Relevant and even prescient commentary on news, politics and the economy.

Exchange rate pegs getting a new look?

This article at Voxeu reminded me that exchange rate pegs might come back in vogue. Voxeu has an article on the “trilemma” of ’emerging’ economies:

Do sterilised interventions allow countries a way around the fundamental trilemma of international finance by providing them with a means of systematically affecting exchange rates independent of their monetary policies? Japan, Switzerland, and China provide some lessons…

The fundamental trilemma of international finance maintains that a country cannot simultaneously peg an exchange rate, maintain an independent monetary policy, and permit free cross-border financial flows (Feenstra and Taylor 2008). At best, only two of the three are feasible.

Lifted from a note, Rebecca Wilder writes in an informal e-mail:

I found it rather difficult to read. But this idea of trilemma is not broadly applicable to developed markets except Switzerland – they did address that. I don’t know, the one thing that I do notice, is that the trade ‘imbalances’ are not really moving back into ‘balance’ neither in Europe nor globally. Thus, something’s gotta give at some point; I suspect that it’ll be exchange rate pegs.

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Baby Steps

By Rebecca Wilder

Baby Steps

In the FT today, Martin Wolf discusses the symbiotic relationship of global creditors and debtors. According to the September 2011 IMF World Economic Outlook, China ran the largest current account surplus in 2007, while the US ran the largest current account deficit (in $). Well, if this creditor-debtor relationship is to become more ‘balanced’, then evidence of success should stem from these two giants.

Progress has been made. The IMF forecasts China’s 2011 current account surplus will be broadly unchanged since 2007 (in levels $). In contrast, the 2011 US current account deficit is expected to have improved by 35% compared to 2007 levels. It’s baby steps toward a more balanced global capital market place. What’s driving this? Primarily the real exchange rate.

The chart below illustrates the real effective exchange rates for China and the US, as measured by a broad set of trading partners and relative inflation. The BIS releases this data. Notably, the Chinese economy experienced real appreciation coincident with US real depreciation (I chose the colors pink and blue for consistency with the ‘baby steps’ theme). Spanning the years 2005 – current, the Chinese yuan appreciated 25% in real and trade-weighted terms, while that of the US dollar depreciated 14%.

Progress is being made.

Filed under: China, Global Imbalances, Real Exchange Rates, USA

Originally published at The Wilder View…Economonitors

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