Transcript What’s Up with the Exchange Rate? Andrew K. Rose UC Berkeley, NBER and CEPR.

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 (!)
– 2007Q1: deficit of $192.6 billion
– Almost all Goods (Services in surplus but small)
 Small persistent income surplus
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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
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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
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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?
 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?
 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
 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?
 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
 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
 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
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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
 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?
 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
 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
 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!
 Other Asian Economies Waiting in Line
behind China
– India
– Indonesia
– Vietnam …
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Historical Precedent
 European Development in 1950s and 1960s
 Export-Lead Growth to transfer underemployed Europeans from countryside to
manufacturing
 Revival of “Bretton Woods” regime,
prevailed before 1971
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Conclusion
 Dollar Decline likely to continue
 Probably Most Dramatically Against Euro
 Good argument for foreign diversification!
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