Economics Essay 57: Exchange Rates

 Explain the factors that might cause a country’s exchange rate to depreciate.

Exchange rate systems can be broadly classified into two categories: fixed exchange rate systems and floating exchange rate systems.

1. Fixed Exchange Rate Systems: In a fixed exchange rate system, the value of a country's currency is pegged to another currency or a basket of currencies. The exchange rate is kept relatively stable through the intervention of the central bank. Examples include currency boards and currency unions like the Eurozone.

2. Floating Exchange Rate Systems: In a floating exchange rate system, the value of a country's currency is determined by market forces of supply and demand. The exchange rate fluctuates freely based on various factors, including economic conditions, interest rates, trade balances, and investor sentiment. Most major economies, including the United States and Japan, operate under a floating exchange rate system.

A reduction in the value of a currency in the Fixed Rate System is called Devaluation while Depreciation happens in a Floating Exchange System. Now, let's explore the factors that can cause a country's exchange rate to depreciate:

1. Interest Rate Differentials: Higher interest rates in one country compared to others can attract foreign investors seeking better returns. This increased demand for the country's currency can drive its value up. Conversely, lower interest rates can make the currency less attractive, leading to depreciation.

2. Inflation Rates: High inflation erodes the purchasing power of a currency, making it less desirable. Countries experiencing higher inflation rates relative to their trading partners may see a depreciation in their exchange rate.

3. Current Account Deficits: A current account deficit occurs when a country imports more goods and services than it exports. This results in a net outflow of the country's currency, increasing its supply in the foreign exchange market. The increased supply can lead to a depreciation of the currency.

4. Political and Economic Stability: Uncertainty surrounding a country's political or economic stability can negatively impact investor confidence. Investors may sell off the country's currency, leading to a depreciation. Factors such as political unrest, policy uncertainty, or economic crises can contribute to a decline in the exchange rate.

5. Speculation: Speculative trading activities in the foreign exchange market can influence exchange rates. Traders may speculate on the future value of a currency based on economic indicators, news, or market sentiment. If speculation suggests that a currency will depreciate, it can trigger selling pressure and lead to an actual depreciation.

It is important to note that exchange rates are influenced by a complex interplay of various factors, and their movements can be volatile and unpredictable. Additionally, government interventions, such as central bank actions or currency market interventions, can also impact exchange rates in the short term.

Overall, the factors discussed above, along with other economic and market forces, can cause a country's exchange rate to depreciate in a floating exchange rate system. However, in a fixed exchange rate system, the exchange rate is generally maintained at a stable level through central bank interventions, which aim to prevent significant fluctuations in the value of the currency.

The £ Sterling’s faded illusion of sovereignty

Philip Stephens in The FT

Margaret Thatcher once told me that she would never allow “the Belgians” to decide the value of the British pound. At the time, the then prime minister was battling her chancellor Nigel Lawson’s plan to fix the value of sterling in the European exchange rate mechanism. For some reason she had identified me as one of the chancellor’s confidants. “The Belgians”, equally inexplicably, was her shorthand for the EU.  

The fight cost the chancellor his job, but a year or so later Thatcher was obliged to relent. Two years after it joined the ERM, sterling crashed out of the system amid a tsunami of speculative selling. 

Thatcher by then had gone, replaced by John Major. Even so, the pound became an inviolable emblem of national sovereignty in the Conservative party’s long war with Brussels. Before too long, another Tory leader, William Hague, was promising to “save” sterling from the euro. Black Wednesday, you could say, mapped the Tory route to the Brexit vote in 2016.

I was reminded of the Thatcher encounter by a report published the other day by analysts at Bank of America. Since the Brexit referendum, the pound has rather lost its lustre as a store of value. It no longer bears comparison, the analysts said, with traditional peers such as the dollar, yen, swiss franc or euro. Instead, sterling may more closely resemble an emerging market currency, such as the Mexican peso. Sterling’s effective exchange rate has fallen by about 14 per cent since 2016, but twin budget and current account deficits promise further trouble.  

In truth, Thatcher’s elevation of the pound into an essential pillar of nationhood belied its postwar role in Britain’s fortunes. For decades, an ever-present threat of devaluation was a ball-and-chain around the ankles of successive prime ministers. In 1945, about half the world’s trade was still transacted in sterling. From then on, it was all downhill.  

The failed effort to defend Britain’s global prestige through preservation of the so-called sterling balances held by overseas central banks and financial institutions left governments at the mercy of international investors and speculators. 

It also produced a series of politically costly devaluations. In 1950, one pound bought about 12 Deutsche Marks. In the absence of the euro, the comparable figure today would be a little above two. 

In effect, pressure on the pound measured the gap between Britain’s determination to hold on to its status as a world power, and the capacity of a stuttering domestic economy to generate sufficient resources to match its overseas ambitions and commitments. The price of propping up the pound was a ruinous stop-go approach to domestic economic management. 

It was no coincidence that the devaluation that was forced on Harold Wilson’s government in 1967 sounded the final retreat from imperial pretensions with the subsequent withdrawal of British forces from east of Suez. 

