Foreign Exchange: The Complete Deal. James McDowell. Sharpe
Читать онлайн книгу.
To understand the foreign exchange systems in the 21st century we need to see where we have come from and why. In this overview I will start from the end of the First World War, which allows us to look at all the main examples of exchange rate systems up to the present day. In essence, every generation has wrestled with the same problem: namely, how to set up an effective system to determine how exchange rates should be calculated and how deficits should be financed.
No system has been without its problems, hence the variety of approaches that have been developed, although these problems have as much to do with an extraordinary passage of events in this period as to specific defects in any particular system. These events include two World Wars, the Korean War, the Vietnam War, the Cold War, the Great Depression, oil shocks and rampant inflation. Over this period the social and political landscape has changed dramatically; political accountability is now widespread and, as mentioned in the preface, events that would have been viewed as inevitable or just economic misfortune in the past are now judged to be mismanagement. For this reason I have paid particular attention to the role of central banks, especially their intervention in the markets.
While the period is littered with crises I have only covered pivotal moments, or events that illustrate a key issue. It is not intended to be a complete history of foreign exchange but rather to provide a rich insight into what actually drives the foreign exchange markets. Each generation is inclined to view its circumstances as something unprecedented or unique, but, as we will see, this is rarely the case.
At the end of the chapter, the overview of the route from fixed exchange rates to a floating rate system is followed by a specific look at the UK foreign exchange experience since 1960.
This chapter will make some reference to countries’ current accounts and, therefore, before we move on to the historical overview of the transition from fixed exchange rates to floating exchange rates, it is important to introduce the idea of current accounts here.
National current accounts
The current account of a country is made up of the difference between the worth of exports and imports (visibles) and the difference in trade in services, e.g., insurance, shipping, banking and investment income (invisibles). Current account deficits (where imports are worth more than exports) are generally seen as a sign of economic weakness, with surpluses (where exports are worth more than imports) viewed as the opposite. This is rather simplistic but it provides a useful starting point.
A current account deficit may occur because of government spending, or spending by private firms and individuals. A deficit, whoever is generating it, will need to be financed. This is either through increased borrowing overseas or by a reduction in investments overseas. Debt in itself is not bad. Borrowings may increase the productive potential of the economy, particularly in a development context. Also, debt may be rising but actually falling as a percentage of Gross National Product (GNP). This normally will not create problems.
However, if the deficit is rising as a percentage of the economy there comes a point when lenders start to worry about the risk of default and refuse to lend more. During this process the cost of borrowing will inevitably rise. Examples of this were provided by Greece, Portugal and Ireland in 2010 and 2011. This can prompt an enforced adjustment where further funding, for example from the International Monetary Fund (IMF) or European Union (EU), is conditional upon cuts in spending, including pension and welfare provisions. Apart from the economic implications – such as a short-term negative impact on employment and growth – this has a political downside as it can lead to demonstrations and civil unrest.
The US experience is a special case in so far as the US dollar is the world’s reserve currency, meaning that it is the currency most other countries use to pay their debts. Spiralling deficits, however, have raised doubts about whether this can continue. More debt will tend to lead to higher costs for the issuer and overseas investors may lose their appetite for funding the deficit by buying dollars, at least at the current exchange rate. As C. Fred Bergsten rather succinctly put it:
It has long been known that large external deficits pose substantial risks to the US economy because foreign investors might at some point refuse to finance these deficits on terms compatible with US prosperity. Any sudden stop in lending to the United States would drive the dollar down, push inflation and interest rates up, and perhaps bring on a hard landing for the United States – and the world economy at large. [1]
This was very much the concern of the US Treasury and Federal Reserve in 2008 when a collapsing dollar was putting at risk the US bond and asset markets.
When the point at which overseas investors refuse to lend any more is reached, countries are forced to return the current account to balance, usually through cutting down on imports, expanding exports, depressing domestic consumption and depressing living standards. This adjustment process is usually relatively short. However, the readjustment forces on sub-Saharan economies in the early 1980s were to have a negative impact for decades.
Some countries (such as Japan and China) run large sustained current account surpluses via the trade balance. This has benefits of increased investment income. A number of oil-producing countries have created funds for future generations from the surpluses, e.g., Norway, Kuwait and Abu Dhabi. The problem with large prolonged surpluses is that they inevitably lead to friction between countries over jobs and exports. Surpluses invested in government bonds are not especially politically sensitive as they have little visibility to the electorate but this soon changes when iconic buildings and flagship companies are bought.
In the 2000s, China has regularly faced accusations of an undervalued currency, manipulated by the authorities, being used to generate enormous surpluses. This has been hotly disputed by the Chinese authorities who, nevertheless, most notably from 2003, have regularly sold the Chinese Renminbi and bought dollars. These imbalances are effectively a savings gap. The US consumes too much, and saves too little; China is saving too much and forgoing consumption. In this context Chinese savings are being used to plug the US deficit through US Treasury purchases.
These imbalances create volatility in the foreign exchange markets in times of crisis as investors repatriate funds (such as in 2008) and if it is felt the currency valuation is seriously at odds with fair value. Global imbalances require global solutions but to date political consensus has not been achieved. Policies that have a negative impact on domestic employment, even in the short term, are not easily embraced. In practice the situation early in the 21st century is not that different to the 1930s, when countries looked to devalue their currencies in order to gain competitive advantage.
A natural partner to protectionism is a global economic and financial crisis leading to a sharp drop in global trade volumes. The 1930s is an obvious example but trade tensions were very evident in 2002 (following the 2001 recession) and in 2009. An indicator in the last two cases is the number of complaints to the World Trade Organisation (WTO), which rose sharply. For example, Europe was increasingly vocal on China. European Central Bank (ECB) President Trichet said in March 2010: “the message is that progressive and orderly appreciation of the Chinese currency would be both in the interest of China and the interest of the global economy”.
There are no recent examples of a full trade war but the impact can be surmised. Protectionist policies will reduce the potential growth of an economy and in a global economic recession protectionism can lengthen the downturn and hinder any recovery. The leading industrialised nations (the members of the G7 and G20) have increasingly looked to the IMF to provide currency surveillance to prevent such circumstances, but not a great deal has come of this as yet.
With the concept of the current account and its importance introduced, I now move on to the overview of exchange rate systems since 1918. This begins with a look at fixed exchange rates.
Fixed exchange rates
A fixed exchange rate system is one where a currency has a fixed value against another currency or commodity. The implied purpose of fixed exchange rate systems is to unite the global economic performance and policies of nations. The best known example of a fixed system was the gold standard