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  • Frankel on the Resilient Dollar

    During the Great Recession, we were starting to come to terms with a weakening U.S. global economic position. And we saw the dollar lose ground (though it remained the chosen global currency). Well, the currency seems to be regaining that ground. At Project Syndicate , Jeffrey Frankel writes that the dollar will likely be replaced as the top currency someday. "But today is not that day." The International Monetary Fund’s most recent statistics suggest, unexpectedly, another pause in the dollar’s long-term decline. According to the IMF, the dollar’s share in foreign-exchange reserves stopped falling in 2010 and has been flat since then. If anything, the share is up slightly thus far in 2013. Similarly, the Bank for International Settlements (BIS) reported in its recent triennial survey that the dollar’s share in the world’s foreign-exchange trades rose from 85% in 2010 to 87% in 2013. Given dysfunctional US fiscal policy, the dollar’s resilience is surprising. Or maybe we should no longer be surprised. After all, when the global financial crisis erupted in 2008 from the bowels of the American subprime-mortgage market, global investors responded by fleeing to the US, not from it. They obviously still regard US Treasury bills as a safe haven and the In particular, the euro has its own all-too-obvious problems. Indeed, the euro’s share in reserve holdings and foreign-exchange transactions have both declined by several percentage points in the most recent statistics. At the same time, the IMF’s data indicate that the vaunted renminbi is not yet among the top seven currencies in terms of central-bank reserve holdings. And, according to the BIS, while the renminbi has finally broken into the top ten currencies in foreign-exchange markets, it still accounts for only 2.2% of all transactions, just behind the Mexican peso’s 2.5% share. Despite recent moves by the Chinese government, the renminbi still has a long way to go. To try to explain the recent stabilization of the dollar’s status, one might note something that the last three years have in common with the previous period of temporary reversal from 1992 to 2000: striking improvements in the US budget deficit. By the end of the 1990’s, the record deficits of the 1980’s had been transformed into record surpluses; today, the federal deficit is less than half its 2010 level. Read The Dollar and Its Rivals here .
  • Planet Money Graph: Break Down of U.S. Debt

    Lawmakers are gathering at the White House, ostensibly to try to find a way to reopen the federal government. If negotiations fail to lead to some sort of resolution, the government won't be able to pay some of its debts. This has led NPR 's special forces econ unit--the Planet Money team--to put together a helpful graph. Here is the breakdown of the U.S. Debt: Click here for more coverage from Planet Money.
  • Kenneth Rogoff on Potential Economic Cost of Incivility in Washington

    Nobody is arguing that the shutdown of the U.S. federal government is not hurting the dollar and U.S. business, but it has yet to spell economic disaster. "At least for now," Kenneth Rogoff writes at Project Syndicate , "the rest of the world seemingly has unbounded confidence." But that is unlikely to last, Rogoff notes. Consider what happened when the Federal Reserve misplayed its hand with premature talk of “tapering” its long-term asset purchases. After months of market volatility, combined with a reassessment of the politics and the economic fundamentals, the Fed backed down. But serious damage was done, especially in emerging economies. If the mere suggestion of monetary tightening roils international markets to such an extent, what would a US debt default do to the global economy? Much of the press coverage has focused on various short-term dislocations from counterproductive sequestration measures, but the real risk is more profound. Yes, the dollar would remain the world’s main reserve currency even after a gratuitous bout of default; there is simply no good alternative yet – certainly not today’s euro. But even if the US keeps its reserve-currency franchise, its value could be deeply compromised. The privilege of issuing the global reserve currency confers enormous advantages on the US, lowering not just the interest rates that the US government pays, but reducing all interest rates that Americans pay. Most calculations show that the advantage to the US is in excess of $100 billion per year. There was a time, during the 1800’s, when the United Kingdom enjoyed this “exorbitant privilege” (as Valéry Giscard d’Estaing once famously called it when he served as French President Charles de Gaulle’s finance minister). But, as foreign capital markets developed, much of the UK’s advantage faded, and had almost disappeared entirely by the start of World War I. CommentsView/Create comment on this paragraphThe same, of course, will ultimately happen to the dollar, especially as Asian capital markets grow and deepen. Even if the dollar long remains king, it will not always be such a powerful monarch. But an unforced debt default now could dramatically accelerate the process, costing Americans hundreds of billions of dollars in higher interest payments on public and private debt over the coming decades. Read America's Endless Budget Battle here .
  • Marketplace Whiteboard: 'Why a currency war could hurt you'

    Marketplace 's Paddy Hirsch is back at the Whiteboard . This time he's trying to get us to understand how currency wars affect us all. As usual, he removes the wonk from the discussion. This time using a story of sibling rivalry, honey, and the US-Canada border:
  • Vox: 'Was the currency war inevitable?'