In the circumstances, one might think that sterling would have lost its talismanic status long ago. The sovereignty so preciously guarded by the Brexiters is an illusion. The truth Thatcher could never admit was that the appearance of national control does not change the facts of foreign exchange markets. The pound’s exchange rate, fixed or otherwise, ultimately depends on the confidence, or otherwise, of foreign investors in the nation’s political stability and economic performance — and, yes, that includes the Belgians. 

Mark Carney, the former governor of the Bank of England, has also remarked on how sterling has “decoupled” from its usual peers. Bank of America’s grim prognosis, however, is not universally shared among financial institutions. 

Some think the pound’s present exchange rate anticipates more economic disruption after the expiry of the Brexit transitional arrangements. In the short term, the conclusion of even a fairly thin trade deal with the EU27 could see a temporary appreciation. 

That said, trade deal or no deal, and even assuming a relatively robust recovery from the coronavirus-induced recession, Brexit will throw up new barriers to trade with Britain’s most important market. This promises in turn lower-than-otherwise economic growth, and a widening of the current account deficit. It is hard to find reasons for a positive view of the pound over the medium to long-term. 

The government, of course, could treat sterling’s move to the sidelines as something of a liberation. For now, it has little problem financing its burgeoning government deficit. Devaluation would also provide at least a temporary route to improved competitiveness. It could even pretend, as Wilson did, that a weak currency does not cut living standards. 

I am not sure this would sit alongside Boris Johnson’s expansive pledge to turn Brexit into the platform for the relaunch of “Global Britain”. The prime minister, I am told, is emotionally sympathetic to grand talk about carving out a new role in the Gulf and beyond. 

But no one knows where the money would come from. 

One way or another, sterling holds up a mirror to the world’s view of Britain. The signals are not encouraging. In the 1970s, the UK earned the sobriquet of “the sick man of Europe”. The danger now is it will become the invalid on Europe’s edge.

Is there any way for Pakistan’s Financial Bailout?

Currency wars are nothing new – but who will be the casualty of the next?

Satyajit Das in The Independent

Wars frequently take place over years, with shifts in theatres, strategy, and tactics.

The current currency wars began in 2009. Badly affected by the sub-prime crisis, the US cut interest rates dramatically and subsequently launched 3 waves of QE. Between March 2009 and August 2011, the US dollar fell by around 16 per cent on a trade weighted basis against major currencies. With its banks exposed to the 2008 financial crisis, the UK adopted similar policies resulting in a sharp fall in the Pound Sterling.

There were counter-attacks commencing late 2011/early 2012. The European debt crisis forced the European Central Bank (“ECB”) to cut rates and then launch its own version of QE. Between 2011 and 2012, the Euro fell by over 25 per cent against the US dollar. As part of Prime Minister Shinzo Abe’s economic program, the Bank of Japan (“BoJ”) expanded its QE programs, weakening the Yen, which fell by over 30 per cent between 2012 and 2015.

There were side skirmishes. After 2014, falling oil prices and diplomatic conflict with the West over the Ukraine and resulting sanctions caused a sharp fall in the Rouble. Since 2011, the Indian Rupee has lost half its value. Falling commodity prices weakened the Canadian, Australian and New Zealand dollars, Brazilian Real and South African Rand.

The battles themselves have been inconclusive. The US recovery was assisted by the weaker dollar which increased exports. But investment in the shale oil boom, growth in emerging markets, budget deficits and also prompt action to deal with banking problems were crucial. In Europe and Japan, fiscal stimulus, demand from emerging markets and a lower commodity, especially oil, prices were arguably as important as the fall in the Euro and Yen in stabilising economic activity.

The complex impact of devaluations can be seen from the case of the UK. The sharp drop in the pound after 2007 was expected to increase exports. In the early 1990s, it stimulated activity pulling the country out recession. The lower pound, this time, improved the balance of trade but not sufficiently to offset declining domestic demand and the higher cost of imports. The muted effect was driven by the lack of external demand from major trading markets such as the US and Europe, the changed structure of UK industry with its focus on services rather than raw materials, advanced machinery, automobiles and luxury goods demanded by emerging markets, and the decline in North Sea oil and gas production.

The divergence in economic cycles between various major economies caused a change in fortunes. Between August 2011 and July 2014, the US dollar rose by 11 per cent on a trade weighted basis. By January 2016, it had risen a further 25 per cent because of a strengthening US economy, anticipation of higher interest rates and the deliberate weakening of the Euro and Yen.

The rise slowed the US economy. It created pressure on emerging market borrowers with substantial US dollar debt not covered by cash flows or assets in the currency. The stronger dollar placed pressure on already weak commodity prices and resulted in a revaluation of the Yuan which is linked to the American currency.

At the March 2016 G20 Shanghai Summit, the leading economies recognised the stresses. There are suggestions that there was agreement to lower the value of the dollar. Between January and July 2016, the US dollar declined by around 5 per cent. But the accord, if there was one, unravelled quickly. At the G7 Finance Minister’s Meeting in May 2016, Japan clashed with the US on the issue of currency valuation. The dollar’s fall reversed, exposing problems for the US and global economy.

