Currency Considerations

Here’s a few links to help you follow the currency crisis as the world’s finance ministers move from APEC meetings to the G20 meeting.  EconBrowser has a very distinguished economist blogging there with some interesting points on East Asian Exchange Rates and China. Willem Thorbecke is an important researcher in the area so this is an extremely wonky post with a lot of nifty graphs.  It basically looks, however, at an important issue.  The issue  is China’s vast trade surplus which has been used in the past to purchase US Treasury securities and its exchange rate that’s been pegged to the Dollar at varying levels over the years.  US Secretary of Treasury, Timothy Geithner, has been discussing this recently and it’s likely to be a central focus at the G20 meetings in Seoul.

The interesting thing about this research is that it shows it’s not just the Chinese currency and its exchange rates, but the entire Far Eastern area and all their currencies that have created the situation.  Thorbecke suggests that these are peg to a basket of currencies rather than just the dollar.

These results indicate that if policymakers are concerned about China’s surplus, they need to consider exchange rates throughout East Asia rather than the Chinese exchange rate alone.

The enormous surpluses in processing trade relative to the U.S. generate pressure for nominal exchange rates throughout Asia to appreciate relative to the dollar. If East Asian currencies were to appreciate against the dollar, it would be advantageous if they could appreciate together while maintaining some measure of intra-regional exchange rate stability. By reducing intra-regional exchange rate volatility and the associated uncertainty, this would facilitate the flow of FDI and intermediate goods in Asian production networks. It would also produce a smaller appreciation of real effective exchange rates in East Asian countries since the majority of their trade is intra-regional. Finally, it would overcome the collective action problem that arises as individual countries in the region resist appreciations because they do not want to lose competitiveness relative to neighboring countries.

Ma and McCauley [5] found that during the 2006-2008 period when China managed its exchange rate relative to a basket of currencies and other Asian countries also managed their currencies relative to currency baskets, there was considerable exchange rate stability between the renminbi and other East Asian currencies. Thus, if China again adopts a regime characterized by a multiple-currency, basket-based reference rate with a reasonably wide band, the huge surpluses that East Asia is running against the U.S. in processing trade would cause currencies in the region to appreciate in concert against the U.S. dollar. Market forces could then allocate these appreciations across supply chain countries as a function of the size of their surpluses in processing trade.

China’s finance officials are actually calling for a stable dollar.  This article is from Bloomberg.com.  It quotes China’s Pension Chief. There’s a consensus that this particular idea won’t fly in the District.

The world needs a stable dollar, Dai Xianglong, chairman of China’s National Council for Social Security Fund and a former head of the nation’s central bank, said today at a forum in Beijing. He spoke two days before a Group of 20 summit aimed at addressing global imbalances in trade and investment flows.

Dai’s proposal follows charges by Chinese officials that the Federal Reserve’s plan to buy $600 billion of Treasuries risks inflating asset bubbles in emerging markets. While Treasury Secretary Timothy F. Geithner said Nov. 6 the U.S. takes its global responsibilities “very seriously,” Fed Chairman Ben S. Bernanke has said his focus must be on the American economy.

The idea “is unlikely to fly given that the U.S. would like to maintain the flexibility of its currrency and the ability to lower its value when it needs to boost exports or inflation, as is the case now,” said Dariusz Kowalczyk, a Hong Kong-based senior economist and strategist at Credit Agricole CIB. “Even a range won’t be acceptable to the U.S.”

Because of all this back and forth, Gold is setting more record highs.  This is from Canada’s Globe and Mail.

At the heart of gold’s climb are concerns over the value of currencies amid mounting tension in the runup to the G20 meeting in Seoul, South Korea, this week. The U.S. is pointing its finger at China, pressing for appreciation of the yuan, while many other countries are pointing fingers at the U.S. central bank over a $600-billion bond-buying scheme that roiled the U.S. dollar before it was even announced.

Again, you can see international concerns over the QE2 announced by the U.S. Fed.

There are basically three things that influence someone’s demand for money.  The first is their need for money as a transactions vehicle.  This means you need money to spend your income for stuff you need and want.  The second dimension is a precautionary demand.  That is you want something that is a safe store for purchasing power that you do not want to spend right now.  This is a place to put your money that can be related to an interest rate, but is frequently just sort’ve your choices between stuffing your savings in a safe place like gold, your mattress or your savings accounting or keeping it in your checking accounting and ignoring it.  It could just be cash in your pocket too.  The last thing that influences how much money people want to hold has to do with speculation. You can casino bet on money too.  The Fed takes all these things into account when it determines how much currency, reserves, bank deposits, and treasuries it wants floating around the world.  Every time you see a move to gold, you know that part of it is the desire to protect future earning power by some but it is also a very powerful market for speculation. The dynamics here are complex so don’t be taken in that all this gold buying is just a good thing for gold bugs and a bad thing for people who hold dollars. There is profit to be made in these Currency Wars.

Right now, the world is going through a massive economic re-balancing. The old idea that China will sell us stuff — while lending us the money to buy it — is unwinding.

In fact Ben Bernanke has declared a currency war on China’s undervalued RMB. Good ol’ Ben says we can make the dollar cheaper than the Chinese yuan, and he aims to prove it.

The Fed recently proclaimed its desire to create and buy $600 billion in U.S. Bonds. “The FOMC intends to buy an additional $600 billion of longer-term Treasury securities by mid-2011 and will continue to reinvest repayments of principal on its holdings of securities, as it has been doing since August,” said Bernanke.

Ben is taking this approach because it works right up until it doesn’t.

It worked after the past five bubbles popped, and it looks to be working this time.

When Ben floated the idea of a $600 billion cash infusion, stock prices rose and long-term interest rates fell in anticipation.

I know some of you will point out that the RMB is pegged to the dollar, and therefore the dollar can’t fall… But it does cause an inflation problem in China, which is a de facto re-balance.

According to Bloomberg, “Over the past five years the real-estate prices have tripled. And as property makes up a third of living costs on average, this alone means the real yuan value has doubled.”

Chinese Commerce Minister Chen Deming said as much in an interview on October 26th: “Uncontrolled” issuance of dollars is “bringing China the shock of imported inflation.”

Look for more information on this and what it means to you as we move through the Seoul meetings of the G20.  This could mean some major relative price changes between what you see in prices now on goods coming in from China and what you will see in the future.  This means that major retailers–like Walmart–that rely on cheap Chinese and Far East Asian goods may have some surprises come down the pike.  Because Walmart is “America’s store”, it will likely effect the buying power of all U.S. households.