Download Exchange Rates

NS3040
Fall Term 2015
Exchange Rates
Exchange Rates I
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Exchange Rates II
• Between the end of WWII and the early 1970’s most
countries including the U.S. had fixed exchange rates
• In the early 1970s when international capital flows
increased the U.S. abandoned its peg to gold and floated
the dollar
• Many countries continued to peg to the dollar while
others adopted various conventions for their exchange
rates
• In 2012:
• 35% of countries had floating rates
• Includes several major currencies such as U.S. dollar, the euro,
the Japanese yen and the British pound – account for about 50%
of global Gross Domestic Product (GDP)
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Exchange Rates III
• Many countries use policies to manage the value of their
currencies
• Some manage it more than others
• Includes many small countries such as Hong Kong, as
well as a few larger economies such as China, Russia
and Saudi Arabia
• In 2012
• 40% of countries used a “soft” peg, which let the currency float
within a desired range
• 13% of countries used a “hard” peg which anchors the
currency’s value more strictly, including the formal adoption of a
foreign currency to use as its national currency – Ecuador
• No large country uses a hard peg.
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Exchange Rates IV
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Exchange Rate Determinants I
• Short Run: Interest Rate Arbitrage
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Exchange Rate Determinants II
• Medium Term: Adjustable Peg
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Exchange Rate Determinants III
• The SDR
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Exchange Rate Determinants IV
• Long Term: Purchasing Power Parity
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Exchange Rate Determinants V
• Big Mac Index
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Exchange Rate Determinants VI
• Big Mac Index January. 2012
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Exchange Rate Determinants VII
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Big Mac Index: 01/2015
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Value of U.S. Dollar I
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Value of U.S. Dollar II
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Recent Dollar Strengthening I
• Mohamed El-Erain, The Return of the Dollar, Project
Syndicate November 10, 2014
• As of early November 2014 the dollar has strengthened
by more than 7% against a basket of a dozen global
currencies – even more against the euro and the yen.
• Has the potential to contribute to the rebalancing that has
long eluded world economy – outcome far from certain
• Two factors working in dollar’s favor – especially against
the euro and yen
• 1. The U.S. is consistently outperforming Europe and Japan in
terms of economic growth and dynamism
• Greater economic flexibility and entrepreneurial energy
• More decisive policy action since the start of the global financial
crisis
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Recent Dollar Strengthening II
• 2. Monetary policies of U.S. , Europe and Japan are diverging
• U.S. will be contracting QE policies
• Europe and Japan will be expanding their monetary stimulus
programs
• Movements in currencies should promote stronger
growth and mitigate deflation risk in Europe and Japan
• Benefits of dollar’s rally far from guaranteed for both
economic and financial reasons.
• While U.S. economy is more resilient not robust enough to be
able to adjust smoothly to a significant shift in external demand
to other countries
• U.S. politicians may interpret currency moves as a currency war
prompting retaliatory response
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Recent Dollar Strengthening III
• Also large currency moves tend to translate into financial
market instability
• By repeatedly repressing financial market volatility over
last few years central bank policies have encouraged
excessive risk taking
• Has pushed many financial asset prices higher than
economic fundamentals warrant
• To the extent that continued currency market volatility
spills over into other markets – and it will – the imperative
for stronger economic fundamentals to validate asset
prices will intensify
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Recent Dollar Strengthening IV
• So while currency realignment has potential to boost the
global economy by supporting recovery of some of its
most challenged components this won’t occur
automatically
• For smooth sustained growth to occur countries will
need to:
• Introduce complementary growth enhancing policy adjustments:
• Accelerating structural reforms
• Balancing aggregate demand and
• Eliminating debt overhangs
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Equilibrium FX in the Eurozone
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Federal Reserve Tapering and Exchange Rates I
• U.S. Federal Reserve policies and announcements are
having a major impact on emerging market currencies.
• In May 2013 the Federal Reserve hinted that it was
considering easing its asset purchase program
• Reaction was swift and brutal.
• Pain not shared equally
• Those countries hit the hardest by taper-talk were those with
large current-account deficits – Turkey, India, Indonesia and
Brazil
• These countries had been doing well under QE3, financing
excesses of consumption over production with dollars, floating
around globe looking for return
• Hint of a QE3 docking enough to panic foreign investors over
fears of depreciation and default risk.
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Federal Reserve Tapering and Exchange Rates II
• These same countries were the biggest beneficiaries of
the Federal Reserve’s September announcement to back
away from its pullback in asset buying
• Message received in emerging markets:
• In good times apply a firm hand to keep imports and currency
down, and
• Exports and reserves up
• May get accused of manipulation, but a small price to
pay for stability.