    Writing at VoxEU , Simon J Evenett --Professor of International Trade, University of St. Gallen in Switzerland-likens a currency war to a "rash" likely to break out depending on how policy makers respond to a global recession. But does that make currency wars inevitable? Evenett writes: Is it possible to design an economic recovery package that takes account of the lessons of history while doing the least possible harm – even potentially benefiting – foreign trading partners? For sure some won’t like this question, reasoning no doubt as follows: when (not if) monetary easing leads to economic recovery, the associated expansion in corporate and personal spending will increase demand for foreign goods and services – so in the long run everything will be hunky dory for trading partners, even with monetary easing. Still, the question is a good one because if there are plausible alternatives then (a) maybe the currency war was not inevitable or (b) the decisions not to pursue these policy alternatives points to underappreciated causes of the currency war. Taking as given that the effect of monetary easing on the exchange rate will harm, at least in the short run, foreign trading partners, what other complementary measures could have been taken to limit international tensions? One such measure would have been to combine monetary easing with expansionary fiscal policy. To the extent that the latter directly or indirectly (through supply chains, the demand for commodities, parts, and components, and induced private-sector capital formation) increased demand for imports then this would have offset, possibly fully, the impact of any currency depreciation by industrialised countries. Seen in this light, no wonder trading partners were worried that currency devaluations that accompanied austerity measures (restrictive fiscal policy) in industrialised economies further harmed their commercial interests. The adoption of austerity measures from 2010 closed the door on policy measures that could have mitigated the international tensions created by go-it-alone monetary easing by in the industrialised countries. There are other ways to bolster demand for foreign goods and services. Another road not taken in recent years was far-reaching trade and investment reforms, which would have provided a fillip to trade partners harmed by adverse currency movements. It is difficult to see how a package of extensive trade reform and monetary easing could have been received worse by trading partners than what actually came to pass. This is not the place to recount the trials and tribulations of completing the Doha Round, but it is worth noting that the unwillingness to further integrate the world markets has exacerbated today currency war. Read Root causes of currency wars here .
  • Knowledge@Wharton: 'Did Japan Just Spark a Currency War?'

    When the G20 meets later this week, avoiding a currency war will be one of the top issues for discussion . With Japan lowering the value of the yen, European nations are highly concerned that an artificially high euro (not just against the yen, but also against a relatively weak dollar) is exacerbating economic distress in the Euro Zone. In an interview with Knowledge@Wharton , Wharton School finance professor Franklin Allen explains how the actions of Japan's leaders might affect economies from Brazil to Russia:
  • World Economic Forum: 'Scenarios for the Future of the International Monetary System'

    As the global economy evolves, the globe's leading economies become more and more interconnected. Surely this has some impact on global currencies--with a focus on the dollar,yuan, and euro. Last year the World Economic Forum embarked on a study of the international monetary system. This study has resulted in a new report on the uncertainties that exist for global currencies and the potential scenarios for the future. Here is a video that sums up the findings of, and some of the key questions raised in, the report: Read Euro, Dollar, Yuan Uncertainties Scenarios on the Future of the International Monetary System here .
  • Eichengreen on the Dollar's Special Status

