February 01, 2011
Thoughts on Rebalancing, Capital Flows, Commodities
Those were some of the topics of a recent Asia-Europe Economic Forum conference that took place at the French Ministry of Economy, Finance and Industry, entitled "G20: Completing the Agenda", organized by Agnès Bénassy-Quéré and co-sponsored by CEPII, DG-ECFIN, and the Ministry of Economy, Finance and Industry.
Figure 2 from Agnès Bénassy-Quéré (CEPII) and Jean Pisani-Ferry (Bruegel)"What international monetary system for a fast-changing world economy?"
The sessions were: What has the G20 Delivered so Far?, Global Rebalancing: are we on the Right Track?, The International Monetary System: Towards a New Era?, Public roundtable: G20 shortcomings and the way forward, Capital Flows: Towards a New Consensus?, and Fighting Volatility in Commodities Markets. The entire agenda, plus the available papers or presentations, is here.
There was way too much interesting material and dialog (the latter of which is not online) to summarize, so I'll just highlight a few points I thought of interest.
Professor HE Fan, of the Chinese Academy of Social Sciences (CASS) made an interesting presentation reflecting (what I think) is a mainstream Chinese view regarding how best to deal with global imbalances: policy induced structural change, along with demographic and other factors, will mean a much altered Chinese economy in a decade -- one that will presumably not run such large current account surpluses. (It occurred to me that it was not substantively different than that view forwarded by PBoC Deputy Governor YI Gang back in October). I commented that in order to get to the long run, one needs to survive in the short run -- and time might not be on the side of the rational policymakers, given high unemployment and the likely rise of protectionist pressures in the advanced economies. Hence, policies with short term impacts might be advisable (e.g., accelerated RMB revaluation).
Masahiro Kawai and Shinji Takagi provided a useful (and refreshingly non-hyperbolic) assessment of the likely prospects for the RMB as international and regional currency. One observation of great importance -- economic size and capital account liberalization are not sufficient conditions for a currency to become an international medium of exchange/store of value. The development of a financial sector (with all the attendant preconditions) is also necessary. (See Chinn and Frankel (2008) on this count).
Professor Jeffrey Frankel presented a paper wherein he argued that "product price target generally does a better job of stabilizing the real domestic prices of tradable goods than does a CPI target" for commodity exporters. This approach certainly outperforms the dollar peg.
My view is that if commodity exporting countries can be persuaded of the superiority of ths type of monetary policy, it might serve to delink a large number of economies from US monetary policy.
The presentation that elicited the most vigorous debate was Jonathan Ostry's discussion of the role of capital controls in managing inflows. His presentation is not online, but some feeling for the main ideas can be gleaned from this IMF Staff Position Note, published earlier this year. In any case, I think it the case that many policymakers allow that capital controls might be of use in limited instances. The question surrounds the issue of efficacy (and over what time horizon), and whether the resort to capital controls might make policymakers feel like they can avoid the tough choices, like fiscal restraint.
Finally, Professor David Vines provided a very interesting discussion (of my paper, as well as the other presentations in the session by Krzysztof Rybinski and Jonathan Ostry). In his presentation, he noted that the current world system is current playing a game with the following features:
We now have three targets: i.e. a satisfactory output levels/growth in three regions: the US, East Asia and Europe, but:
- We have only one-and-a-half instruments left --
- the dollar-renminbi real exchange rate, still set in East Asia to give exportled growth
- But we have reached the zero bound -- so the real interest-rate-instrument has gone -- although QE is half an instrument ...
He concludes "This is an unhappy game", with China as the Stackelberg leader, adjusting slowly, and the US and Europe as Stackelberg followers, trying to depreciate their currencies in any way they can. The end result is that real interest rates are too low for China, the emerging market economies, and the commodity exporters.
Posted by Menzie Chinn at February 1, 2011 01:49 PMdigg this | reddit
I wonder, did Japan appear to be the "Stackelberg leader" in the 1980s, before their crash?