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Federal Reserve Tapering and Exchange Rates III
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2014 Emerging Market Crisis I
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2014 Emerging Market Crisis II
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2014 Emerging Market Crisis III
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2014 Emerging Market Crisis IV
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2014 Emerging Market Crisis V
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2014 Emerging Market Crisis VI
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Impact on U.S.?
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Strong Dollar/Weak Dollar I
• Strengthening Dollar
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Strong Dollar/Weak Dollar II
• Weakening Dollar
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Strong Dollar/Weak Dollar III
• Factors Contributing to a Strong Currency
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Strong Dollar/Weak Dollar IV
• Factors Contributing to a Weak Currency
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Currency Manipulation I
The Case of China
• Many feel China has kept its currency week (undervalued) to
give that country’s products an unfair advantage in the U.S.
market
• In 1994 China began to peg its currency to the U.S. dollar
and kept it pegged at a constant rate through 2005
• In July 2005 it moved to a managed peg system in which the
government allowed the currency to fluctuate within a range
and the currency began to appreciate
• In 2008 China halted appreciation of the RMB due to
concerns about effects of global financial crisis on Chinese
exports
• In 2012 China again allowed more flexibility in the value of
the RMB against the U.S. dollar.
• Between 2005 and the end of 2012 the RMB appreciated by
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almost 25% against the dollar.
Currency Manipulation II
• The Chinese government has used various policies
including intervening in foreign currency markets and
capital controls to manage its currency
• Does so primarily by printing Yuan and selling it for U.S.
currency and assets denominated in U.S. dollars –
usually government bonds
• It also manages the value of its currency through capital
controls that limit buying and selling of RMB
• As China engaged in currency interventions its holdings
of foreign exchange reserves have increased from $715
billion in the first quarter 2005 to $3,463 billion in first
quarter of 2013
• This is equivalent to 38% of China’s GDP
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Currency Manipulation III
• Some economists feel substantial increase in foreign
exchange reserves as evidence of keeping the country’s
currency weak
• More recently some economists starting to question
whether the yuan is still undervalued against the U.S.
dollar
• Especially when adjusting for differences in price levels – the
real exchange rate
• China has had a more rapid rate of inflation than the U.S.
• They also point to fact that foreign exchange reserves
have not grown as quickly since 2011 as some evidence
of this position
• In July 2012 the IMF changed its assessment of the
RMB’s value from significantly undervalued to
moderately undervalued.
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China’s Foreign Exchange Rate and International Reserves
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Currency Manipulation IV
The Case of Switzerland
• Before the global financial crisis of 2008-09 Switzerland
had a floating exchange rate
• During crisis the Swiss franc was viewed as a “safe
haven” currency – a currency investors trusted more
than others in period of uncertainty
• Increased investor demand for the franc put upward
pressure on the currency raising concerns over export
competitiveness
• In 2009 and 2010 the Swiss central bank intervened in FX
markets to prevent or limit appreciation against the euro
by selling Swiss franks for foreign currencies
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Currency Manipulation V
• When a worsening of the Eurozone crisis put additional
upward pressure on the Swiss franc,
• The Swiss central bank announced in September 2011 it would
buy “unlimited quantizes” of foreign currency
• Action intended to keep the franc from appreciating above a
specific value
• As a result of the currency intervention, Switzerland’s
foreign exchange reserves increased more than tenfold
• From $46 billion in the fourth quarter of 2008 to 4470 billion in
the first quarter of 2013
• This represented about 73% of Swiss GDP
• Before the financial crisis the Swiss central bank had last
intervened in the foreign exchange market in 1995
• Most view the Swiss action as defensive and do not
consider it a threat or an attempt to gain an unfair
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advantage.
Swiss F/X Rate and International Reserves
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Gangon: Currency Manipulation I
Joseph Gangon, “Combatting Widespread Currency
Manipulation”
Currency manipulators often identified on the based of excessive
levels of foreign exchange reserves.
• To be a currency manipulator a country must meet all of the
following criteria:
• Countries must have foreign exchange reserves that are greater
than the value of six months of goods and service imports
• Countries must have an average current account balance (as a
percent of GDP) between 2001 and 2011 that is greater than
zero
• Countries must have increased their reserve stocks relative to
GDP over the past 10 years
• Low income countries as defined by the World Bank are
excluded on the principle that they should have greater freedom
than other countries to pursue economic development policies
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that may have negative externalities.
Gangon: Currency Manipulation II
• Reserves and the Current Account
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Gangon: Currency Manipulation III
• Foreign Exchange Reserves
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Gangon: Currency Manipulation IV
• Foreign Exchange Reserves by Region
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Gangon: Currency Manipulators V
• (% GDP)
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