    Writing in the May/June issue of The American Interest , Barry Eichengreen argues that while the role of the dollar on the global economic stage is likely to diminish somewhat, it will be some time before we see any significant drop in the greenback's importance. But he uses recent currency maneuverings in China and Japan to outline some of the benefits we in the US receive from the dollar being the global currency. With international business being conducted in dollars, U.S. banks aren't burdened with a lot of the exchange rate machinations that banks elsewhere deal with. And the U.S. Treasury costs of borrowing are lessened by the stability that the dollar offers. And on the political front, Eichengreen points to " America’s unique ability to provide dollars in unlimited quantities, but also to withhold them, provides U.S. foreign policymakers with another pressure point to push." But Eichengreen points out that there are some downsides to the dollar being the global currency. By U.S. Treasury estimates, China holds some $1.1 trillion in U.S. government bonds. Total official foreign holdings exceed $3.2 trillion, nearly a third of the $10 trillion of U.S. Treasury debt held by the public. It is worth noting that these official figures are almost certainly underestimates. In addition to purchases in the United States, which are tracked by the U.S. Treasury, governments and central banks can purchase U.S. Treasury bonds through intermediaries in foreign centers like London, where they are harder to detect. Foreign central banks also hold the securities of government-sponsored agencies like Freddie Mac and Fannie Mae, although they have trimmed those holdings since the subprime crisis. If by purchasing U.S. Treasury bonds foreign central banks can lower U.S. interest rates by as much as a full percentage point, then they could, by curtailing those purchases, presumably raise U.S. rates by a corresponding amount. The U.S. housing market and construction sector would feel the pain. This would be a not-so-subtle way for China to make known its displeasure with U.S. policy toward North Korea or Iran, or with a U.S. Treasury decision to label China a currency manipulator. The benefits that America derives from Chinese purchases of U.S. debt are a factor in the State Department’s reluctance to push Beijing harder on human rights issues and the Treasury Department’s reluctance to push it harder on the exchange rate issue. In principle, China could go further and sell its previous purchases. Given the magnitude of its holdings, this would cause bond prices to crater and U.S. interest rates to spike. Smaller bond market shocks than that have caused financial mayhem in the United States. Consider the 1.5 percent rise in thirty-year Treasury yields that occurred in 1994 when Japanese investors faced with a financial crisis at home sold off their U.S. holdings. The result was serious losses and fears of insolvency of major financial companies and hedge funds. If the Chinese wished to wreak havoc in U.S. financial markets, this would be the way. The deterrent to China’s doing so is that it might also be wreaking havoc in its own markets. When institutional investors in Japan sold off some of their U.S. treasuries in 1994, driving down the price, they suffered losses on their remaining holdings. This heightened concern about the solvency of not just U.S. financial firms but Japanese financial institutions as well. China would face an analogous problem. Eichengreen goes on to outline reasons such behavior would create problems for China's economy, so no need to get alarmist. The article as a whole raises a series of interesting discussion points on the impact of the dollar's global status on the U.S. economy and business. Read The Once and Future Dollar here . (Hat tip, Greg Mankiw )
  • BCG's Hal Sirkin on the Rise and Recovery of Manufacturing in the US

    Add Boston Consulting Group's Hal Sirkin to the list of industry experts who believe that reports of the death of US manufacturing have been, as Twain might put it, "an exaggeration." With the decline of the dollar and the rise of wages in China, "It's now becoming more effective to produce in the U.S. than it is to produce in a lot of different countries," says Sirkin. Sirkin recently discussed the state of manufacturing in the US with the Knowledge@Wharton editor in chief Mukul Pandya .
  • Is the Euro Overvalued?

    The euro hit a two-month high against the dollar earlier this week, prompting some to wonder whether the currency is overvalued at the moment. Time will tell, but the ups and downs of the currency are nothing new. To mark moments in the young currency's history when it has been overvalued, INSEAD 's Antonio Fatas charted the dollar/euro exchange rate against the Purchasing Power Parity. (Note: Fatas used the German mark to estimate what the value of the euro would have been had the currency existed before 1999): Fatas: The Euro has fluctuated from a high value of 1.59 in July 2008 to a low value of 0.59 in February 1995. Are these numbers comparable? Not quite. Currencies are expressed in nominal terms so they are likely to move over time when inflation rates are not the same in both countries. In this particular case, we have witnessed an upward drift of the Euro over the years because inflation was on average lower in Europe. This trend can be captured by estimates of Purchasing Power Parity (PPP), in red in my chart. But even when we take into account this trend, the value of 0.59 in 1985 was a significant undervaluation of the Euro (the German Mark then) in comparison to PPP (around 0.95). Same for July 2008, the value of almost 1.6 represented a large overvaluation of the Euro relative to its PPP value (below 1.2). We also see in the chart that episodes of overvaluation or undervaluation relative to PP are persistent. A strong Euro in the late 70s was followed by a very weak Euro during most of the 80s. During the 90s the Euro was in general above PPP estimates. Before the official launch of the "real" Euro in 1999, the German Mark was already heading down and this trend continued leading to another episode of undervaluation of the Euro. An episode that was stopped by a join intervention of the US Fed and the ECB in November 2000. Since then the Euro became stronger and stronger until it reached its peak of 1.6 in July 2008. So, Fatas sees the euro as overvalued today, though not at an historically unprecedented level. Read The overvalued Euro here .
  • Marketplace Morning Report: Gold's Dropping Value