That type of analysis seems way too simplistic.
Posted by: Bob_in_MA at February 1, 2011 04:11 PM
"The end result is that real interest rates are too low for China, the emerging market economies, and the commodity exporters."
China, like the US & much of the world, has negative real interest rates, thanks to the wonders of modern fiat money. I'm pleasantly surprised that a professional economist would conclude that they are too low.
Posted by: Bryce at February 1, 2011 08:14 PM
A stern warning from a central banker, by Sovereign Man
Mervyn King is Britain’s chief central banker and a key figure in the global financial system. Last week, after surprising reports surfaced that the British economy had once again contracted in the 4th quarter of last year, King delivered a stern, sobering message to his country:
- “In 2011, real wages are likely to be no higher than they were in 2005… One has to go back to the 1920s to find a time when real wages fell over a period of six years.”
- “The Bank of England cannot prevent the squeeze on real take-home pay that so many families are now beginning to realise is the legacy of the banking crisis and the need to rebalance our economy.”
- “The squeeze on living standards is the inevitable price to pay for the financial crisis and subsequent rebalancing of the world and UK economies.”
- Furthermore, inflation may rise “to somewhere between four per cent and five per cent over the next few months.”
- “The idea that the MPC could have preserved living standards, by preventing the rise in inflation without also pushing down earnings growth further, is wishful thinking.”
- “[U]npleasant though it is, the Monetary Policy Committee neither can, nor should try to, prevent the squeeze in living standards, half of which is coming in the form of higher prices and half in earnings rising at a rate lower than normal.”
- “I sympathise completely with savers and those who behaved prudently now find themselves among the biggest losers from this crisis.”
To summarize, one of the world’s leading central bankers has looked his country in the eye and admitted that he is completely powerless to prevent the inevitable decline in living standards that will result from years of reckless behavior.
Posted by: Ivars at February 2, 2011 12:07 AM
At this juncture it doesn't look like the Chinese policy makers know what to do--and understandably so given the predicament they're in. If they allow the RMB to appreciate, it bankrupts many of their exporters; and if they don't, they continue to get hit by inflation. Currently, the Chinese have enough power to make the RMB a political question more than an economic one; however, ultimately they'll have to pay for this inflation, and right now my guess is that they'll pay for it with a massive deflationary bust. And once the dust clears, perhaps then price signals and valuations might make more sense to run a healthy economy.
In any case: it leaves one to wonder why the Chinese have sat on their hands regarding the RMB; makes you wonder what they see.
Posted by: Brian at February 2, 2011 12:16 AM
What the Chinese see is that serious depegging exposes their massive misallocation of resources to an unsustainable export sector, uneconomic real estate developement, etc. It will make reality visible.
Posted by: Bryce at February 2, 2011 07:30 AM
There is a lot of beauties of path growing out of a bubble in a managed reflation process( especially wages and general prices level ), assuming you can manage it at benign level without blowing out political stability like Egypt.
Since China has more or less muddle through the global financial crisis largely unscathed due to its massive saving rate and balancsheet, top policymakers does not give a rat ass about global structural imbalance and grand design of Rmb despite a few technocrats noise at davos or G20; certainly they worry about property bubble and bankings, but that will be tackled through domestic monetary tightening, FX control and property tax.
I would say China afer a while fine tuning , can comfortablly living with 6-8% inflation, 7-8% real GDP, 14-15% Nominal GDP and 5-10% REER and 0% Rmb-USD rise; By adjusting through this reflationary process rather than nominal FX, and exporting a lot of inflation globally, I wonder what is the implciation for US,EU monetary policy stance, other emerging market
Posted by: isaac at February 3, 2011 02:21 AM
I think the Chinese also understand that currency pegs are a form of negative carry (you have to take money out of a fast growing economy and reinvest it in a slower growing economy.) The cost of the peg hasn't gotten too high yet, but there will come a day...
Posted by: Frank in midtown at February 9, 2011 12:07 PM