Category Archives: Capital Controls

China Currency Manipulation Update

Posted on by
Reply

Menzie Chinn is reviewing recent developments. Here are the pertinent aspects (October 25, 2012)

(1) the Chinese currency has
appreciated considerably since 2005 to arguably near equilibrium levels, and

(2) Chinese reserve accumulation has
tailed off; in particular accumulation of USD has stabilized. 

First, to the point of Chinese
currency appreciation. Figure 1 shows the nominal bilateral USD/CNY exchange
rate, with Deutsche Bank forecasts, and the trade weighted real CNY exchange
rate.

romneystrikes1.gif 

Figure 1: Log trade weighted real (CPI deflated, broad basket, 2010=0) CNY index (blue, left scale), nominal USD/CNY exchange rate (dark red), as of 10/24 (dark red triangle), and forecasts from Deutsche Bank (Oct. 3) (red +). Sources: BIS, St. Louis Fed FRED, and Deutsche Bank, Exchange Rate Perspectives(October 3, 2012).
Figure 4. Source: “Capital Inflows Become Outflows in China, WSJ Analysis Shows,” WSJ Real Time Economics (October 16, 2012).

 

In general, the trade weighted real exchange rate (blue line) is the most relevant one for assessing China’s role in the world economy; it has appreciated substantially since the end of the Great Recession. The BIS (and IMF) trade weighted exchange rates are CPI-deflated. One might reasonably argue that this measure of competitiveness (see Chinn (2006)for definitions) is not the most appropriate. It turns out that using unit labor costs does not change the conclusion considerably. Figure 2 shows that the IMF CPI deflated measure and the unit labor cost deflated to do not differ substantially (and in fact has exhibited greater appreciation since 2009Q2). 

 romneystrikes2.gif 

Figure 2: Excerpt from Figure 4 of IMF, Staff Report for Article IV Consultation: People’s Report of China (July 2012).

 

[Some argue] China is keeping the exchange rate weak in order to gain competitive advantage, presumably by intervening in foreign exchange markets. However, the evidence for massive intervention is quite limited, insofar as we can infer from the data. 

 romneystrikes3.gif 

Figure 16 from Deutsche Bank, Exchange Rate Perspectives (October 3, 2012).

 

Total reserves are barely rising, while the share of reserves held in US dollar assets is estimated by DB to be declining over time. Moreover, it is not quite right to equate reserve accumulation with the trade surplus, as shown in the below figure from the Wall Street Journal Real Time Economics: 

 

romneystrikes4.png 

Would it be better for the U.S. and world economy if the Chinese allowed the currency to appreciate more rapidly? Most likely; as I’ve argued, this would help re-allocate aggregate demand away from China and to the rest-of-the-world. 

IMF Capital-Control Confusion

Posted on by
Reply

Having just reversed its stance on capital controls, the IMF is reversing again. Bob Davis of the WSJ points out that countries facing attendant risks of asset bubbles, use of capital controls “is justified as part of the policy toolkit to manage inflows,” the IMF paper wrote. Even if investors figure out ways around the controls, the restrictions still can be useful, the IMF said because “the cost of circumvention acts as ‘sands in the wheels’” and slows down investment.

 

Today, the IMF came close to changing its mind again. “Even if capital controls prove useful for individual countries in dealing with capital inflow surges,” the IMF wrote  its semi-annual Global Financial Stability Report, “they may lead to adverse multilateral effects… A widespread reliance on capital controls may delay necessary macroeconomic adjustments in individual countries and, in the current environment, prevent the global rebalancing of demand and thus hinder the recovery of global growth.” It seems the IMF backs controls as short-term measures, but not as long-term solutions, but doesn’t give specific advice how to tell one situation from another. Here’s the IMF’s best shot: “Since the use of capital controls is advisable only to deal with temporary inflows… they can be useful even if their effectiveness diminishes over time,” the GFS report suggests. “However the decision to implement capital controls should consider the distortionary effects” too. Davis summarizes it nicely: IMF to policy makers in developing countries: Good luck making the call.

 

The End of a Gospel

Posted on by
Reply

Those who have followed the IMF's policy prescription over the years, would have thought that the headline "IMF Suggests Capital Controls" was more likely to have come from The Onion than from Wall Street Journal, or – god forbid – the IMF! 

 

Click on the listen button to hear the the NPR piece that summarizes it all (here is the transcript). 

There must be a lively debate going on behind closed doors at IMF Headquarters. This after decades of pushing financial openness as a centerpiece of IMF reforms (see also here or here). For a long time the official policy was that "liberalization of restrictions on external and domestic financial transactions would (1) improve financial efficiency by increasing competition in domestic financial systems and (2) to reduce financial risks by allowing domestic residents to hold internationally diversified portfolios." 

Bhagwati's original Foreign Affairs piece is here. The IMF's rejoinder under the pen name for a PR guy (I guess no IMF economist was willing to have his/her name under the statement…) show how difficult it is to adopt new ideas and reject orthodoxy at leviathan institutions.   Here is a longer treatise on the history of capital flows – and their effects. I have a personal interest in this I coauthored a paper (with Steve Turnovsky) in May 1998 that explained and highlighted such capital flow reversals. You guessed it, it was skeptically received and not published until 1999, since it violated the orthodoxy.  

Update 11/11/2011 – from the New York Times: Countries See Hazards in Free Flow of Capital

LONDON — In China and Taiwan, regulators are imposing fresh restrictions on stock market investments by foreigners. In Brazil, officials have twice raised taxes on foreign investors. Even in South Korea, host to this week’s Group of 20 meeting, pressure is building on the government to take similar steps. As the leaders of the 20 major economic powers gather in Seoul, an increasing number of them have either imposed curbs or are in the process of doing so to slow the torrent of hot money into their markets…

But as the sums have compounded and led to more market volatility, fast-growing countries have begun to worry that short-term investment will push up the value of their currencies, make their goods less competitive in the global market, and lead to asset bubbles that will be painful to deflate… “The world has learned about the perils of free market finance — global financial liberalization just does not work as advertised,” said Dani Rodrik, a political economy professor at the John F. Kennedy School of Government at Harvard. “Just as John Maynard Keynes said in 1945 — capital controls are now orthodox.”

Many countries are discussing additional steps because they fear that the Federal Reserve’s latest bid to revive the United States economy by pumping an additional $600 billion into the banking system will further weaken the dollar and send more money into fast-growing markets. The latest restrictions are as various as taxes on bond and equity flows and extended rules on how quickly short-term capital may be repatriated.