    The value of gold has dropped more than 400 dollars per ounce since an August 2011 high of $1900, Marketplace reports. This appears to be the result of growing confidence in the US economy, and the dollar gaining strength. Marketplace's Steve Chiotakis and Stephen Beard discussed the iconic metal's drop in this report .
  • Feldstein: Just Because a Single Currency Works in the US, Does Not Mean it Will Work in Europe

    Martin Feldstein is not a big fan of the euro. He says that European leaders who pushed for a single currency did so in spite of history and "economic logic" that showed it was not a good idea. As for the argument that the dollar works for the US and EU, like the US, is a made up of many smaller economies with varying rules, he rejects the comparison. At Project Syndicate , Feldstein writes: First, the US is effectively a single labor market, with workers moving from areas of high and rising unemployment to places where jobs are more plentiful. In Europe, national labor markets are effectively separated by barriers of language, culture, religion, union membership, and social-insurance systems. To be sure, some workers in Europe do migrate. In the absence of the high degree of mobility seen in the US, however, overall unemployment can be lowered only if high-unemployment countries can ease monetary policy, an option precluded by the single currency. A second important difference is that the US has a centralized fiscal system. Individuals and businesses pay the majority of their taxes to the federal government in Washington, rather than to their state (or local) authorities. When a US state’s economic activity slows relative to the rest of the country, the taxes that its individuals and businesses pay to the federal government decline, and the funds that it receives from the federal government (for unemployment benefits and other transfer programs) increase. Roughly speaking, each dollar of GDP decline in a state like Massachusetts or Ohio triggers changes in taxes and transfers that offset about 40 cents of that drop, providing a substantial fiscal stimulus. There is no comparable offset in Europe, where taxes are almost exclusively paid to, and transfers received from, national governments. The EU’s Maastricht Treaty specifically reserves this tax-and-transfer authority to the member states, a reflection of Europeans’ unwillingness to transfer funds to other countries’ people in the way that Americans are willing to do among people in different states. Read Europe is Not the United States here .
  • The Economist: Multimedia Explainer on Currency Wars

    The Economist provides another helpful primer on currency battles across the globe. The trick: keeping your currency low enough to make exports more affordable. Not an easy thing to do as dominant global currencies like the dollars remain down:
  • Europe's Dollar Problems

    Europe has its euro problems. But it has dollar problems as well. Like most of us, European banks don't have enough dollars. In the latest Marketplace Whiteboard , Paddy Hirsch explains why European banks need US capital, even though they have their own currency:
  • Strong Dollar Rhetoric, Weak Dollar Reality

    Politicians and policy makers in the US often talk a big game when it comes to the need for a strong dollar. But as Willem Buiter , Chief Economist of Citigroup, and Ebrahim Rahbari , an economist for Citigroup, write at VoxEU , "US strong-dollar rhetoric has contrasted sharply with a weak dollar reality." Buiter and Rahbari argue that current policy will keep the dollar relatively weak against other currencies. But they also see no viable alternative to the dollar as the key currency in global business. Stepping away from the rhetoric about the dollar, Buiter and Rahbari remind us of some of the reasons policymakers may be okay with the dollar not getting to strong too quickly: [A] low actual dollar exchange rate may be seen as a net benefit for the US, because, in the presence of nominal rigidities, a depreciation of the nominal dollar exchange rate implies a real depreciation and therefore an increase in the international competitiveness of the US tradables sectors. The US is quite an open economy today, with the ratio of trade (the sum of imports and exports) to GDP at around 30%, comparable to Japan (Figure 3). Net exports have also played a significant part in the slowly solidifying recent cyclical recovery in the US, though it is, of course, true that many factors affect the evolution of net exports besides the level of the (nominal or real) exchange rate. Read The ‘strong dollar’ policy of the US: Alice-in-Wonderland semantics vs. economic reality here .