Wednesday, December 14, 2005

The view from the PBOC

From an interview with Yu Yongding, an Oxford-trained economist who sits on the Monetary Policy Committee of the People's Bank of China. Who can doubt that everyone sees the handwriting on the wall? He clearly understands the inevitability of dollar devaluation, the need for Asian countries to dump those dollars, the prisoner's dilemma problem that central banks of China, Taiwan, Japan and Korea have, etc. Barring a disaster in Asia (China invades Taiwan, N-S Korea conflict, etc.), I predict a 2x devaluation of the dollar against E. Asian currencies over the next decade. Sorry that prediction is not precise enough to trade on :-)

(See here for previous posts on Bretton Woods II and dollar devaluation.)

" the first stage we must reduce accumulation, then later we should reduce our reserves....[China and Asian countries] don't need that large an amount- more than $2 trillion- of foreign exchange reserves.... This is a very big problem and I think the Chinese government should take some action to reduce the growth rate of the accumulation of foreign exchange reserves as we're still facing the possibility of a big devaluation of the US dollar, so the capital losses will be huge. If that happens, it will be tremendous hit to the Chinese economy."

This is hardly the statement of a gentleman with a benign view toward the US dollar's valuation. It is instead a gentleman, in a position of authority, with a great deal of concern. He went on: "The trouble is, with such a huge amount of foreign exchange reserves, that there is no way to spend it very quickly and there's no plan to sell it of course-- otherwise that inflicts damage on ourselves. You don't want to dump shares when the stock market has not collapsed yet and you are the biggest shareholder." Then, he said "all east Asian countries have tremendous foreign exchange reserves and they all want to get rid of them, but if you do this then you cause competitive devaluation, not of their own currencies, but of the US dollar. So we should do this in an orderly fashion. If Asian countries moved too fast, everyone would lose... It would be utterly unfortunate if Japan sells a proportion [of their reserves, for] that causes problems. Then China panics and China sells a proportion -- it would be very damaging."

The "nicest possibility" for China, Japan and the US to escape this problem was for further "tightening of US monetary policy so that further dramatic devaluation of the US dollar can be stopped. Then, because of the slowdown in the economy, the US current account deficit would reduce and in this way will create conditions for East Asian countries to get off the hook."


Seth said...

I'll admit to being a bit obsessed with the question of what the Asian central bankers plan to do with their dollar stockpiles. But our cash is flowing other places as well (OPEC for example).

Why "2x devaluation" rather than some other number?

PPP seems to suggest an even more dramatic devaluation (at least vs. China), but I suppose the PPP approach would provide a sort of lower bound. The reserve currency effect, plus other factors clubbed under the new "dark matter" rubric would justify a premium.

Got any arguments beyond this sort of heuristic reasoning?

Steve Hsu said...

I just made the 2x up, but it is consistent with dollar-yen in the aftermath of the Plaza Accord (see graph here).

PPP does give a good bound on what can happen. I discuss some related issues in earlier posts.

See Brad Setser's blog for more detailed analysis. Roubini and Setser argued very strongly for a dollar collapse in an academic paper about a year ago.

Mike Reardon said...

The capitalist advanced nations transfer of tech to lower wage nations is working well for them and us as I see it. Now would be a good time for the Asian nations and India to invest their reserves under the IMF G8 direction in other under nations to extract more commodities to fill their growing demand.

The cover under IMF G8 could bring advanced nations skills in oil exploration and production and mining development and still lead control of these commodities into Asian need.

The dollar going to be held up by the fed funs rate, out front of any other interest rate. It give us inflation and foreign investors a greater return. Can't give you a why but you can see that from 3000 ft.

Seth said...


I've been reading Setser for a while now. Also Obstfeld & Rogoff and Blanchard, Giavazzi & Sa have models for the possible extent of depreciation. Numbers range pretty widely from 20%-ish to 60%-ish.

Certainly the FF rate is a short term prop to the dollar. Longer term, the reserve currency effect seems the biggest missing variable from the models.

But there's that Plaza Accord graph to consider -- NO, the dollar isn't likely to lose reserve currency status, but YES, the dollar *can* nevertheless drop 50% in a year or two against key trading partners.

A picture (or graph) is truly worth 1000 words (especially words written by economists) ;)

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