Friday, March 18, 2011

Let the Yen Rise

The Yen is rising, and various nations are acting in concert, with Japan, to bring it back down. This is crazy.

Think about it -- Japan has just suffered a tremendous negative real shock. Buildings, roads, equipment, factories, etc. have all been destroyed and need to be replaced. More tragically, thousands of people have died and aren't there to replace them all. What the country needs is a stronger yet, so it can import more sweat and atoms from abroad to make up for everything it has lost.

Instead, it is devaluing its currency to help its exporters. So atoms, desperately needed at home, will be rearranged by sweat, which could be spent at home, and then sent abroad, in exchange for numbers in a spreadsheet.

Exports are real costs. Imports are real benefits.

17 Comments:

Blogger Ramanan said...

Such ideas depend on the belief that indebtedness to foreigners is not debt at all.

It can be disproved by appealing to the IMF's Articles Of Agreement - Section VII, Article 4:

Convertibility of foreign-held balances

(a) Each member shall buy balances of its currency held by another member if the latter, in requesting the purchase, represents:

(i) that the balances to be bought have been recently acquired as a result of current transactions; or

(ii) that their conversion is needed for making payments for current transactions.

The buying member shall have the option to pay either in special drawing rights, subject to Article XIX, Section 4, or in the currency of the member making the request.

(b) The obligation in (a) above shall not apply when:

(i) the convertibility of the balances has been restricted consistently with Section 2 of this Article or Article VI, Section 3;

(ii) the balances have accumulated as a result of transactions effected before the removal by a member of restrictions maintained or imposed under Article XIV, Section 2;

(iii) the balances have been acquired contrary to the exchange regulations of the member which is asked to buy them;

(iv) the currency of the member requesting the purchase has been declared scarce under Article VII, Section 3(a); or

(v) the member requested to make the purchase is for any reason not entitled to buy currencies of other members from the Fund for its own currency.


I posted the above at a Chartalist blog and met with comments which looked like denial of its existence!

The whole analysis is backward. One should ask "why would the foreigner want to sell you something if your pieces of paper have no value to him?" Hence international trade cannot happen unless a nation explicitly borrows in the foreign currency. To make international trade possible and easier, the trick applied is convertibility of currencies into each other. There should be "Market Convertibility" so that agents can convert the currencies to their home currency. However a territory as a whole needs to have convertibility. This is enforced using "Official Convertibility" which is what the IMF Treaty solves.

8:57 AM  
Blogger Neil Wilson said...

R,

The IMF treaty is of use while it is convenient. But like all treaties it will be discarded the moment it isn't.

It is not a fundamental operational constraint of the system. It is a political choice.

US dollars have value to non-US citizens because of a belief in the US dollar as a store of value - not because of treaties.

If the US starts to take advantage of that position then it will be a long, long time before the foreigners realise they are being exploited.

You could convert into Gold until 1971. Then Nixon change the system unilaterally.

If everybody starts taking advantage of the system, then nobody can take advantage of it and the balance of payments will tend towards parity across the globe.

10:49 AM  
Blogger winterspeak said...

Ranaman: A foreigner would want to trade something with you for obvious reasons. A foreigner would only run a trade surplus if they believed the pieces of paper were worth something. Right now they do.

If that belief changed, which it might, then to Neil's point countries would run balanced current accounts.

Suppose that a country decided to renege on its IMF obligations -- what then? Is there an IMF police? Is there an IMF gaol? Such an action would certainly shut it out of international trade, until countries decided it was worth trading with again.

I am not denying the existence of Section VII, Article 4. I'm just pointing out that it's based on an incorrect understanding of monetary operations

12:25 PM  
Blogger Ramanan said...

"It is not a fundamental operational constraint of the system. It is a political choice."

Neil,

Unfortunately there is globalization and the world has become a small place. A nation can of course withdraw its membership from the IMF but the consequences may not be straightforward. For example, Cuba and North Korea are non-members and they run currency board arrangements to make their currency acceptable to international markets. They may be free to impose protectionist measures. The credit nature of money is crystal clear in those examples and they have to run surpluses in trade to keep their currencies acceptable in international trade. Its also obvious in those cases that imports are purchased on credit.

For IMF members the way the international monetary system is setup also makes it clear that if the balance sheets of all sectors of an economy (i.e., households, producers, the financial system and the official sector) are combined and is found that the net overseas assets position is negative, the nation is a debtor nation.

Running trade imbalance continuously just increases indebtedness to foreigners as a simple identity connecting stocks of net overseas assets and the current account balance shows. This process itself is not sustainable and hence nations keep demand low so that imports stay low, because imports are demand dependent.

