The RMB Has Now Moved Back to the Dollar
Wednesday, March 11th, 2009In July 2005, the Chinese government announced that it was changing its official exchange rate regime. As American politicians had been demanding, the yuan or renminbi would no longer be pegged to the dollar. Rather the authorities would:
(2) allow a margin of fluctuation in the exchange rate that, though small in any given day, could cumulate substantially over time.
The use of a new, more sophisticated, statistical equation reveals that during the course of 2007 the anchoring basket began for the first time to assign substantial weight to the euro. For a period that ran up to approximately May 2008, the anchor was a true basket that put virtually as much weight on the euro as on the dollar. There was also some limited flexibility around that anchor. When high or low international flows were working to push the currency away from the basket, the authorities would intervene, or “lean against the wind,” to push the currency back. [Frankel, 2009, forthcoming in Pacific Economic Review.])
De facto regime of RMB: 100% weight on $ ↓Some weight on won↓½ weight on $ + ½ on € ↓ ↓100% weight on $
The recent link to the dollar is visible in the flattening of the magneta line at the end. What has been the implication of the movement back toward a dollar peg over the last year? It has been to strengthen the RMB above what it would be if Beijing had stuck with the regime of 2007. Why? Because over the last year, the dollar has appreciated strongly against the euro. If the RMB had stuck with the basket peg in 2008 and 2009, it would have depreciated against the dollar (because the euro depreciated) by an estimated 14%. This would have been the opposite of what congressmen really want!
It is interesting to speculate why the Chinese monetary authorities have moved back to the dollar during the period when the US recession has worsened and gone truly global. One possibility is that the dollar feels like a security blanket to them, and its familiarity in time of crisis trumps the desire to maximize their price competitiveness on world markets. A more likely explanation is that they switched to a dollar peg sometime in 2008 because they expected that the dollar would continue to depreciate as it had in preceding years – a forecast that would not have sounded entirely unreasonable at the time, given that the financial crisis originated in the United States, on top of the preceding seven-year trend depreciation. If that is the answer, it is likely that the regime will change once again before long. But American politicians might want to think twice before demanding that the RMB abandon its link to the dollar.
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UAE and Other Gulf Countries Urged to Switch Currency Peg from the Dollar to a Basket That Includes Oil
Tuesday, July 8th, 2008
The possibility that some Gulf states, particularly the United Arab Emirates, might abandon their long-time pegs to the dollar has been getting increasing attention recently (for example, from Feldstein and, especially, Setser). It makes sense. The combination of high oil prices, rapid growth, a tightly fixed exchange rate, and the big depreciation of the dollar against other currencies (especially the euro, important for Gulf imports) was always going to be a recipe for strong money inflows and inflation in these countries. The economic dynamism — most striking in Dubai – is admirable and fascinating as a longer term phenomenon, but also now clearly shows signs of overheating. Indeed inflation has risen alarmingly, as predicted. Among other ill effects, it is producing unrest among immigrant workers. An appreciation of the dirham and riyal is the obvious solution.
Most often discussed as an alternative to the dollar peg is a peg to a basket of major currencies. This would be an improvement. Kuwait, for example, made this switch a year ago.
But a basket peg does not address the fact that when oil prices rise generally (not just against the dollar), as they have in recent years, monetary policy is constrained to be looser than it should be. Similarly, when oil prices fall generally (not just against the dollar), as they did in the 1990s, monetary policy is constrained to be tighter than it should be. A floating exchange rate regime is the traditional alternative, on the theory that the currency would then automatically appreciate when oil prices rise and depreciate when they fall, thus accommodating the terms of trade shocks. But there are serious disadvantages to small open countries floating, such as the loss of a nominal anchor for monetary policy.
Today’s reigning orthodoxy is to add an inflation target as the new nominal anchor. But this doesn’t solve the problem, if the targeted price index is the CPI, which gives little weight to oil, the biggest sector in production and exports.
I believe that a better solution would be to include the price of oil in the basket of currencies to which the Gulf currencies would peg. I have laid out the case elsewhere (including also for the case of Iraq). I call the proposal PEP, for Peg the Export Price. I was pleased to see that the FT mentioned this option approvingly yesterday (“Dollar-pegged Out,” July 7):
“The Gulf needs to peg to something. A first step (after revaluation) would be to peg to a basket of currencies that included the euro and the yen. A bolder step would be to include the price of oil in that basket, so that currencies would appreciate when oil is strong, and depreciate when it is weak.”
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