The war is entering a more dangerous phase. Gold, which now functions as a de facto currency, has risen in value anticipating the currency crisis which appears increasingly unavoidable.

Japan and Europe are likely to further ease monetary policy weakening their currencies to address the lack of growth and low inflation. For Europe, the immediate effect of the Brexit decision and the depreciation of the pound is an additional consideration. China needs to devalue to help manage a slowing economy, property bubble, industrial overcapacity, fragile banking system and export-dependent, debt-based economic model.

Policy makers risk losing control. A falling Yen or Euro could force China to retaliate by devaluing the Yuan significantly. Other countries, especially in Asia where currencies are directly or indirectly pegged to the dollar, are likely to be forced to take measures to counter the effects of the stronger US dollar and a loss of competitiveness against the Euro, Yen or Yuan.

The currency wars will spill over into interest rate markets. Central banks globally will be forced into accommodative monetary policies to avoid large capital inflows seeking higher returns pushing up the currency. Sharp falls in interest rates anticipates this trajectory.

Low rates will increase risk in already over-valued asset markets. They will be reinforced by deflationary pressures as countries, such as China, with excess production capacity undercut competitors. Political responses, such as a declaration by the US of Europe, Japan and China as currency manipulators or reporting countries to the WTO for violation of dumping rules, will add a geo-political dimension.

In foreign exchange wars as in military versions, there are no winners. A weaker dollar means that the rest of the world loses. Japan and the Euro zone benefit from a stronger dollar but the US loses. At the same time if the Euro and Yen weaken, then as the dollar rises China loses because the Yuan appreciates. If a country lowers rates to weaken their currency to improve export competitiveness, there is a risk of capital flight, which may weaken the domestic economy. If a country takes no action and their currency appreciates due to aggressive measures from competing nations, then exports suffer as competitors gain market share. It will end, as it does always, in stalemate with major casualties on all sides.

George Soros on the consequences of Brexit

George Soros in The Guardian

David Cameron, along with the Treasury, the Bank of England, the International Monetary Fund and others have been attacked by the leave campaign for exaggerating the economic risks of Brexit. This criticism has been widely accepted by the British media and many financial analysts. As a result, British voters are now grossly underestimating the true costs of leaving.

Too many believe that a vote to leave the EU will have no effect on their personal financial position. This is wishful thinking. It would have at least one very clear and immediate effect that will touch every household: the value of the pound would decline precipitously. It would also have an immediate and dramatic impact on financial markets, investment, prices and jobs.

As opinion polls on the referendum result fluctuate, I want to offer a clear set of facts, based on my six decades of experience in financial markets, to help voters understand the very real consequences of a vote to leave the EU.

The Bank of England, the Institute for Fiscal Studies and the IMF have assessed the long-term economic consequences of Brexit. They suggest an income loss of £3,000 to £5,000 annually per household – once the British economy settles down to its new steady-state five years or so after Brexit. But there are some more immediate financial consequences that have hardly been mentioned in the referendum debate.

To start off, sterling is almost certain to fall steeply and quickly if there is a vote to leave– even more so after yesterday’s rebound as markets reacted to the shift in opinion polls towards remain. I would expect this devaluation to be bigger and more disruptive than the 15% devaluation that occurred in September 1992, when I was fortunate enough to make a substantial profit for my hedge fund investors, at the expense of the Bank of England and the British government.

It is reasonable to assume, given the expectations implied by the market pricing at present, that after a Brexit vote the pound would fall by at least 15% and possibly more than 20%, from its present level of $1.46 to below $1.15 (which would be between 25% and 30% below its pre-referendum trading range of $1.50 to $1.60). If sterling fell to this level, then ironically one pound would be worth about one euro – a method of “joining the euro” that nobody in Britain would want.

Brexiters seem to recognise that a sharp devaluation would be almost inevitable after Brexit, but argue that this would be healthy, despite the big losses of purchasing power for British households. In 1992 the devaluation actually proved very helpful to the British economy, and subsequently I was even praised for my role in helping to bring it about.

But I don’t think the 1992 experience would be repeated. That devaluation was healthy because the government was relieved of its obligation to “defend” an overvalued pound with damagingly high interest rates after the breakdown of the exchange rate mechanism. This time, a large devaluation would be much less benign than in 1992, for at least three reasons.

First, the Bank of England would not cut interest rates after a Brexit devaluation (as it did in 1992 and also after the large devaluation of 2008) because interest rates are already at the lowest level compatible with the stability of British banks. That, incidentally, is another reason to worry about Brexit. For if a fall in house prices and loss of jobs causes a recession after Brexit, as is likely, there will be very little that monetary policy can do to stimulate the economy and counteract the consequent loss of demand.

Second, the UK now has a very large current account deficit – much larger, relatively, than in 1992 or 2008. In fact Britain is more dependent than at any time in history on inflows of foreign capital. As the governor of the Bank of England Mark Carney said, Britain “depends on the kindness of strangers”. The devaluations of 1992 and 2008 encouraged greater capital inflows, especially into residential and commercial property, but also into manufacturing investments. But after Brexit, the capital flows would almost certainly move the other way, especially during the two-year period of uncertainty while Britain negotiates its terms of divorce with a region that has always been – and presumably will remain – its biggest trading and investment partner.