The fx markets do not move to make the trade balance. Even if the fx markets somehow move toward a rate which balances trade, the nation would have picked up a lot of international trade till that time.

For let us say that somehow the fx markets reach an "equilibrium". Even in that state, the government's choice is limited because a fiscal expansion will lead to an increase in trade imbalance which shows the spurious nature of the above assumption.

As far as the US is concerned, it is really constrained by the external sector as can be seen by the behaviour of officials in the Treasury and the Federal Reserve. There is no mechanism for trade to balance except through political economic means.

As far as 1971 is concerned, there is some kind of misunderstanding on what changed in 1971. Article VIII, Section 4 was the same before 1971!

Nations were no obliged to settle in Gold. They had the choice.

The difference was that there was a "Par Value System" in which nations undertook the responsibility of keeping the exchange rates fixed.

The US undertook to convert the dollar to Gold - but not as a part of an agreement but by its own choice. It was under no obligation.

There are of course some advantages of the floating exchange regime. The exchange rate can move in the direction that governments want etc. Only that, it hasn't so far.

To really prove that imports are benefits, one has to show examples where full employment has been reached with no issues whatsoever (such as with the currency).

There is a law called Thirlwall's Law in PKE which says that the growth of nations is dependent on the growth of exports and inversely to the import elasticity of demand. And it seems to explain the growth of nations.

I guess the Asian Tigers learned it and grew massively in the past 10-20 years.

1:21 PM  
Blogger Ramanan said...

Winter,

The IMF may just be considered to be an organization which makes sure that the Treaty works as per designed.

And needless to say it has sufficient powers and writes the budgets of nations because it is the international lender of the last resort.

"If that belief changed, which it might, then to Neil's point countries would run balanced current accounts"

How ?

That is equivalent to saying that the game between a nation and its international creditors can smoothly come to an end.

"I'm just pointing out that it's based on an incorrect understanding of monetary operations"

I think I understand all central banking operations but still I have a difference in opinion.

The implicit assumption in the monetary operations described by the Chartalists is that foreigners cannot redeem their balances.

1:30 PM  
Blogger Ohm (Ώ) said...

"Instead, it is devaluing its currency to help its exporters. So atoms, desperately needed at home, will be rearranged by sweat, which could be spent at home, and then sent abroad, in exchange for numbers in a spreadsheet.

Exports are real costs. Imports are real benefits."

Lot of truth in this, as it is also true that exports are needed to pay for imports without going into debt. So it's really an optimization issue. Having said that, if you have a big war chest of forex reserves, when else are you going to use it if not at a time of crisis, when you need to import for cheap to recover from devastation? From that angle, today Japan does need to look at valuing it's currency upwards rather than downwards. Perhaps it wld not want to lose price competitiveness of it's exports completely by revaluing up too much, still revaluing up shld be the basic, at least short term, direction. Even from a long term perspective, it is overdue for nations to realize - that, in the long run, balanced trade is sustainable trade, and beyond building reserves worth a year or so of imports, running a perpetual a trade surplus means you are sacrificing internal consumption and living standards for accumulating hard currency, which too is paper in the ultimate absolute.

3:10 PM  
Blogger Ohm (Ώ) said...

Read: "as it is also true that exports are needed to pay for imports without going into debt....and/or using Foreign Portfolio Investment Inflows, which can prove rather fickle, and cause mayhem if-when they reverse"

3:29 PM  
Blogger Neil Wilson said...

"The implicit assumption in the monetary operations described by the Chartalists is that foreigners cannot redeem their balances"

No its not. The implicit assumption is that they will not be allowed to hold the home country to ransom based on pieces of paper - because that would be clearly an act of war.

I'm afraid your assertions fall into the 'what if pens got hot' category of arguments.

12:19 AM  
Blogger Neil Wilson said...

"Suppose that a country decided to renege on its IMF obligations -- what then?"

They wouldn't do it explicitly, it would implicitly by increasing friction somewhere in the system. Increasing bureaucracy, tariffs, some sort of matched goods exchange controls and a myriad of other little tricks that would bend the rules as far as they would go.

In the current political climate you could pretty much do what you like monetarily to China and imply they brought it on themselves by refusing to free float their currency.

1:10 AM  
Blogger Ramanan said...

Neil,

"I'm afraid your assertions fall into the 'what if pens got hot' category of arguments."

Billy Blog:

"Ultimately, the holder of the USD can only realise these holdings by buying goods and services (or assets) denominated in US dollars."

