we have a plan.

  3. ppcm

    G20 may try to define currencies value.Prior to do so, define the worthiness of the currencies markets.
    World GDP around 45/46 trillion usd
    Total debts in Europe ~15 trillion euros and yet
    Through the prism of currency markets share London is dwarfing New York
    Trade in currencies vs trade of goods and services
    BIS is providing for comprehensive statistics data on the global foreign exchange market
    London (UK) is the most active center in foreign exchange as it would handle 46% of the daily turn over in currencies 1.853 trillion USD
    New york (USA) seems to have lost the currency market war with only 904 billion usd daily
    The hereunder figures may give more perspective on added value products in the trade of goods and sercices war.
    Trade in good and services source Bloomberg
    Trade Goal
    Cameron said he wants to double U.K. trade with Turkey, currently $9 billion a year, over the next five years.
    “We cannot let the protectionists win,” he said. “The truth is that trade is the biggest wealth creator we’ve ever known, and it’s the biggest stimulus we can give our economies right now
    Naked capitalism isnt it?

  4. don

    MC: “Paul Krugman has observed that quantitative easing that involves further purchases of short term Treasury debt will have limited impact on exchange rates given the high substitutability of money and (short term) bonds at the zero interest bound.”
    The statement “QE that involves further purchases of short term Treasury debt” confuses me. I thought “QE” meant purchases of longer term debt.
    MC: “I have two observations: (i) if long term bonds are purchased, then quantitative easing/credit easing should have an impact, given the lower degree of substitutability.”
    But PK agrees.
    PK: “It would be different if the central banks acquired long-term assets instead; then we’re talking about quantitative easing through the back door. But I see no reason to believe that central banks reluctant to buy domestic long-term debt will be more willing to buy foreign long-term debt.”

  5. rayllove

    Brazil’s real has risen 30% against the dollar these past few months. This is the largest divergence that I know of but now that the Brazilians have protected their bond and equity markets with capital controls the carry-trade dollars that are causing the real to rise are likely to go elsewhere. South Korea now also has capital controls along with Thailand; and, other nations, including India and Indonesia, have announced intentions to put similar protections in place.
    In other words, artificially low interest rates and QE by the USA and the UK, and Japan’s efforts to devalue the yen, are causing many currencies to rise against the major currencies. But this is the result of carry trades which occur as a result of dollars or yen being converted into reals etc. so as to invest accordingly. This means that the laws of supply and demand regarding currencies are being artificially swayed by excess liquidity that has become a counterproductive ploy that benefits only speculators. This will of course make exports from these nations rise in price and it therefore seems very likely that price inflation on a global scale will follow, but… with little chance for wage inflation as the competition for exports intensifies. That is to say that wealth distribution will worsen globally.
    But of course the citizens of the developed nations, especially the USA, will maybe, perhaps, be able once again to over-consume and continue enlarging their carbon footprints. This, assuming that they can produce competitive exports.
    On the positive side, it will be obvious whether QE2 works or not, when it is all said and done, that the USA will have attempted to devalue its currency while criticizing China for similar tricks, (with Japan using the same type of political hypocrisy on South Korea), showing that a depreciating dollar will have shifted some of cost of the recent downturn from the USA to those foreigners who have savings in dollar related assets. And this is a positive thing because in retrospect it will matter very little if the trade imbalance issues are improved upon, that can only drive up costs as production shifts from nations with low labor/burden costs to those with higher such costs; so it isn’t as if any major improvement is possible regarding human progress, but it will be perfectly obvious that the USA failed to take responsibility for its faulty governance of both domestic and global affairs. And this should be enough evidence that the political ineptitude that has become all encompassing has created a Corporatist/Investor Tyranny that must be brought under control. Ironically, it may well be that the emerging nations, the ones just finally starting to show some progress after hundreds of years of being victims of imperialism, that can right some of the historical wrongs by disregarding the WTO provisions by their imposing of capital controls. This disregard, combined with the long standing disregard for the WTO’s purpose by the developed nations, will finally make it unanimous that the WTO was never anything more than a corrupt institution from the start. And this unanimous disregard has caused a deterioration of the WTO that has lead to nearly all of the emerging nations following China’s lead in regards to the protection of their currencies. This will make the argument that the Chinese have been the global wrongdoers increasingly less credible. Ultimately, the truth does have a way of coming out.

