In few policy areas does good economics seem to conflict so dramatically with good politics as in the practice of subsidies to food and energy. Economics textbooks explain that these subsidies are lose-lose policies. In the political world that can sound like an ivory tower abstraction. But the issue of unaffordable subsidies happens to be front and center politically now, in a number of places around the world. Three major new leaders in particular are facing this challenge: Sisi in Egypt, Jokowi in Indonesia, and Modi in India.read more
I visited Korea earlier this summer and gave a talk on effects of U.S. Tapering on Emerging Markets. (This was also the subject of comments at an Istanbul conference sponsored by the NBER and the Central Bank of Turkey in June.)
An interview on the effects of policy at the Fed and other advanced-country central banks on East Asian EMs now appears in KRX magazine (in Korean), August. Here is the English version:
Special Interview with Jeffrey A. Frankel <KRX MAGAZINE> August
Q: On 10 June 2014, Federal Reserve Bank of Boston President Eric Rosengren said in a speech that the Fed’s “new” monetary policy tools, including forward guidance and large-scale asset purchases, were “essential” in ensuring the economic recovery in the United States. What do you think about the ‘ongoing’ U.S’s ‘Tapering’ policy? And what is your idea about appropriate “new” monetary policy?read more
A long-awaited reform of the International Monetary Fund has now been carelessly blocked by the US Congress. This decision is just the latest in a series of self-inflicted blows since the turn of the century that have needlessly undermined the claim of the United States to global leadership.
The IMF reform would have been an important step in updating the allocations of quotas among member countries. From the negative congressional reaction, one might infer that the US was being asked either to contribute more money or to give up some voting power. (Quotas allocations in the IMF determine both monetary contributions of the member states and their voting power.) But one would then be wrong. The agreement among the IMF members had been to allocate greater shares to China, India, Brazil and other Emerging Market countries, coming largely at the expense of European countries. The United States was neither to pay a higher budget share nor to lose its voting weight, which has always given it a unique veto power in the institution.read more
Most people know that the general trend in the dollar’s role as an international currency has been slowly downward since 1976. International use of the dollar as a currency in which to hold foreign exchange reserves, to denominate financial transactions, to invoice trade, and to serve as a vehicle for foreign exchange transactions is below where it was during the heyday of the Bretton Woods era (1945-1971). But few are aware of what the most recent numbers show. It is not hard to think of explanations for the downward trend. Since the time of the Vietnam War, US budget deficits, money creation, and current account deficits have often been high. Presumably as a result, the dollar has lost value in terms of other major currencies or in terms of purchasing power over goods. Meanwhile, the US share of global output has declined. Most recently, the disturbing willingness of some American congressmen in October to pursue a strategy that would have the Treasury default on legal obligations has led some observers to ask the natural question whether the dollar’s international currency status is now imperiled. Moreover some EM currencies are joining the list of international currencies for the first time. Indeed, some analysts have suggested that the Chinese yuan may rival the dollar as the leading international currency by the end of the decade! (Eichengreen, 2011; and Subramanian, 2011a, 2011b.) The trend in the dollar as an international currency has not been uniformly downward, however. Interestingly, the periods when the public is most concerned about the issue do not coincide well with the periods when the dollar’s share is in fact falling. By the criteria of international use as a reserve currency among central banks and as vehicle currency in foreign exchange markets, the most rapid declines took place during the intervals 1978-1991 and 2001-2010. (The yen and deutschemark were the rising currencies during the first period, and the euro during the second.) In between these two intervals, during the years 1992-2000, there was a clear reversal of the trend, notwithstanding a popular orgy of dollar declinism around the middle of that decade. Central banks held only an estimated 46% of their foreign exchange reserves in the form of dollars in 1992, but had returned to almost 70% by 2000. Subsequently, the long-term downward trend resumed. According to one estimate, the share in reserves declined from about 70% in 2001 to barely 60% in 2010 (Menzie Chinn). During the same decade, the dollar’s share in the foreign exchange market also declined: The currency constituted one side or the other in 90% of foreign exchange trading in 2001, but only 85% in 2010. The most recent statistics unexpectedly suggest that the dollar’s standing has again taken apause from its long-term decline. The International Monetary Fund reports that its share in foreign exchange reserves stopped declining in 2010 and has been flat since then. If anything, the share is up very slightly thus far in 2013 (COFER, IMF, Sept. 30, 2013). Similarly, the Bank for International Settlements reported in its recent triennial surveythat the dollar’s share in the world’s foreign exchange markets rose from 85% in 2010 