currency wars @ 2010

8/6/2019 currency wars @ 2010

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Currency WarsCurrency Wars


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CURRENCYCURRENCY WARWAR

The issue is usually framed in termsof some countries are cheating

by holding their exchange rates at

an undervalued rate, thus

boosting their exports and limitingimports relative to what wouldhappen if their central banks

floated the local currency freely.

o Main culprit considered to be

China & the International

Monetary Fund (IMF)


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Advantages perceived of controllingAdvantages perceived of controlling

Exchange ratesExchange rates

Costlier Imports/Cheaper Exports

High Net Exports

Increased Domestic production.

Higher employment and economic growth.


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Ways of Controlling Exchange RatesWays of Controlling Exchange Rates

Quantitative Easing: The central government puts cash (e.g. byprinting) into circulation by buying back its own bonds.

It increases money supply, thus the move lowers down thedomestic currency and makes domestic products cheaper.

Currency Intervention: The central bank fixes the exchange ratesand prevents the appreciation of its currency.

Capital Controls: The central government intervenes to buyforeign currency, or imposed taxes on foreign capital flows, suchas taxes on bonds.


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What is happening?What is happening?

Chinas government undervalues its currency by using Yuan to buy foreigncurrencies

o This puts more Yuan in circulation and keeps down their value.

o This makes exports cheaper.

Q

uantitative easing :The U.S. government is putting cash into circulation bybuying back its own bonds

o The move drives down the dollar value.

o A weaker dollar makes U.S. products more affordable globally, increasingU.S. exports, income and employment.

Due to the low interest rates in the U.S., and low returns on U.S. bonds, investors

make purchases - whether for stocks, bonds or real estate - in local currencies

(of developing countries).

o That increases demand for those currencies, raising their values and

making it harder to export goods.

Developing countries combat demand for their currencies by imposing

capital controls, such as taxes on bonds, on foreign investment.


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What is happening?What is happening?


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Why is it happening?Why is it happening? Consumer spending on the decline in many parts of the

world

Manufacturers have little domestic demand for their products.

Everyone is looking to export products overseas, and aweaker currency makes products seem cheaper and

more attractive to foreign markets

A strong currency is like a hot potato no one wants tobe the nation with the strong currency because then therest of the world wont import those products


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What China did?What China did? China had fixed exchange rate up till 2005 RMB pegged at 8.2768 to 1USD

China runs a huge Trade Surplus & buys dollars in the openmarket, pushing the dollar price upwards relative to the Yuan

Indirect measures such as cap on foreign asset investments bycitizens.

Complete control over the exchange rate it pays for US dollarsearned through the sale of exports, and exporters are requiredto convert all foreign currencies to the yuan.

In most countries, such intervention would tend to push upinflation, but because the Chinese financial system remainstightly controlled and the options for investors are very limited,the usual inflationary consequences have not followed.


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USUS vsvs ChinaChina Blame-game is on US blames Chinas

deliberate attempts to

prevent appreciation ofYuan

China blames US for weakmonetary policies and

Feds attempt to pump inliquidity by printing money thus leading todepreciating Dollar


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US vs. China vs. EuropeUS vs. China vs. Europe


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THE CHINESE DILEMMATHE CHINESE DILEMMA

IF IT LETS YUAN TO APPRECIATEo Exports could take a hit, denting the trade surpluses.

o The high value of foreign reserves held in dollar bonds could take

a hit with the devaluated Dollar.

o The market would become more competitive for US exportgoods, fueling growth in US.

o ChinaMight decide to sell of the US Bonds devaluating US dollar

further . This could hurt Dollars standing as a Global reserve

currency.

o If the RMB appreciates, a fall in exports as well as import

substitutes will reduce national income. Since consumptiondecisions depend on income, people will consume less and

spend less. As a result, spending on imports falls as well. Besides,

due to a more expensive Yuan, foreign investment as well asdomestic investment will be reduced


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THE C

HINESE D

ILEMMA

THE C

HINESE D

ILEMMA

IF IT PEGS BACK YUAN

o YUAN most undervalued currency according to Big Mac Index.

This would mount political pressure like with JAPAN leading toPLAZA accord.

o US has hinted towards stricter trade policy if CHINA does not let

YUAN correct itself.

o China can only keep its currency pegged to the dollar by

printing money to buy green-backs, and all those billions of

Renminbi (RMB) ultimately feed back into the real economy chasing assets, creating bubbles and stoking prices. HIGHER

INFLATION

o Domestic consumption keeps lagging.


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What Japan did?What Japan did?

Japan began a massive sale of yen and boughtdollars instead, last month

The aim was to weaken the yen's value against the

dollar China also sold zillions of Yuan to keep the price low

Economists calculate that the Yuan is about 20

percent lower than it would be otherwise.

The competitive undervaluation of China isinfecting the entire global economy


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IndiaIndia

It has not rushed to impose capital controls or let its currencyappreciate steeply

India has wide current account deficit which expects theeconomy to absorb high capital flows without unduly putting

a pressure on the local currency

Buying dollars involves fiscal cost

RBI has to pump equivalent amount of Rupees

Then mop it up by selling bonds Bonds need service by govt.

This in turn worsens fiscal position


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What are the Possible outcomes?What are the Possible outcomes?

If China appreciates currency:Chinese exporters will have lower margins for their goods.

Chinese goods will be less attractive in US market.

Imports will be cheaper in China and inventories will pile up.

Since, China is heavily dependent on trade surplus, if exports are less, it

may sell its Dollar reserves flooding US market with dollars.

If US stops selling Bonds to China

Decrease in the value of US bonds as large percentage of USG bondsare with China.

Rise in inflation in US

If China sells USD in open marketLead to devaluation of US dollar leading to inflation in US.

US government would have to increase the interest rate in its economywhich will further lead to recessionary situation.


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currency wars @ 2010

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