  6. Kien

    Dear Professor – what if the US raises the withholding tax rate on interest earned by foreigners from US dollar denominated financial assets? This could discourage foreign purchases of US dollar financial assets, including via secondary markets. Would this be a third way to “win” the currency war?

  7. Menzie Chinn

    don: I don’t think QE is a fixed term. One could undertake QE (increasing the money base) by buying short term debt. That’s why I prefer credit easing as a description, which entails purchases of long term debt and non-Treasury assets (e.g., MBS’s), presumably while increasing the money base.

    I thought Professor Krugman was discussing purchases of foreign long term debt as an option. Perhaps I misunderstood Professor Krugman; if so, I am happy to be in agreement with him.

    Rayllove: I’m not sure I understand — but in any case I think moralistic arguments about right and wrong are not the most productive way to proceed in this debate.

    Kien: I assume that if the US raises the withholding tax rate, and agents are not able to arbitrage their way around those higher tax rates, then this would indeed make US assets less desirable and would weaken the dollar, cet. par.

  8. Matthew

    Is there a mechanism by which Chinese actions can increase the value of the dollar? I mean we know that US actions reduce the value of the yuan, as the yuan is tied to the dollar. But can the reverse work? For example, the Chinese interest rate rise saw the dollar increase, most explain by markets seeing it as the firing shot of a ‘grand bargain’. But could it simply be that these two countries now form one monetary bloc, and so China can pull the US up, not just the US dragging China down?
    Or does the yuan’s lack of convertibility, small capital markets etc prevent it being two-way?

  9. isaac

    if winning currencies war is so important an transmission mechanism for FED to reflate, why not just ask treasury to do unsterilized FX intervention; create 1trillion USD worth of foreign reserve ?
    in my view, this will be really currency war and permanently change the landscape of FX market

  10. Kien

    Thank you Professor. US withholding tax seems to apply to all interest income paid by a US resident to a non-resident ( However, I think it may not apply to interest earned on US dollars held outside the US. Also, I am not entirely sure whether Double Tax Agreements may prevent the US from unilaterally varying the tax rate. My guess is that each party is free to revise the tax rate by giving due notice, but I’m not a tax expert.

  11. Ricardo

    I have recently been doing some research on the inter-war period (WWI-WWII). During this time there were many economic declines in most countries of the world, but what is most interesting is that countries the began to consider leaving the gold standard fell into decline. Countries that returned to a stable currency and a gold standard saw surprising recoveries. France and Germany are great examples. Both countries strengthened their currencies and escaped huge inflations (franc going from pre-WWI 4:1 dollar to 50:1, and I don’t think I need to mention German inflation).
    The one country that never really recovered was the UK. The currency was always undervalued as indicated by huge gold out-flows. Norman, rather than deal with British monetary problems, ran whining to Ben Strong to pull his but out of the fire. Finally, at the end of his life Strong saw the error of his enabling Norman and would not even talk to him, but it was too late. The seeds of destruction were alread sewn.
    What does all this have to do with today. The weak and weakening dollar has pulled the US down just like the weakening pound pulled down the UK. It doesn’t happen over night, but the signd and direction are clear if you simply open your eyes and not amount of rationalization and pontification will change reality.

  12. ppcm

    Bloomberg is reporting today of the current proposal made at the G20
    Focus on the current accounts and this is a fair and the most homeopathic therapy approach not only worldwide,but within the Eurozone.
    Current accounts imbalances are unsustainable, they are drivers of the next crisis through government debts default.
    Geithner Push for Current Account Targets Splits G-20 Nations Bloomberg

