Abstract
During and immediately after the last global crisis exchange rates have shown peculiar behaviour and sometimes heightened instability. This is particular worrying as skirmishes are among the US dollar and the euro, the two pillars of the current international reserve system, but also among such key currencies such as the yen and the renminbi and the other two currencies. The paper explores, in particular, how national interests explain the renminbi’s return to a fixed peg to the dollar from 2008 to 2010 and how internal problems are behind the recent euro’s slide vis-à-vis the dollar. The episodes highlighted not only the dangers of not having an international reserve system disconnected from national currencies, but that the US dollar and the euro with all their weakness have not yet obvious substitutes.
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Notes
The euro does not seem to be a viable alternative to the US dollar because of the segmentation of its sovereign bond market. The absence of an integrated and liquid market for sovereign bonds and a federal budget precludes the single currency from fully developing its potential international role.
The foreign debt results from the accumulation of liabilities, i.e. a structural deficit in a country's current account.
An excessive foreign debt is a threat to national and foreign banks. The crisis erupts in the capital market as the value of sovereign and corporate bonds and the value of bank stocks falls. In a single country the crisis is immediately passed on to the national currency, but in a monetary union it is transmitted to the common currency.
According to the IMF (2010) next to that of the US dollar (62%), the euro had the largest share (27%) in global exchange reserves at the end of 2009.
The basket seemingly included the US dollar, the euro, the yen and the Korean won, but the actual weights used to average out the exchange rates remained undisclosed.
RMB 6.84–8.28 per 1 USD means −17% nominal appreciation.
The yen actually depreciated until 2005 against the US dollar due to low interest rates, expected depreciation and ensuing private capital arbitrage.
The relation between the US dollar and the other currencies has always been problematic since the demise of Bretton Woods. When the US dollar is too weak, the other countries complain to Washington because of its neglect; but when the currencies of big exporters and destination countries of foreign direct investment do not appreciate, it is the turn of Washington to complain about exchange rate manipulation.
A number of studies have been carried out to estimate the necessary real appreciation. For a recent assessment see: Cline and Williamson (2010).
Exporters gain while wage earners lose.
As is well known, the Treaty rules out such a possibility.
These bonds are hoped to get top rating and thus imply a low spread over the bund.
Yield spreads reached record highs in May and some governments faced problems in selling their debt. In the same weeks, European banks faced increasing problems in financing themselves in the monetary market.
That is, the virtual peak of the latest increase at 4.25% was as unfit as it was ephemeral.
The fiscal stimulus was adjusted in March 2009 and consisted in infrastructure investment (39%), post-earthquake reconstruction (25%), civilian projects (19%) and other expenses.
As is well known, with a flexible exchange rate, fiscal expansion worsens the trade balance.
In the inter-bank market the large state commercial banks are the major suppliers of liquidity and the collateralized repos.
The two forces are not mutually exclusive.
More balanced than the current SDR.
Similar limits exist for the euro (fragmentation of the bond market and surplus in the EU) and for the yen (surplus).
The East Asian Dollar Standard was formed by Hong Kong, Indonesia, Korea, Malaysia, Philippines, Singapore, Taiwan, Thailand by narrowly pegging their currencies to the US dollar. The system was shocked by the crisis in 1997, but it has recovered as over time the same countries established new pegs to the dollar (McKinnon and Schnabl 2004). The system has gradually changed since the rapid growth of trade relations with China shifted the trade pattern in the region.
China, Singapore, Malaysia and India peg or have pegged their currencies to a currency basket.
The ASEAN (Brunei Darussalam, Cambodia, Indonesia, Lao PDR, Malaysia, Myanmar, Philippines, Singapore, Thailand, Vietnam) agreed in 2003 to remove trade barriers by 2015 to create an integrated economic entity and (26 February 2009) to establish a single market.
As a system for stabilising intra-regional exchange rates from 1979 to 1999, EMS delivered mixed results in the sense that when it was not backed by coordination and convergence in macroeconomic policies, internal exchange rates have been unstable. Indeed, during the first phase (1979–1984) inflation rates were different and adjustments in exchange rates have been frequent, but during the second phase (1985–1992), nominal exchange rates have been more stable. Particularly from 1987 on, virtually all central banks followed the Bundesbank and used the D-mark as a nominal anchor for domestic monetary policy and targeted the exchange rate with the D-mark. By 1993, i.e. after the severe exchange rate crisis of 1992, the EMS was visibly weakened. After a while, the Maastricht process delivered convergent inflation rates, convergent interest rates and stable exchange rates. The EMS experience proved that exchange rate stability is more a consequence than a premise of nominal convergence and macroeconomic stability and the euro experience in 2010 is proving that real convergence is a precondition for financial stability.
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Martellato, D. Skirmishing Currencies. Transit Stud Rev 17, 645–661 (2010). https://doi.org/10.1007/s11300-010-0180-0
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DOI: https://doi.org/10.1007/s11300-010-0180-0