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Diego Zuluaga

Should the PIGS leave the Euro?

Last week, the yield on Italian bonds hit an unprecedented 6.68%, pushing up the differential with German bonds to almost 5% and forcing prime minister Silvio Berlusconi to resign this weekend amid concerns that the world’s seventh-largest economy will not be able to confront its mounting debt on its own.This new challenge to European political and economic cohesion, coupled with the European Central Bank’s inept management of the debt crisis in southern Europe and Germany’s reluctance to pick up the tab, has revived debates about the euro’s viability in the long run, prompting many to consider the implications of leaving the euro. So, what are the implications?A switch back to national currencies by Europe’s struggling southern economies (Italy, Spain, Portugal and Greece) would, for starters, return monetary and fiscal decisions to national banks, enabling these countries to, once again, handle interest rates as they saw fit. Naturally, their renewed monetary autonomy would not come without consequences. The new national currencies would quickly devalue vis-à-vis the euro in the short run reflecting investors’ lack of confidence in southern Europe’s economic future.A plunge in the currencies’ value could help countries like Italy and Spain recover competitiveness by making their goods and services cheaper on the world market. Workers and families would only be partly hurt, since foreign goods would become more expensive as national currencies lost value but domestic products (provided that inflation did not skyrocket) would remain affordable. Debtors would also be relieved significantly, since the real value of their debts would starkly diminish. At the same time, however, savers and pensioners would see their purchasing power substantially reduced, while creditors’ assets would shrink to a fraction of what they had lent in the first place.In terms of fiscal autonomy, there is no doubt that governments would have a freer hand… Read More

Romney’s trade war with China will hurt the U.S.

Mitt Romney wants to go to war with China. He has let it be known at every single Republican debate so far that, if elected President in 2012, one his first moves will be to label China a currency manipulator. If the People’s Republic does not stop its “cheating,” he threatens that further measures will ensue. Although he has not gone into specifics, one assumes that these will include protectionist barriers such as tariffs to compensate for the artificially low value of the yuan. Romney says that the Chinese stand to lose more than the United States from a trade war, given that “we [the U.S.] buy a heck of a lot more from them than they buy from us.”Every time a monetary authority prevents exchange rates from being determined by supply and demand, it is manipulating its currency. Considering that, the American Federal Reserve is as guilty as the Bank of China; over the last four decades, it has often attempted to keep interest rates low and the U.S. dollar “within a reasonable range” through open-market purchases (buying government bonds with newly printed money) and, lately, quantitative easing (which involves the purchase of financial assets from private banks). The Fed has certainly not been following “the rules that exist in a free trade society,” which is what Romney has accused China of doing. [By the way, the yuan has increased in value vis-à-vis the dollar by a monthly 0.5% since June 2010 – still not enough, but it’s a start.]Furthermore, the former Massachusetts governor’s contention that a trade war will hurt China more than America is very debatable. First of all, the primary victims of tariffs are consumers, since imports become more expensive. And considering that it is particularly lower-priced items that are produced in China (luxury goods are… Read More

Prospects for a fairer monetary regime: the failure of the gold standard

Over the next three weeks I will discuss possibilities for change in the international monetary regime.Despite the fact that the prevailing regime today, that of floating exchange rates, is theoretically market-based and does not allow for institutional manipulation, governments have often put their particular short-term interests before the system’s neutrality, increasing expenditures, fostering inflation and thereby making the majority worse off.Understanding that the impartiality of the market should not be jeopardized to benefit special interests, I will analyze the historical record of the two types of regimes which have been tried so far: the gold standard and floating rates. Given their observed flaws, I will look at the possibility of a fairer regime. Let’s start from the beginning: the gold standard.‘The gold standard’ is a monetary regime of fixed exchange rates; all participating countries under this arrangement tie their currencies to gold, meaning that they have a fixed value relative to the commodity. This also means that participating countries promise to exchange currency for gold at the customer’s request.This was how the Gold Standard functioned between 1870 and 1914; all central banks had reserves of gold which backed the currency exchanged in the system. This also meant that clients could go to the central bank and ask for their currency to be exchanged for its equivalent in gold.Following the Bretton Woods Accords at the end of World War II, the gold standard was re-established, albeit with some modifications; all currencies would now be tied to the US dollar, which would in turn be backed by gold. However less than 30 years later in 1971, the regime was abandoned in favour of floating exchange rates. Why?Some aspects of this regime can affect domestic economies. Since individuals are free to exchange their money for gold and to move that gold to another… Read More

China: The best hope for fair money?

The People’s Republic of China is set to become the world’s largest economy by 2020. Along with this title, it will have to assume new responsibilities in the international economy, among them regulating and enforcing the international monetary regime. Will it be more consistent with the free-market principles and outcomes of floating exchange rates than the United States has been? Or will it too embrace the suboptimal “dirty float”?Judging from its record, one would be inclined to the latter. China reported an inflation rate of 6.1% for September – even at a time when developed countries, by far China’s most important trade partners, are still recovering from a recession. Furthermore, the Asian giant has often been labelled a currency manipulator; mainly for its propensity to resort to open-market purchases of US dollars in order to keep the Yuan low. In any case, none of these facts reflect a commitment to monetary stability and free trade – quite the opposite, rather.However, the situation might seem graver than it actually is. Given that China’s GDP has been growing by around 10% every year for the past half-decade, a rate of inflation significantly above what we have seen from developed countries (whose GDP was growing at a yearly 3% before the recession). Moreover, as we have seen, currency manipulation (understood as the distortion of free-market exchange rates undertaken by monetary authorities) is not an exclusive practice of the Chinese central bank.In addition, it is perhaps not wise to predict a country’s future performance by reference to its past record, since its preferred methods can (and probably will) radically change as its role within the international economy changes. Take the United States, for instance. Up until the early 20th century, the US often resorted to protectionism to shield its infant industries from foreign competition,… Read More

Prospects for a fairer monetary regime: Bretton Woods and floating rates

In 1944 the US attempted to address the shortcomings of the gold standard by modifying its nature: currencies would no longer be tied to gold, but rather to the US dollar, which would itself be backed by gold. International transactions would were to be conducted in US dollars and exchange rates would be revised to account for inflation or deflation in any participating countries.This system worked for the first two decades after the Second World War, as the United States maintained a fairly stable balance of payments and was the world’s hegemonic economic superpower.As the US saw its share of global GDP decline with the emergence of new economic powers, such as Japan and West Germany, and as America’s trade deficits started to mount (especially during the Vietnam War), many became suspicious of the status quo, arguing that it was primarily a tool for the US to maintain its economic influence abroad and to export inflation. By the time President Nixon forced the gold window (the last vestige of the US dollar’s convertibility to gold) closed in 1971, the regime had largely been discredited.Its replacement, at least in theory, was to be floating exchange rates. Under floating (or fluctuating) rates, a currency’s value in terms of other currencies is subject to the forces of supply and demand, varying in response to mass speculation and countries’ fiscal situations. This was to eliminate the gold standard’s fundamental problem.Now, with governments free to follow inflationary policies, the value of their currency would fall accordingly on the market, so long as said governments were willing to bear the market consequences of their actions.This new monetary regime has some disadvantages; namely, it creates uncertainty in international monetary transactions. Since investors, when investing in foreign markets, cannot predict with accuracy what will happen to currencies’ relative… Read More
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