  13. rayllove

    The Japanese have been accusing the S. Koreans of currency manipulation in much the same vein that the USA has been accusing China of foul play. The Koreans have a saying that goes:
    “When I do it, it is true love, when you do it is adultery”.
    Of course most Americans would prefer to ignore the moral aspects of this issue. But the rest of the world has a different opinion:
    Investors blame US for currency woes October 14, 2010 Ads by GoogleTradeStation
    Australian investors blame the US for a looming currency crisis that threatens to turn into a trade war with China.
    An Investor Pulse survey conducted by Colmar Brunton and BusinessDay shows 46 per cent of shareholders agree that the US Federal Reserve’s expected move to resume “quantitative easing” (printing money) early next month is a move to deliberately devalue its dollar.
    Only 23 per cent of investors surveyed blame the Chinese policy of pegging its currency, the yuan, to the US dollar and for ignoring a request from the US to allow the yuan to appreciate quickly on the basis that it is artificially keeping its currency devalued to make its exports cheaper.
    The current meet in Korea is the one big opportunity that the emerging nations have to get a seat at the table. The G-20 construct was in fact created because the Doha Round came to an impasse and so the G-20 came as a conciliatory offering to smooth over the failure of the WTO to make ‘any’ progress on trade issues these past 15 years or so. Yet Brazil’s Finance Minister, Guido Mantega, has chosen not to attend the current meeting. Mantega has been tacit as to why, but other finance ministers from emerging nations have said that these meetings are mostly just a waste of time and every person in the world who follows international politics knows why these people are frustrated: US hegemony. So pretending that morality is not at the center of global issues is delusional.
    The following is M. Hudson from an article in the FT on the 19th, (the South Koreans imposed capital controls on the 20th. Brazil raised their tax on foreign purchases of bonds to 6% on the 18th and on the 19th they announced that controls on equities were to follow). Economists do not of course make forecasts, but Hudson is once again ahead of the game:
    The real threat is a world broken into two competing financial blocs, one centred on the dollar, the other on the Bric nations of Brazil, Russia, India and China. Tentative steps in this direction occurred last year when China, India and Russia, along with Iran and members of the Shanghai Co-operation Organisation took early steps to use their own currencies for trade, rather than the dollar. China took a simpler path last month when it supported a Russian proposal to start direct trading using the renminbi and the rouble. It negotiated similar deals with Brazil and Turkey.
    To deter this the US and Japan should refrain from QE2, even at the cost of lower US growth. An even better response, however, would be new regulations stopping western banks from speculating in foreign currencies, by using heavier reserve requirements or a short-term tax on foreign currency trades and options. Without such steps other countries will soon move to protect their currencies. If they do it will have been US policy short-sightedness, conducted without concern for its effect on developing economies, that will ultimately have isolated the dollar and its users.
    ” Without such steps other countries will soon move to protect their currencies.” The word “soon” suggests that Professor Hudson wrote this a day or two before it was published. Thailand, Brazil, S. Korea, and Indonesia have already ‘moved’, and India has stated intentions to do the same. If the meetings in Korea do not bring about a solution, all of the emerging nations will very probably be ‘moving’.

  14. jonathan

    Terrific post. Thank you.
    Turns out that talking about inflation expectations has a tendency to affect expectations, at least as those translate into currency value.
    As to currency wars, isn’t the idea to avoid one? There is a range of action any country can take, the US included, which is aggressive but which is not war-inducing. People fear cascades of action and reaction but I think they’re influenced by the outsized memory of the few times that actually happens.