to 87% in 2013 (preliminary global results). That the dollar has been holding up so well comes as a surprise, in light of dysfunctional US fiscal policy. Or maybe we should no longer be surprised. After all, when the global financial crisis erupted out of the American sub-prime mortgage mess in 2008, the reaction of global investors was to flee into the United States, not out. They clearly still regard the US Treasury bill market as the safe haven and the dollar as the top international currency. The explanation must be the one that is so often noted: the absence of good alternatives. In particular, the euro has its own all-to-obvious problems. Indeed the euro’s share of reserve holdings and its share of foreign exchange transactions have both fallen by several percentage points over the last three years (reserves from 28% of allocated reserves in 2009 and 26% in 2010, to 24% in the most recent 2013 figures; forex trading from 39% of transactions in 2010 to 33% in 2013). What about the vaunted yuan? According to the IMF statistics, it hasn’t yet broken into the ranks of the top seven currencies in terms of central bank reserve holdings. The top six are the US dollar and euro, followed by the yen and pound (the latter quietly reclaimed the number three position in 2006 and has been running neck-and-neck with the yen recently), and the Canadian dollar and Australian dollar (also running neck-and-neck). According to the BIS statistics, China’s currency has finally broken into the top ten in forex trading; but its share is only 2.2% of transactions. This is behind the Mexican peso at 2.5%, and still farther behind the Canadian dollar, Australian dollar and Swiss franc. (See Table 1 and Figures 2 & 3). Since 2.2% is much less than China’s share of world trade, it would be more accurate to say that the renminbi is becoming a normal currency than to say that it is becoming an international currency, let alone the top international currency.Despite recent moves by the Chinese government, the yuan still has a long way to go. Of the three kinds of attributes that a currency needs to become widely used internationally the yuan has two – size of the home economy and the ability to hold its value – but still lacks the third: deep, liquid, open financial markets. What might account for the recent stabilization of the dollar’s status? What do the last three years have in common with the preceding period of temporary reversal, 1992-2000? Both intervals saw striking improvements in the US budget deficit, both structural and overall. The federal deficit is now less than half what it was in 2009 or 2010; and the record deficits of the 1980s were converted into record surpluses by the end of the 1990s. Perhaps the fiscal observation is a coincidence. It would be foolish to read too much into two historical data points. It would be even more foolish to believe, just because American politicians have failed to dislodge the US dollar from its number one status over the last forty years, that they could not accomplish the job with another few decades of effort. Pound sterling had the top spot in the nineteenth century, only to be surpassed by the dollar in the first half of the twentieth century. It is not an eternal law of nature that the US currency shall always be number one. The day may come when the dollar too succumbs in its turn. But that day is not this day.
Figure 1: The share of the dollar in central banks’ foreign exchange reserves stopped its downward trend in 2010-2013
source: Menzie Chinn (2013), based on IMF’s COFER.
Table 1: The share of the dollar in global foreign exchange trading reversed its downward trend in 2010-2013
Source: Bank of International Settlements’ Triennial Central Bank Survey, Sept.2013.
Figures 2 and 3: The share of China’s yuan in foreign exchange trading is rising, but still ranks behind many other currenciesread more
On July 27 negotiators reached a compromise settlement in the world’s largest anti-dumping dispute, regarding Chinese exports of solar panels to the European Union. China agreed to constrain its exports to a minimum price and a maximum quantity. The solution is restrictive relative to the six-year trend of rapidly rising Chinese market share (which had reached 80% in Europe), and plummeting prices. But it is less severe than what had been the imminent alternative: EU tariffs on Chinese solar panels had been set to rise sharply on August 6, to 47.6%, as the result of a “finding” by the EU Trade Commissioner that China had been “dumping.” The threat of likely retaliation by China helped persuade the Europeans to back off from their determination to impose such high protective walls around their own solar panel industry.
The value of the yen has fallen sharply since November, owing to the monetary component of Japan’s efforts to jump-start its economy (“Abenomics”). Thus the issue of currency wars is expected to feature on the agenda at the G-8′s upcoming summit in Enniskillen, UK, June 17-18.
The phrase “currency wars” is catchy. But does it have genuine analytical content? It is another way of saying “competitive devaluation.” To use the language of IMF Article IV(1) iii, it is what happens when countries are “manipulating exchange rates…to gain an unfair competitive advantage over other members…” To use the language of the 1930s, this manipulation would be a kind of beggar-thy-neighbor policy, with each country seeking to shift net exports toward its own goods at the expense of its neighbors.read more
My preceding blog-post discussed the process whereby the undervalued renminbi and large Chinese trade surplus have begun to adjust in earnest, over the last three years.
