October 07, 2003

The Value of the Dollar

A correspondent writes: "What's prevented a much sharper dollar correction of late is that demand from central banks has been essentially perfectly elastic:  what the foreign private sector won't finance at current exchange rates, they will.  That came to $220 billion last year, and looks to be running ahead of that pace this year."


Posted by DeLong at October 7, 2003 03:39 PM | TrackBack


How long can they keep it up?

Posted by: Henry on October 7, 2003 05:59 PM

"Remarkable..." - Yes but logical. USA has short rates near zero, so they look to depreciate its currency for stimulus. Japan has had short rates of zero for quite some time, so they are selling Yen to depreciate it.

"How long can they keep it up?" - A central bank can sell its own currency indefinitely.

Posted by: Mats on October 8, 2003 03:35 AM

Mats is right about central banks being able to sell as much of their currency as they want, unless there are legal or technical barriers. Japan"s central bank is limited to borrowing roughly Y79 trillion for fx intervention purposes this fiscal year (which ends March 31, 2004, I believe). So far, something like Y69 trillion has been spent, so there is a technical/legal limit, for now. The mechanism for expanding that borrowing capacity is a supplemental budget, which is fairly common in Japan. So far, there have been some statements that have been at cross purposes from Japanese officials about whether expanded borrowing capacity will be needed (it pretty obviously will be). The point of each statement, however, has been to convince dollar short sellers that they will continue to face strong resistance from the Bank of Japan, in an effort to prevent the sort of speculative attack that Sterling suffered in the early 1990s.

Posted by: K Harris on October 8, 2003 05:36 AM

Mats is right. China and Japan have endless supplies of domestic currency to sell for dollars. The only question is whether the Japanese government will begin to sell Yen soon. China is busily buying dollars to keep the currency peg in place.

Posted by: anne on October 8, 2003 08:18 AM

I made a simialr argument in comments to this post. Not that I claim any special credit, just makes me feel smart...

This underlines the point that you can't talk about the sustainability of the capital inflows needed to finance the US deficit in terms of "foreign investors." The marginal purchasers of dollar assets are foreign central banks. And there are at least two reasons why, within very broad limits, their demand for dollar assets is unresponsive to expected returns:

1. Need to hold dollars as reserves to guard against currency crises. (There was an interesting article in the FT a week or two ago suggesting that you could make a conspiracy argument where the US pushes neoliberalism on Asia, leading to crises, leading to a much greater need/desire to hold dollar reserves, allowing the US to easily finance its deficits...)

2. Currency interventions, as folks noted above.

In general, as long as the dollar serves as world money, you would expect demand for dollar assets to rise in line with world trade. And since the growth rate of trade exceeds that of world (and US) output, US trade deficits ought to rise indefinitely as well. This is no more unsustainable than gold exports by gold-producing countries were in the 19th century.

Posted by: jw mason on October 8, 2003 09:10 AM

Ah -- the FT article was Martin Wolf's October 1 column, subscribers only.

Also, how come the HTNL tag supposed to be attached to "this post" disappeared?

Posted by: jw mason on October 8, 2003 09:23 AM

Interesting analogy JW Mason but I hope we all realize that at the end of the day gold is gold and paper money is just paper. If the erosion of U.S. fiat relative to 'everyone else' reaches a certain point, speculators could do a great deal of damage in a very short amount of time.

Posted by: Michael Carroll on October 8, 2003 01:18 PM

US on risky strategy to bring dollar lower

"The US administration has embarked on a risky strategy to bring down the value of the dollar as part of an effort to keep a fragile economic recovery on track."

"Analysts say the US effort could alleviate some economic woes, but that if not handled correctly could scare off foreign investors needed to finance the country's massive trade and investment deficits."


Posted by: Kosh on October 8, 2003 04:45 PM

I think you folks need a Bloomberg.

The dollar has been falling for more than a year now. That is fairly straightforward evidence that the the price elasticity of demand for the currency is NOT infinite.

Nor is the rapidly falling dollar compelling evidence that the balance of payments are a sideshow.

I realize that deficit=depreciation is a bit incomplete as a theory of foreign exchange rate determination. But your reasoning should at least take account of the trend in the currency, which has been DOWN.

Posted by: Gerard MacDonell on October 9, 2003 06:34 PM

The BoJ eased today, when the economy is arguably doing better and when there has long been some difficulty translating reserve expansion into broad money expansion (though Poole yesterday said very nice things about the BoJ's quantitative easing policy). Meanwhile, fx intervention appears to have slowed down, perhaps stopped. Some analysts are beginning to wonder whether the BoJ/MoF have, indeed, come very close to running out of borrowing authority for intervention purposes, resorting instead to easing to weaken the yen. The Diet is in recess and Koizumi has called an election for November 9, till which time there will be no opportunity to pass a supplemental budget raising the intervention borrowing limit. So again, governments can sell unlimited amounts of thier own currency, unless there are legal or technical barriers. In Japan's case, there apparently is such a barrier, for now.

Posted by: K Harris on October 10, 2003 04:15 AM
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