  15. rayllove

    Nouriel Roubini:
    The next stage of these wars is more quantitative easing, or QE2. The BoJ has already announced it, the Bank of England (BoE) is likely to do so soon, and the Fed will certainly announce it at its November meeting. In principle, there is little difference between monetary easing – lower policy rates or more QE – that leads to currency weakening and direct intervention in currency markets to achieve the same goal. In fact, quantitative easing is a more effective tool to weaken a currency, as foreign exchange intervention is usually sterilized.
    Expectations of aggressive QE by the Fed have already weakened the dollar and raised serious concerns in Europe, emerging markets, and Japan. Indeed, though the US pretends not to intervene to weaken the dollar, it is actively doing precisely that via more QE.
    The following is from Chatham House in London:
    ‘Currency Wars’: the US should take the lead to stop the race to the bottom
    Thursday 21 Oct 2010 by Dr Paola Subacchi, Research Director, International Economics
    As rhetoric on ‘currency wars’ heats up, escalating tensions between the US and China are casting a shadow over the world economy. Yet we must be clear on one point. No matter whether or not China is free riding on the exchange rate, the threat of a full-scale currency war will be defused only if the US takes the lead in promoting international exchange rate coordination and acts responsibly to prevent any rise of protectionism. Since the dollar is the key reserve currency, the US sets the pace on currency issues. South Korea, the host of this year’s G20, is unlikely to put exchange rate coordination on the Seoul summit agenda in November unless the US is willing. The US should seize the opportunity to set a positive role model and defuse the undoubted protectionist threats overhanging the world economy.
    This agenda clearly extends to the issue of quantitative easing, where it seems almost a foregone conclusion that the Federal Reserve will resort to a new round of Treasury securities purchases in early November. European as well as Asian governments and central banks will be watching closely for signs that America is moving over-aggressively in a deliberate ploy to force the dollar down further – a policy that the US of course denies it is following.
    World economic uncertainty is irrefutably increasing as a result of countries’ measures to use the exchange rate to rebalance their domestic economies. Domestic interests seem to be increasingly at odds with the goal of reducing global financial imbalances.
    My only point is that US citizens need to know more about what is actually happening. The US guv/MSM/corporate line regarding China’s manipulations being the cause of these ‘currency wars’ is losing ground on a daily basis and to the point it is becoming laughable outside of the USA.

  16. Cezmi Dispinar

    What is the most important price after the interest rate in an open economy?
    Exchange rate between the currencies.
    Why don’t we have a monetary system by the nominal exchange rate, which are largely supposed to follow the inflation differentials of the countries?
    Is not it speculation in the foreign exchange markets which account for a massive distortion of the international trade (flows)?

  17. tc

    A good read from Andy Xie
    QE: The Numberless Oblivion
    The stimulus has failed.
    How should one interpret the result? If you were Paul Krugman, you would say it wasn’t enough. Of course, if 20 percent of GDP in budget deficit and another round of QE still don’t work, he would say not enough again. You can never prove Krugman wrong. Such a smart fellow.
    The second interpretation is that it takes time for the economy to heal. No economy recovers so quickly after a bubble that big. During this prolonged and massive bubble, resources have become so misallocated that it takes time for regeneration. In particular, when the labor market is misallocated, it just can’t correct itself quickly. Hence, when an economy is in a misallocated state, a stimulus kicks up growth through its own power but can’t get the multiplier effect for the economy to sustain growth beyond.
    The third interpretation is that it’s China’s fault. Yes, China’s exports to the U.S. rose sharply during its stimulus-inspired pickup, i.e., the stimulus partly went to China. But, whose fault is it? Apple makes all the iPhones in China, because it costs under US$ 20 each, even after the massive wage increase for Chinese workers. Apple’s gross margins are 30 times the processing cost that goes to China. Maybe Apple is an extreme example. But, the fact is that China’s exports to the US are American goods that retail for 3-4 times of the factory-gate prices. American companies want to make the goods in China to satisfy the stimulus-inspired demand.

  18. don

    To argue that QE (by which I mean central bank purchases of longer term debt under conditions of a liquidity trap) is equivalent to currency intervention, one must argue (implicitly) that QE is ineffective in increasing the domestic demand other than through the effect on exchange rates. I have been a bit inconsistent (OK, not just ‘a bit,’ totally) by arguing that the only practical effect of QE is through the exchange rate and at the same time arguing that China’s policy of currency purchases is more objectionable.
    Mea Culpa
    I’ll go do my penance now.
    Menzie – the prior abbreviated post was a case of thick fingers – please ignore.

  19. Duffman

    The United States spends $1,300,000,000,000 MORE than it earns and over 60% of this must be funded by borrowing overseas. How long can the Print and Spend fest continue before the money stops flowing in?