Third, a post-Brexit devaluation is unlikely to produce the improvement in manufacturing exports seen after 1992, because trading conditions would be too uncertain for British businesses to undertake new investments, hire more workers or otherwise add to export capacity.

For all these reasons I believe the devaluation this time would be more like the one in 1967, when Harold Wilson famously declared that “the pound in your pocket has not been devalued”, but the British people disagreed with him, quickly noticing that the cost of imports and foreign holidays were rising sharply and that their true living standards were going down. Meanwhile financial speculators, back then called the Gnomes of Zurich, were making large profits at Britain’s expense.

Today, there are speculative forces in the markets much bigger and more powerful. And they will be eager to exploit any miscalculations by the British government or British voters. A vote for Brexit would make some people very rich – but most voters considerably poorer.

I want people to know what the consequences of leaving the EU would be before they cast their votes, rather than after. A vote to leave could see the week end with a Black Friday, and serious consequences for ordinary people.

Is China really devaluing its currency?

China's foreign exchange reserves have fallen from a gigantic $4 trillion in the first half of 2014 to around $3.2 trillion today Photo: Reuters

By Mehreen Khan in The Telegraph

What's happened to the renminbi?

Since the summer, investors have been keeping an uneasy eye on the value of the Chinese currency.

In August, Beijing decided to tweak its exchange rate peg with the dollar, making the renminbi float in a wider band against the greenback.

This sparked immediate market panic that China was entering into the world's currency wars.

But the devaluation in itself was small. Allaying fears further, the Chinese began to immediately intervene to prop up the RMB to stop it falling too fast by drawing down their reserves.

But devaluation fears are returning. The country's export performance has stuttered, while the dollar has rocketed on the back of a stronger US economy.

In response, on January 7, authorities set their "daily fix" against the dollar 0.51pc lower. This was the single biggest move since August and set off a new bout of mass stock market hysteria.

Overall, the RMB has weakened by around 10pc against the dollar over the last two years.

"Over half of the weakness has come in the last four months," says Sean Yokota at SEB.

"We are heading to 6.83; the level China pegged to the dollar post the global financial crisis of 2008."

Kevin Lai at Daiwa Capital expects the RMB to fall even further. He forecasts it will hit 7.50 by the end of the year.

"There is likely still to be plenty of depreciation to come," he said.

Does it really matter?

China has said it is not in the business of competitive currency devaluation.

The central bank, The People's Bank of China (PBOC), has said its main exchange rate target is against a broader basket of currencies and it's not fixated on the greenback.

The PBOC has repeated this claim again, saying that it is happy to let the yuan-to-dollar rate have a more "market determined value".

It wants to ensure that when measured against a wider basket of currencies - which includes sterling and the yen - the RMB remains "stable."

What's happened to the trade weighted value?

In worrying signs for the Politburo, the RMB's weakness is being reflected across the board - and not just against the dollar.

The chart below shows how the exchange rate against a basket of currencies has broadly tracked the dollar rate since the start of last summer.

Are the Chinese losing control?

Beijing has been intervening heavily to support its currency and latest evidence suggests it has been drawing down on its reserves on a massive scale.

The latest December figures show reserves fell by a record $108bn. Such steep falls are also evidence of worsening capital flight in the country.

Net outflows reached $140bn last month, surpassing the previous peak seen in August, says Mark Williams, at Capital Economics.

The Communist party has responded to mass capital outflows by using the full force of the state to punish those it accuses of "illegal cash transfers" out of the country.

Some claim that the Chinese are beginning to lose control over their exchange rate and their economic policy.

Burning through reserves exerts a tightening effect on the economy. This has been offset in the past by cutting interest rates. However, rate cuts only hasten capital outflows and so the vicious cycle continues.

China's exchange rate policy, it could be said, has put the country in a bind.

Currency wars in emerging markets hammer global stocks

 Ben Chu in The Independent

Developing world devaluations have sent global stock markets into a funk and stoked fears of an intensifying global currency war.

In response to China’s surprise devaluation of the yuan last week, several emerging market economies have slashed the value of their own currencies to retain their competitiveness.

Kazakhstan’s tenge lost 24 per cent of its value against the dollar after the country’s central bank announced that it would allow the currency to float freely. Meanwhile, South Africa’s rand slid to its weakest level against the dollar in 14 years and Malaysia’s ringgit fell to its lowest level against the greenback in 17 years. Turkey’s lira and the Russian rouble also dropped.

This followed the decision by Vietnam on Wednesday to cut the value of the dong against the dollar by 1 per cent, the country’s third devaluation of the year. Since Beijing’s yuan devaluation last week, an index of 20 developing-nation exchange rates has been falling fast.

The ructions depressed the FTSE100, pushing the index down into technical “correction” territory, more than 10 per cent below its April peak. Year-to-date, the benchmark index of UK-listed shares, is down 2.9 per cent. The S&P 500 also quickly fell 1.2 per cent after trading opened in America, wiping out all of the US index’s gains made this year.