Which is clearly incorrect.

Need I say more ?

I am afraid, there is just so much confusion around in this circle and it is not surprising that Economics is a hard subject.

Yet to know of a country whose State is bigger than the currency markets and which has reached full employment without troubles in the external sector!

Moral refuge seems to be the only way of arguing out of the situation.

6:18 AM  
Blogger Ramanan said...

"The implicit assumption is that they will not be allowed to hold the home country to ransom based on pieces of paper - because that would be clearly an act of war."

Btw, that seems like saying "Hell with you creditors. If you come knocking on my doors, that will be immoral and hence I do what I want".

6:34 AM  
Blogger Neil Wilson said...

"Which is clearly incorrect."

No it isn't. Your last line of action to enforce your debt is to move in with force and extract real things. That's how all unpaid debts are ultimately settled in all societies - who has the bigger stick.

If I refuse to pay you and refuse to recognise your courts and rules what other option do you have?

Rules are followed for as long as everybody agrees to and no longer. I point you to the fudge around the Israeli security resolutions and the fudges around the European Monetary Rules as evidence of the pragmatic nature of rules.

What is written is just a starter for negotiation in all cases.

2:39 AM  
Blogger Ramanan said...

"Rules are followed for as long as everybody agrees to and no longer."

Yes. The IMF was created to have everyone reach some agreement on how to "settle" international debt.

If you want to propose something else then feel free to propose such as not honoring commitments - which is what you are effectively proposing.

"I point you to the fudge around the ..."

Traffic rules exist and they are broken by people either intentionally or not intentionally everyday. Doesn't mean everyone goes around breaking rules.

10:17 AM  
Blogger winterspeak said...

Ramanan: To your point, there *have* been sovereign debt defaults. I'm thinking of some in Latin America, where I believe they defaulted on dollar denominated debt, and also the Russia default of '98 where they chose to not pay back Rouble denominated debt.

There was certainly disruption then, but I don't remember creditors swooping in to take real resources by force. I think they just took their haircut, and a few years (months?) later were back investing again.

Do you have more details?

12:42 PM  
Blogger Ramanan said...

Winterspeak,
Winter,

I know the argument. Some of the MMTers have said that more explicitly. However that is not really an argument.

For example Argentina has been running a current account surplus every quarter since the episode when the currency board setup had to give in.

Latin American nations keep running into balance of payments crisis and minicrises.

Even if one defaults on an obligation, there is still a current account deficit adding to the stock of international indebtedness. The MMT argument implicitly assumes that there is a seigniorage for the nation "enjoying" imports.

Digressing ... as was often discussed in the Bretton-Woods conference and later, the system was meant to be a system to *settle* international trade.

It is unfortunate that the present system is called a non-system. According to a leading IMF figure, the late Sir Joseph Gold, this was the impression even pre-1971!

The IMF has been designed so that international trade is smooth and the credit nature of money is maintained. Its not a perfect system, but then someone has to propose an alternative system such as the Keynes idea of a Clearinghouse. I am not a fan of this because it socializes exchange rate losses.

What is the concept of money which has been used to think about this 'non-system' ? Augusto Graziani provides the answer:

i) since money cannot be a commodity, it can only be a token money;
ii) the use of money must give rise to an immediate and final payment and not a simple
commitment to make a payment in the future; and
iii) the use of money must be so regulated as to give no privilege of seignoriage to any
agent


The Article VIII, Section 4 makes sure that debt owed to foreigners even if in your currency and even if on the books of the official sector is debt and not "not debt". Else international trade cannot happen. Or can happen if one explicitly borrows in a foreign currency to purchase imports.

So why all the above ? If one defaults on a foreign member asking for a conversion and if you refuse, you are effectively breaching the IMF articles of agreement.

Its true that nations can become non-members of the IMF but at present, they are.

The MMTers keep asserting that currencies are "non-convertible" - I think they didn't know the Article VIII, Section 4!

Its a case of mixing a proposed world and the present institutional setups plus the "non-system"

Non-IMF members are Cuba, North Korea .. who run currency boards to make their currencies acceptable in currency markets.

Btw here is a continuation of Marshall's Longest ... I think you followed the original one

http://moslereconomics.com/2011/03/18/guest-on-reuters-insider/ starting #11.

11:06 AM  
Blogger Ramanan said...

have to had something ...

Argentina took steps to improve exports and it may partly be due to the depreciation. However, its often forgotten and not stated.

11:39 AM  
Blogger Intrinsic said...

I agree just let the market do its thing

9:13 PM  

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