  20. rayllove

    It is folly to think that morality is not inherent in economics, and inescapably so. Economists have however been trying to feign objectivity all along.
    For example, the objective (alleged) view of the issue at hand, claims that, as a matter of fact, “a total of $1.725trn asset purchases resulted in an accumulated decline in the dollar of 6.5%”, but, aside from the fact that there were many other factors at work, factors being ignored, there is what might be called a subjective view of that same depreciation. That would be the view from the other side of the same equation during the same time period. Looking for instance at the 30% rise in the Brazilian real and the other accumulated appreciation of other currencies, that were, in aggregate, required to sway the overwhelming weight of the dollar downward. And of course it is on this side of the equation that the moral issues are integral and apparent. That being rather easily understood by how a fairly innocuous 4% in one economy results in volatility that is represented by the figure of 30% in another economy, and so on.
    From the subjective side it therefore becomes obvious that smaller economies are sacrificing gains so as to prop up the very economy that is responsible for the shortfalls in the first place. Naturally, as the dollar depreciates the bulk of global savings become less valuable. And, as the emerging nations export less due to their currencies appreciating, the prices of global goods and services and goods must rise. So, what this currency shift comes down to is a devaluation of debt. It is obviously the US using its muscles to push some of the responsibility for its lack of competent governance on to those who are the most productive. On to nations that are in fact the ones making the most progress regarding poverty and the ills left by hundreds of years of colonialism.
    If the progress that China is making on poverty is removed from the global equation, global poverty is worsening even with the ridiculously low standard at $1.25. Take India’s and Brazil’s progress on poverty out of the equation, and that which remains is a dismal display of what happens when the citizens of the developed nations are allowed to dictate what is morally justifiable by the standards that they have deemed applicable. And this is not possible without economists providing the statistical analysis from the ‘objective’ perspective.

  21. rayllove

    The following is not major news, but, this was ignored by the MSM and yet worth noting:
    By Agence France-Presse, Updated: 10/21/2010
    Indonesia finance minister adds to G20 absentee list
    Indonesian Finance Minister Agus Martowardojo will not be attending this weekend’s G20 meeting in South Korea, an official said Thursday without giving a reason.
    The announcement comes after Brazil’s finance minister, who has accused the world’s leading nations of waging a “currency war”, also said he would not be at the talks.
    “The Finance Minister will not be attending the G20 meeting in Seoul. The Secretary General of the ministry, Mulia Nasution, will replace him,” finance ministry spokesman Yudi Pramudi told AFP.

  22. rayllove

    The text to follow was originally published in the ‘CHINA DAILY’:
    BEIJING, Oct. 20 (Xinhuanet) — The world’s largest debtor is using dollar dominance and debts to suck the wealth from emerging economies.
    In a drummed-up currency war, in which China is viewed as the main target, the United States once again revealed its desire to promote the redistribution of global wealth to its own advantage.
    A currency war is in essence a financial war, or a war for more wealth possession, one in which the country that has the dominant say in world’s currency issuance will gain an absolutely advantageous position in global wealth distribution.
    The US has long skillfully exercised financial policies characterized as “economic egoism”. The world’s sole superpower has been depending on the inundating issuance of the dollar and its national debts to be the two major engines that sustain its economic growth. As a result, the Dollar Standard System has evolved into a kind of “debt standard system” to the US’ advantage.
    A typical example is Washington’s attitude toward its bulging fiscal debts. To defuse its astronomical government financial debt, which increased to $12 trillion in 2009, or 82.5 percent of its gross domestic product the same year, the US Federal Reserve adopted a Quantitative Easing Monetary Policy in the hope of expanding the country’s balance sheet and monetizing its fiscal deficits, so as to reduce its debt-holding costs. In this sense, inflation is likely to cause no panic among US decision-makers. On the contrary, Washington will no doubt prove to be the largest beneficiary of the fiscal war it has started.
    China and other emerging economies, however, will be the victims of this well-designed US “zero-sum” game. Due to their faster economic recovery amid the global economic slowdown, international floating capital has swarmed into emerging economies on a larger scale and at a faster speed than it did before the global financial crisis. It is estimated that from April 2009 to the end of June 2010, the amount of international financial capital that flowed into the world’s 20 leading emerging economies reached $575 billion, and more than half of that went to emerging Asian markets. The large-scale inflow of international liquid capital has increased pressure for the recipients to appreciate their currencies and has sown the seeds for inflation.
    The complete article is here:

  23. don

    So, to clarify further, IMO QE will do little outside of causing dollar depreciation and perhaps support asset prices. (PK appears to agree in his post today. It would be hard to dispute an effect on the exchange rate, given the recent plunge in the dollar in clear anticipation of QE.) So I think Bens’ QE is little better than currency manipulation, another example of policy to please the people in the short run, rather than benefit them over the long run. However, this does not excuse past currency purchases abroad, nor does it refute the notion that such purchases were the first cause of the housing bubble. (I know our host favors the notion that U.S. capital inflows were drawn in by irresponsible fiscal behavior rather than forced in by currency purchases abroad – I respectfully disagree.)
    Timmy is now arguing, in effect, that each country has a right to its own AD in the current world of AD shortage. Germany and China disagree vehemently. In ordinary times, capital inflows enrich the home country (this is old estblished theory, going back to MacDougal’s seminal piece). In the current situation, however (with excess desired savings globally), they impoverish the home country (they are like a negative fiscal stimulus). China’s policies remain the most objectionable IMO, as they literally force government-encouraged savings on ROW through currency purchases combined with capital controls. My solution would be strict sanctions on such behavior, instead of QE. PK clearly agrees with the sanctions bit, at least (recall he said the Levin bill was a step in the right direction). This would not bring prosperity, but the attendant adjustments need to be started sometime, and although I don’t think conditions are ideal now, I also don’t think they will be better anytime soon.

  24. rayllove

    It is interesting, and telling, that the concern about the harm being done by the combination of QE and low interest rates in the developed nations, was not mentioned in the MSM coverage. US citizens have very little chance of understanding these issues and yet they have more influence over global issues than any other population. Geithner’s spin team did their jobs well.

  25. Ivars

    The world is deco-operating and will continue to do so over next 5 years in more and more drastic ways. To much cooperation led to bubble and following crisis, so this reaction is just natural, if not always conscious.

  26. isaac

    German finance minister is blunt” Excess and permanent money creation , is indirect exchange rate manipulation” ,

  27. rayllove

    When Geithner left for Korea his stance was that QE etc. does not have a depreciating influence the dollar. But in the official statement at the meeting’s close there was a consideration mentioned that was essentially a promise not to use excessive QE etc. to depreciate currencies. But no mention by the MSM about the rather obvious reversal by Geithner required for this to occur. Yet the most pressing issue of the accord, that which was prompting nations to impose capital controls, which are what the ‘lending nations’ have been guarding against for decades, was almost entirely ignored.

  28. anon
    Chinese vice premier talks economy with U.S. treasury secretary 2010-10-24 15:27:55
    “….The U.S. congress, appalled by the country’s large trade imbalances, is preparing to “shoot the messenger” through a punitive bill targeting China, Hossein Askari and Noureddine Krichene wrote in Who’s the Currency Manipulator on the Asia Times online.
    The two writers, respectively a professor of international business and international affairs at George Washington University and an economist, said: “The US trade imbalances are the result of the Fed’s unrestricted credit policy and fiscal deficits and have little to do with China, Japan, or any other country.”
    They further said the present unorthodox credit policy could only worsen trade imbalances and unemployment, regardless of the bills adopted by the US Congress targeting China.
    This month has seen frequent high-level discussions between China and the U.S. on the economy. Wang Qishan, himself, held phone conversations last Friday with Timothy Geithner to exchange opinions on issues concerning China-U.S. economic relations. Wang also met with Senator Max Baucus, chairman of the U.S. Senate Finance Committee, and Madeleine Albright, former U.S. Secretary of State, earlier October.

  29. don

    Subramanian’s arguments don’t seem to meet the ground on all four. It seems he is saying the U.S. cannot win a unilateral currency war with China, because it doesn’t have the will. He points to weak U.S. measures so far and possible Chinese retaliations. As to the latter, I would agree with Krugman that China is “holding an uiloaded water pistol to our head” (unless the U.S. concedes on the basis of ‘strategic global interests.’ But why, for example, should the U.S. bear the primary burden of concerns over North Korea?) His arguments for why U.S. business is ambibalent are opaque (business is ambivalent “because capital is mobile and can escape the effects of undervaluation?” How about business opposes yuan revaluation because multinationals like Nike and Apple can pay wages in undervalued yuan and sell their products for dollars and euros?)

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