Last week, the People’s Bank of China caught markets napping by allowing the yuan to fall in value against the dollar by 4 per cent in two days. The perception that the world’s single biggest customer for raw materials is in economic difficulties has stoked fear over the prospects of big commodity producing economies like Kazakhstan, Russia, Brazil, South Africa and Malaysia. The slumping global oil price has also hammered investor confidence in the prospects of the big energy exporters.


“The appearance of China weakening its exchange rate to boost growth has added urgency for policymakers elsewhere to do what they can to grab more export revenue” said Koon Chow, of Union Bancaire Privée.

Many analysts expect further global devaluations if the US Federal Reserve, as expected, increases interest rates for the first time since the financial crisis later this year. “Emerging market currencies, in general, still have high devaluation risks” said analysts at CrossBorder Capital. Analysts predicted the likes of Egypt and Nigeria could be next to devalue their currencies.

Per Hammarlund, of Sweden’s SEB, said Kyrgyzstan, Turkmenistan and Tajikistan could allow their currencies to depreciate by between 10 and 20 per cent. “They simply don’t have much of a choice but to follow Russia and emerging markets more generally,” he said.

Capital has been flowing out of emerging markets at a rapid rate this year, as fears rise of a sharp slowdown in the former stars of the global economy. Over the past 13 months $1 trillion is estimated to have flowed out of the 19 largest emerging countries.
The International Monetary Fund expects global growth among emerging markets and developing economies to be just 4.2 per cent this year, the weakest output growth since 2009.

Nariman Behravesh, of IHS Global Insight, said emerging markets are arguably facing “the toughest environment since the Asia Crisis of the late 1990s” and predicted that they will drag on global growth into next year.

China cannot risk the global chaos of currency devaluation

"The world economy is sailing across the ocean without any lifeboats to use in case of emergency" Photo: Bloomberg

 By Ambrose Evans-Pritchard in The Telegraph (How wrong he was - the Chinese devalued the yuan for three consecutive days as on 13 August 2015)

  12 Aug 2015

If China really is trying to drive down its currency in any meaningful way to gain trade advantage, the world faces an extremely dangerous moment.


Such desperate behaviour would send a deflationary shock through a global economy already reeling from near recession earlier this year, and would risk a repeat of East Asia's currency crisis in 1998 on a larger planetary scale.


China's fixed investment reached $5 trillion last year, matching the whole of Europe and North America combined. This is the root cause of chronic overcapacity worldwide, from shipping, to steel, chemicals and solar panels.


A Chinese devaluation would export yet more of this excess supply to the rest of us. It is one thing to do this when global trade is expanding: it amounts to beggar-thy-neighbour currency warfare to do so in a zero-sum world with no growth at all in shipping volumes this year.










It is little wonder that the first whiff of this mercantilist threat has set off an August storm, ripping through global bourses. The Bloomberg commodity index has crashed to a 13-year low.

Europe and America have failed to build up adequate safety buffers against a fresh wave of imported deflation. Core prices are rising at a rate of barely 1pc on both sides of the Atlantic, a full six years into a mature economic cycle.

One dreads to think what would happen if we tip into a global downturn in these circumstances, with interest rates still at zero, quantitative easing played out, and aggregate debt levels 30 percentage points of GDP higher than in 2008.

"The world economy is sailing across the ocean without any lifeboats to use in case of emergency," said Stephen King from HSBC in a haunting reportin May.

Whether or not Beijing sees matters in this light, it knows that the US Congress would react very badly to any sign of currency warfare by a country that racked up a record trade surplus of $137bn in second quarter, an annual pace above 5pc of GDP. Only deficit states can plausibly justify resorting to this game.

Senators Schumer, Casey, Grassley, and Graham have all lined up to accuse Beijing of currency manipulation, a term that implies retaliatory sanctions under US trade law.

Any political restraint that Congress might once have felt is being eroded fast by evidence of Chinese airstrips and artillery on disputed reefs in the South China Sea, just off the Philippines.

It is too early to know for sure whether China has in fact made a conscious decision to devalue. Bo Zhuang from Trusted Sources said there is a "tug-of-war" within the Communist Party.

All the central bank (PBOC) has done so far is to switch from a dollar peg to a managed float. This is a step closer towards a free market exchange, and has been welcomed by the US Treasury and the International Monetary Fund.

The immediate effect was a 1.84pc fall in the yuan against the dollar on Tuesday, breathlessly described as the biggest one-day move since 1994. The PBOC said it was a merely "one-off" technical adjustment.



If so, one might also assume that the PBOC would defend the new line at 6.32 to drive home the point. What is faintly alarming is that the central bank failed to do so, letting the currency slide a further 1.6pc on Wednesday before reacting.

The PBOC put out a soothing statement, insisting that "currently there is no basis for persistent depreciation" of the yuan and that the economy is in any case picking up. So take your pick: conspiracy or cock-up.

The proof will now be in the pudding. The PBOC has $3.65 trillion reserves to prevent any further devaluation for the time being. If it does not do so, we may legitimately suspect that the State Council is in charge and has opted for covert currency warfare.

