Fixing the exchange rate 1

Plan 1.Exchange rate and protectionism 2.International reserve currencies 2

Exchange rates & protectionism “Currency manipulator” ?? Should the WTO be involved in regulating the exchange rate? 3

Brazilian President Dilma Rousseff referred to unstable capital flows as a “liquidity tsunami” 11 Apr 2012: 4 Or are capital controls the solution?

Brazilian exports getting crushed by currency appreciation 5

Do trilemma solutions need to be compatible across countries? Brazil is complaining now Used to have a fixed XR Then East Asian Financial Crisis hit Currency value collapses under speculation (Dec 1998/ Jan 1999) MERCOSUR? Argentina’s exports become uncompetitive over night Argentina’s currency collapses in

Do the world’s 2 largest economies have compatible solutions to the trilemma? US “shock absorber”: –Floating exchange rate China opts for: –restrictions on capital flows –fixes its currency to the dollar How can the dollar adjust if China fixes to it? If this is the current monetary system… We’re all doomed 7

What can China do? Gradual appreciation? –A one-way road to “hot money” and a scary bubble A one-off revaluation? –Catastrophic economic dislocation –Politically possible given the export-oriented sector strength? Status quo? –Unsustainable in the long-run 8

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11 Complaints from Mexico But even as their currency appreciated, it was far below where it was before the crisis

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So, are global imbalances the fault of the United States? How can the US get away with running Current Account deficits year after year? Capital Account surpluses Why? Are we really a great place to invest? International Reserve Currency –The world has coordinated on the dollar 13

The Euro The ultimate commitment So, if it’s credible, will it overtake the dollar as the international reserve currency? 14

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Good Will Hunting SKYLAR: Maybe we could go out for coffee sometime? WILL: Great, or maybe we could go somewhere and just eat a bunch of caramels. SKYLAR: What? WILL: When you think about it, it's just as arbitrary as drinking coffee. SKYLAR: (laughs) Okay, sounds good. 16

Is the euro an alternative? Coordination game The NY meeting game… –The Dollar is “noon, Grand Central information booth” Present distribution of reserve currencies: –Dollar: ~60% –Euro: ~25% –Pound: ~4% –Yen: ~4% –Swiss franc: ~0.1% –Other: 5% 17

Obstacles A focal point: The more people who use an international currency, the more effective it is (increasing returns to scale) No equivalent to the US treasury the EU level Leadership – who do you trust? –US track record v. EU (…Greece?) 18

Is the renminbi an alternative? 19

Dollar retreats on stimulus speculation (4/9/2012) “The dollar continued its retreat against the yen yesterday … “after last week’s US employment data showing a slowdown in the pace of job creation stoked speculation about further stimulus measures to keep economic recovery on track.” Yen is a safe-haven And it’s killing Japanese exports 20

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Japan How would you describe the Japanese Diet? a)Low in poly-saturated fats b)A parliament 22

Japan’s Diet rejects central bank pick Japan’s parliament has rejected a government nominee to the policy board of the central bank, in a sign of tensions over the pace and scale of monetary easing needed to revive the world’s third-biggest economy. If the parliament selects the Prime Minister / Government, why would they reject the government? Bicameral! –House of Representatives –House of Councillors Both houses of parliament must approve nominees. The 4 biggest opposition groups have a combined 122 seats in the upper house (104 seats for the ruling Democratic Party of Japan). 23

24 Prime Minister Noda must enjoy the confidence of the House of Representatives to remain in office ?

Japan’s Diet rejects central bank pick The opposition-controlled House of Councillors on Thursday (4/5/2012) voted 127 to 111 against the appointment to the central bank’s highest decision- making body. The cabinet’s nomination... had been seen as a tacit endorsement of the bank’s basic view on the limitations of monetary policy in banishing Japan’s persistent state of deflation. In February the BoJ surprised markets by expanding its asset-purchasing programme - its key monetary policy tool, with interest rates near zero - while adopting an inflation “goal” of 1 per cent. AND: Last month “took various measures to ensure a smooth supply of funds for the nation’s small to medium-sized enterprises” BUT: “refrained from increasing asset purchases” Opposition view: "the BoJ has not done enough to spur a rebound in an economy that shrank in 3 of the past 4 years and continues to experience falling prices.“ “This is democracy in action,” said Robert Feldman, senior economist at Morgan Stanley MUFG Securities in Tokyo. “There’s a genuine policy debate going on right now about the role of the central bank in fighting deflation.” 25

Other “safe havens”? 26

27 Why have the Swiss been more successful in bringing down the franc than the Japanese have been in bringing down the yen?

Is the SDR an alternative? 28

Be careful what you wish for… Benefits of international reserve currency –finance fiscal deficits –enhance international prestige –debt denoted in your own currency Costs of international reserve currency –Monetary policy autonomy is hindered - vast quantities of your currency held abroad –Overvaluation leads to uncompetitive export- oriented/import-competing sectors 29

Take-homes on Euro Solves the old problem that the IMF failed to solve Still limited as a currency –No EU level bond Will it become the new international reserve currency? –Not any time soon –Coordination game –The Dollar is still “noon, Grand Central information booth” 30

Thank you WE ARE GLOBAL GEORGETOWN! 31