What s up with the exchange rate
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What’s Up with the Exchange Rate? . Andrew K. Rose UC Berkeley, NBER and CEPR. The Basic Long-Run Issue. America’s Current Account Deficit 2006: $811.5 billion deficit (!) 6.2% of American GDP Implies annual Capital Inflows of $2700 per person annually (!)

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What’s Up with the Exchange Rate? 

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What s up with the exchange rate

What’s Up with the Exchange Rate? 

Andrew K. Rose

UC Berkeley, NBER and CEPR


The basic long run issue

The Basic Long-Run Issue

  • America’s Current Account Deficit

    • 2006: $811.5 billion deficit (!)

      • 6.2% of American GDP

      • Implies annual Capital Inflows of $2700 per person annually (!)

    • 2007Q1: deficit of $192.6 billion

    • Almost all Goods (Services in surplus but small)

      • Small persistent income surplus

Exchange Rates


Causes

Causes

  • Some Dispute among Economists

  • Still, Low American Savings chief reason

    • Personal Savings very low lately, often negative

    • Public Sector also dis-saving (Federal deficits)

  • Lack of Investment outside US also possible issue

Exchange Rates


Current account sustainable

Current Account: Sustainable?

  • Size of Deficit unprecedented for America

  • Also unprecedented for “Anchor” country

  • US now taking over 75% of all global savings flows

  • Capital running “uphill” from poor to rich (!)

  • Growing US external debt

Exchange Rates


Adjustment must involve prices

Adjustment must involve Prices

  • For current account to close, savings must rise (or investment fall, or both)

  • Symmetrically, exports must rise dramatically, while import growth slows

  • Exchange Rate one of the key adjustment mechanisms

  • So long-run depreciation of Dollar is likely

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How much

How Much?

  • Many Different Estimates, Little Consensus

  • Most expect at least another 15-25%, sometimes more

  • Exchange Rates often overshoot

  • Timing: almost impossible

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Where will effects be felt

Where will Effects be Felt?

  • Three Big Currency Zones in World:

    • Dollar, Asian-zone, Europeans

    • But exchange rate policy varies across world

  • Dollar floats freely against Many Currencies

    • Europeans (including UK, Norway)

    • Also Canada, NZ, Australia, etc

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But asia is different

But Asia is Different

  • Asians take Exchange Rate Policy Seriously

  • Almost all East Asians manage currencies, will continue to do so

  • Part a Legacy of Asian Crisis of ’97-’98

  • Part a Development Strategy …

    • Which Leads us to China

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How to think about the yuan

How to Think about the Yuan?

  • Chinese Communist Party Needs Growth to Survive Politically

    • Growth is Required to Absorb Massive Unemployment in Chinese Countryside

  • Agricultural Peasants Must Be Transformed

    Into Manufacturing Workers

    • Exports Provide Only Possible Outlet

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Asian paradigm for development

Asian Paradigm for Development

  • Competitive (Cheap) Unemployed Labor Absorbed into Manufactured Sector

    • Example of key theory of W.A.Lewis (Nobel Laureate)

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Implications for west

Implications for West

  • China has every incentive to maintain under-valued exchange rate

    • Under-valuation the key to rapid export growth

    • Right in theory

    • Effective in practice (past twenty years!)

    • Hence rapid accumulation of US$ reserves, as China maintains under-valued peg to US

    • Reserves act as “collateral”, encourage FDI

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Special role of usa

Special Role of USA

  • US is issuer of $, global reserve currency

  • East Asians fixes against US$

  • US is largest, most open economy

  • US willing to handle large, persistent current account deficits

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Special role of usa contd

Special Role of USA, contd

  • American FDI high in Asia

    • High Returns on Asian Investments help protect against American Protectionism

    • China Importing Financial Services, since Domestic Financial Sector Weak

    • US also premier provider of collateral service (hence Asian pegs against $)

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Where does europe fit in

Where Does Europe Fit In?

  • No Direct Role

  • Still, Large Indirect Role

    • Euro floats against $

    • Europe has powerful central bank with independent monetary policy

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Dollar depreciation likely to be mostly against euro

Dollar Depreciation Likely to be Mostly against Euro

  • Some Already Occurred

  • Dollar depreciated from .8$/euro to 1.4$/euro already

  • Worse for pound!

  • More likely to come!

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Asia and the euro

Asia and the Euro

  • Crisis in Confidence Possible

    • American Current Account Deficits large

      • >6% GDP, highly persistent

  • Dollar Depreciation Resisted by Asians

    • But Euro Floats Freely!

  • Euro Likely to Continue to Appreciate Against Dollar over long Term

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It isn t only china

It isn’t Only China!

  • Other Asian Economies Waiting in Line behind China

    • India

    • Indonesia

    • Vietnam …

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Historical precedent

Historical Precedent

  • European Development in 1950s and 1960s

  • Export-Lead Growth to transfer under-employed Europeans from countryside to manufacturing

  • Revival of “Bretton Woods” regime, prevailed before 1971

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Conclusion

Conclusion

  • Dollar Decline likely to continue

  • Probably Most Dramatically Against Euro

  • Good argument for foreign diversification!

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