Personally, I doubt that this is the start of a long slippery slide. The risks are too high. Chinese companies have borrowed huge sums in US dollars on off-shore markets to circumvent lending curbs at home, and these are typically the weakest firms shut off from China's banking system.








Hans Redeker from Morgan Stanley says short-term dollar liabilities reached $1.3 trillion earlier this year. "This is 9.5pc of Chinese GDP. When short-term foreign debt reaches this level in emerging markets it is a perfect indicator of coming stress. It is exactly what we saw in the Asian crisis in the 1990s," he said.

Devaluation would risk setting off serious capital flight, far beyond the sort of outflows seen so far - with estimates varying from $400bn to $800bn over the last five quarters.

This could spin out of control easily if markets suspect that Beijing is itself fanning the flames. While the PBOC could counter outflows by running down reserves - as it is already doing to a degree, at a pace of $15bn a month - such a policy entails automatic monetary tightening and might make matters worse.








The slowdown in China is not yet serious enough to justify such a risk. True, the trade-weighted exchange rate has soared 22pc since mid-2012, the result of being strapped to a rocketing dollar at the wrong moment. The yuan is up 60pc against the Japanese yen.

This loss of competitiveness has been painful - and is getting worse as the shrinking supply of migrant labour from the countryside pushes up wages - but it was not the chief cause of the crunch in the first half of the year.

The economy hit a brick wall because monetary and fiscal policy were too tight. The authorities failed to act as falling inflation pushed one-year borrowing costs in real terms from zero in 2011 to 5pc by the end of 2014.








They also failed to anticipate a “fiscal cliff” earlier this year as official revenue from land sales collapsed, and local governments were prohibited from bank borrowing -- understandably perhaps given debts of $5 trillion, on some estimates.

The calibrated deleveraging by premier Li Keqiang simply went too far. He has since reversed course. The local government bond market is finally off the ground, issuing $205bn of new debt between May and July. This is serious fiscal stimulus.

Nomura says monetary policy is now as loose as in the depths of the post-Lehman crisis. Its 'growth surprise index' for China touched bottom in May and is now signalling a “strong rebound”.

Capital Economics said bank loans jumped to 15.5pc in June, the fastest pace since 2012. "There are already signs that policy easing is gaining traction," it said.

It is worth remembering that the authorities are no longer targeting headline growth. Their lode star these days is employment, a far more relevant gauge for the survival of the Communist regime. On this score, there is no great drama. The economy generated 7.2m extra jobs in the first half half of 2015, well ahead of the 10m annual target.

Few dispute that China is in trouble. Credit has been stretched to the limit and beyond. The jump in debt from 120pc to 260pc of GDP in seven years is unprecedented in any major economy in modern times.

For sheer intensity of credit excess, it is twice the level of Japan's Nikkei bubble in the late 1980s, and I doubt that it will end any better. At least Japan was already rich when it let rip. China faces much the same demographic crisis before it crosses the development threshold.

It is in any case wrestling with an impossible contradiction: aspiring to hi-tech growth on the economic cutting edge, yet under top-down Communist party control and spreading repression. That way lies the middle income trap, the curse of all authoritarian regimes that fail to reform in time.

Yet this is a story for the next fifteen years. The Communist Party has not yet run out of stimulus and is clearly deploying the state banking system to engineer yet another mini-cycle right now. One day China will pull the lever and nothing will happen. We are not there yet.

Greece is a sideshow. The eurozone has failed, and Germans are its victims too

'This is what the noble European project is turning into: a grim march to the bottom. This isn’t about creating a deeper democracy, but deeper markets.' Photograph: Matt Kenyon

 Aditya Chakrabortty in The Guardian

Nearly every discussion of the Greek fiasco is based on a morality play. Call it Naughty Greece versus Noble Europe. Those troublesome Greeks never belonged in the euro, runs this story. Once inside, they got themselves into a big fat mess – and now it’s up to Europe to sort it all out.

Eurozone creditors raise hopes of Greek bailout deal

Read more

Those are the basics all Wise Folk agree on. Then those on the right go on to say feckless Greece must either accept Europe’s deal or get out of the single currency. Or if more liberal, they hem and haw, cough and splutter, before calling for Europe to show a little more charity to its southern basketcase. Whatever their solution, the Wise Folk agree on the problem: it’s not Brussels that’s at fault, it’s Athens. Oh, those turbulent Greeks! That’s the attitude you smell when the IMF’s Christine Lagarde decries the Syriza government for not being “adult” enough. That’s what licenses the German press to portray Greece’s finance minister, Yanis Varoufakis, as needing “psychiatric help”.

There’s just one problem with this story: like most morality tales, it shatters upon contact with hard reality. Athens is merely the worst outbreak of a much bigger disease within the euro project. Because the single currency isn’t working for ordinary Europeans, from the Ruhr valley to Rome.