The adjustment in the Chinese trade balance is reminiscent of Japan with a 30-year lag, like other aspects of the US-China relationshkp (though not all). Japan’s balance of trade in goods and services went into deficit in 2011, for the first time since 1980. Special factors have played a role in the last year, including high oil prices and the effects of the tsunami in March 2011. But the downward trend in the trade balance is clear. Even the current account temporarily showed a deficit in January. (Because Japan has long been the world’s largest creditor, a large surplus in investment income is usually enough to change any trade deficit into a surplus on the overall current account.)read more
The world is waiting to see whether China has successfully achieved a soft landing, slowing down the economy from its overheated state of a year ago to a more sustainable rate of growth. Some China-watchers fear it could hit the ground in a crash landing as have other Asian dragons before it. But others, particularly American politicians in this presidential election year, talk only about one thing: the trade balance.
Here the important message is that long-term forces of adjustment are at work in the Chinese economy. Foreign perceptions need to be adjusted as well. It is true that not long ago the yuan was substantially undervalued and China’s trade surpluses were very large. But the situation is changing.
China’s trade surplus peaked at $300 billion in 2008, and has been declining ever since. In fact it even reported a trade deficit in the month of February ($31 billion, its largest deficit since 1998). It is not hard to see what is going on. Ever since the Middle Kingdom rejoined the world economy three decades ago, its trading partners have been snapping up exports of manufacturing goods, because low Chinese wages made them super-competitive on world markets. It was known as the unbeatable “China price.” But in recent years, following the laws of economics, relative prices have adjusted to the demand.
The change can be captured by real exchange rate appreciation. This comprises in part nominal appreciation of the yuan against the dollar, and in part Chinese inflation. Government officials would have been better advised to let more of the real appreciation take the form of nominal appreciation (dollars per RMB). But since they didn’t, it has shown up as inflation instead. (See charts below, which show both nominal and real appreciation, against the dollar or against an index.)
The natural process was delayed. In the first place, as is well-known, the authorities intervened to keep the exchange virtually fixed against the dollar, in the years 1995-2005 and 2008-2010. In the second place, workers in China’s increasingly productive coastal factories were not paid their full value. The economy has not completed its transition from Mao to market, after all. As a result of these two delaying mechanisms, Chinese continued to undersell the world.
But then two things happened. First, the yuan was finally allowed to appreciate against the dollar during 2005-08 and 2010-11, by 25% cumulatively [=17% + 8%]. Second, and more importantly, labor shortages began to appear and Chinese workers at last began to win rapid wage increases. Major cities raised their minimum wages sharply over each of the last three years [FT, Jan. 5]: 22% on average in 2010 and 2011 (somewhat less this year, in response to slowing demand: 8.6 % in Beijing, 13% in Shenzhen and Shanghai). Meanwhile another cost of business, land prices, rose even more rapidly.
As a result, whereas all signs still pointed to a substantially undervalued yuan as recently as four or five years ago, this is no longer the case. One important measure of undervaluation — a comparison of China’s prices with what is normal given the country’s level of income (the so-called Balassa-Samuelson relationship) – showed the renminbi as undervalued against the dollar by as much as 36% on 2000 data (Frankel, 2005) . Even after an improvement in the international price data, Balassa-Samuelson regressions estimated the undervaluation at roughly 30% in 2005 and 25% as recently as 2009. (Others had other ways of estimating undervaluation; see Goldstein, 2004, and those surveyed by Cline and Williamson, 2008.)
The renminbi’s real appreciation against the dollar over the last three years has amounted to 12%, reducing the degree of undervaluation by roughly half, depending on whether one measures it against the dollar or against all countries. More is to be expected, as Chinese relative wages continue to rise. In any case, China’s real exchange rate is already closer to this measure of equilibrium than are most countries’ exchange rates (Cheung, Chinn and Fuji, 2010).
Emerging markets have performed amazingly well over the last seven years. They have outperformed the advanced industrialized countries in terms of economic growth, debt-to-GDP ratios, and countercyclical fiscal policy. Many now receive better assessments by rating agencies and financial markets than some of the advanced economies.
As 2012 begins, however, emerging markets may be due for a correction, triggered by a new wave of “risk off” behavior among investors. Will China experience a hard landing? Will a decline in commodity prices hit Latin America? Will the sovereign-debt woes of the European periphery spread to neighbors such as Turkey in a new “Aegean crisis”?read more
All of a sudden, the renminbi is being touted as the next big international currency. Just in the last year or two, the Chinese currency has begun to internationalize along a number of dimensions. RMB bank desposits are now available in Hong Kong. A RMB bond market has grown rapidly there as well, with the issuers including major multinationals such as McDonald’s. Some of China’s international trade is now invoiced in the currency. Foreign central banks have been able to hold RMB since August 2010, with Malaysia going first.read more