On saying this, I don’t close my eyes to the endemic corruption and tax-dodging in Greece (nor indeed, does the outsiders’ movement Syriza, which came to power campaigning against just these vices). Nor am I about to don Farage-ist chalkstripes. My charge is much simpler: the euro project is not only failing to deliver on the promises of its originators, it’s doing the exact opposite – by eroding the living standards of ordinary Europeans. And as we’ll see, that’s true even for those living in the continent’s number one economy, Germany.

First, let’s remind ourselves of the noble pledges made for the euro project. Let’s play the grainy footage of Germany’s Helmut Schmidt and France’s Giscard d’Estaing, as they lay the foundations for Europe’s grand unifier. Most of all, let’s remind ourselves of what the true believers felt. Take this from Oskar Lafontaine, Germany’s minister of finance, on the very eve of the launch of the euro. He talked of “the vision of a united Europe, to be reached through the gradual convergence of living standards, the deepening of democracy, and the flowering of a truly European culture”.

 We could quote a thousand other such stanzas of euro-poetry, but that single line from Lafontaine shows how far the single-currency project has fallen. Instead of raising living standards across Europe, monetary union is pushing them downwards. Rather than deepening democracy, it is undermining it. As for “a truly European culture”, when German journalists accuse Greek ministers of “psychosis”, that mythic agora of nations is a long way off.

Of all these three charges, the first is most important – because it explains how the entire union is being undermined. To see what’s happened to the living standards of ordinary Europeans, turn to some extraordinary research published this year by Heiner Flassbeck, former chief economist at the United Nations Conference on Trade and Development, and Costas Lapavitsas, an economics professor at Soas University of London turned Syriza MP.

In Against the Troika, the German and the Greek publish one chart that explodes the idea that the euro has raised living standards. What they look at is unit labour costs – how much you need to pay staff to make one unit of output: a widget, say, or a bit of software. And they map labour costs across the eurozone from 1999 to 2013. What they find is that German workers have barely seen wages rise for the 14-year stretch. In the short life of the euro, working Germans have fared worse than the French, Austrians, Italians and many across southern Europe.

Yes, we’re talking about the same Germany: the mightiest economy on the continent, the one even David Cameron regards with envy. Yet the people working there and making the country more prosperous have seen barely any reward for their efforts. And this is the model for a continent.

Perhaps you have an image of Deutschland as being a nation of highly skilled, highly rewarded workers in gleaming factories. That workforce and its unions still exist – but it’s shrinking fast. What’s replacing it, according to Germany’s leading expert on inequality, Gerhard Bosch, are crap jobs. The low-wage workforce has shot up and is now almost at US levels, he reckons.

Don’t blame this on the euro, but on the slow decline of German unions, and the trend of business towards outsourcing to cheaper eastern Europe. What the single currency has done is make Germany’s low-wage problems the ruin of an entire continent.

Workers in France, Italy, Spain and the rest of the eurozone are now being undercut by the epic wage freeze going on in the giant country in the middle. Flassbeck and Lapavitsas describe this as Germany’s “beggar thy neighbour” policy – “but only after beggaring its own people”.

In the last century, the other countries in the eurozone could have become more competitive by devaluing their national currencies – just as the UK has done since the banking meltdown. But now they’re all part of the same club, the only post-crash solution has been to pay workers less.

That is expressly what the European commission, the European Central Bank and the IMF are telling Greece: make workers redundant, pay those still in a job much less, and slash pensions for the elderly. But it’s not just in Greece. Nearly every meeting of the Wise Folk in Brussels and Strasbourg comes up with the same communique for “reform” of the labour market and social-security entitlements across the continent: a not-so-coded call for attacking ordinary people’s living standards.

This is what the noble European project is turning into: a grim march to the bottom. This isn’t about creating a deeper democracy, but deeper markets – and the two are increasingly incompatible. Germany’s Angela Merkel has shown no compunction about meddling in the democratic affairs of other European countries – tacitly warning Greeks against voting for Syriza for instance, or forcing the Spanish socialist prime minister, José Luis Rodríguez Zapatero, to rip up the spending commitments that had won him an election.

The diplomatic beatings administered to Syriza since it came to power this year can only be seen as Europe trying to set an example to any Spanish voters who might be tempted to support its sister movement Podemos. Go too far left, runs the message, and you’ll get the same treatment.

Whatever the founding ideals of the eurozone, they don’t match up to the grim reality in 2015. This is Thatcher’s revolution, or Reagan’s – but now on a continental scale. And as then, it is accompanied by the idea that There Is No Alternative either to running an economy, or even to which kind of government voters get to choose.

The fact that this entire show is being brought in by agreeable-looking Wise Folk often claiming to be social democratic doesn’t render the project any nicer or gentler. It just lends the entire thing a nasty tang of hypocrisy.

Syriza can transform the EU from within – if Europe will let it

 

Syriza’s anti-austerity programme is more sensible than radical, and what Greece needs. But the EU is far from convinced
 

• 
• • Costas Lapavitsas
  • theguardian.com, Monday 29 December 2014 15.06 GMT

Presidential guards in front of the Greek parliament. Photograph: Kostas Tsironis/AP

The Greek parliament has failed to elect a new president and the country’s constitution dictates that there should now be parliamentary elections. These will be critical for Greece and also important for Europe. A victory for Syriza, the main leftwing party, would offer hope that Europe might, at last, begin to move away from austerity policies. But there are also grave risks for Greece and the European left.

The rise of Syriza is a result of the adjustment programme imposed on Greece in 2010. The troika of the European Commission, the European Central Bank (ECB) and the International Monetary Fund (IMF) provided huge bailout loans, with the cost of unprecedented cuts in public expenditure, tax increases and a collapse in wages. It was a standard, if extreme, austerity package, with one vital difference: austerity could not be softened by devaluing the currency as, for instance, had happened in the Asian crisis of 1997-98. Greek membership of the euro had closed all escape routes.

Brutal austerity succeeded in stabilising Greece and keeping it in the economic and monetary union by destroying its economy and society. The budget deficit has been drastically reduced, the current account deficit has turned into a surplus and the prospect of default on foreign debt has receded. But GDP has contracted by 25%, unemployment has shot above 25%, real wages have fallen by 30% and industrial output has declined by 35%. The human cost has been immeasurable, amounting to a silent humanitarian crisis. Homelessness has rocketed, primary healthcare has collapsed, soup kitchens have multiplied and child mortality has increased.

Since the summer of 2014, the depression has been drawing to a close, helped by the strong performance of the tourist sector. Yet, the damage from troika policies is so severe that growth prospects are appalling. The weakness is manifest in foreign trade, which the IMF expected to act as the “engine of growth”. In 2014, Greek exports will probably contract, while imports began to rise as soon as the depression showed signs of ending. This is a deeply dysfunctional economy.

In the midst of this catastrophe, the troika is insisting on further austerity to achieve massive primary budget surpluses of 3% in 2015, 4.5% in 2016 and even more in future years. Its purpose is to service the enormous foreign debt, which has risen to 175% of GDP from about 130% in 2009. Astonishingly, the IMF still expects Greece to register average growth of 3.4% during the next five years – provided, of course, that it goes full speed ahead with privatisation, deregulation of labour and market liberalisation. The troika has truly embraced the economics of the absurd.

In 2010-11, the Greek people actively opposed the disastrous policies of the troika and its domestic allies, but failed to stop them. After 2012, however, as unemployment and poverty escalated, it became difficult to organise popular protest. Still, exhaustion with troika policies is so great that voters have turned in droves to the left, in the hope that Syriza will offer a better future.

Syriza promises first to achieve a substantial write-off of Greek debt and, second, to lift austerity by aiming for balanced budgets, instead of the surpluses demanded by the troika. It will reconnect families to the electricity network, provide food relief and shelter the homeless. It will take immediate action to reduce unemployment through public programmes. It is committed to lowering the enormous tax burden and to boosting public investment in an effort to accelerate growth.

There is nothing radical, much less revolutionary, in these policies. They represent modest common sense and would open a fresh path for other European countries. After all, Syriza has repeatedly declared its intention to keep the country within the economic and monetary union, and to avoid unilateral actions. There is little doubt that its leaders are committed Europeanists who truly believe that they could help transform the EU from within.

The trouble is that the EU is far from amenable to Syriza’s ideas. Germany’s exporters and banks have benefitted substantially from the euro and have no incentive to abandon austerity. Berlin has its plate full anyway as the eurozone is exhibiting renewed weakness, with France and Italy on the ropes. There is also Mario Draghi at the ECB,rambling on about quantitative easing, a policy that Berlin detests. The last thing that Germany would welcome would be Syriza and its programme.

A scaremongering campaign is likely in the coming weeks to deter Greeks from voting for the leftwing party. Should the campaign fail, a Syriza government can expect hostility from the EU, which is not short of weapons. Syriza’s programme is sensible and modest, but lacks secure funding. Greece also needs substantial finance to service its debts in 2015, perhaps up to €20bn. There are some debt repayments in the spring that might be manageable, but further repayments – €6.7bn – must be made in July-August, which will need fresh funding from abroad. And, needless to say, Greek banking would be rapidly asphyxiated if the ECB stopped providing liquidity.

A Syriza government will probably face an ultimatum to capitulate, perhaps by being offered some watered-down version of austerity. This would be a disaster for Greece and a major defeat for opponents of austerity in Europe. It is vital that Syriza wins and applies its programme without flinching, helped by international support. The battle lines are forming in Greece.

Britain: a nation in decay

The UK's problems go far deeper than the cuts agenda. It simply can't produce enough to revive its ailing economy

• 
• • Ha-Joon Chang
  • The Guardian, Friday 8 March 2013 21.00 GMT

‘Despite the huge incentive to export created by a devalued pound, Britain is still running trade deficits because it has lost the productive capacity to respond.’ Photograph: Alamy

David Cameron's speech on the economy this week, and the reactions to it, have again confirmed that the British debate on economic policy is getting nowhere. The coalition government keeps repeating that it has to cut spending in order to cut deficits, no matter what. The opposition has been at pains to explain – as a teacher may do to a particularly slow or obstinate child – that trying to cut deficits by cutting spending in a stagnant economy is a largely self-defeating exercise, as it reduces growth and thus tax revenue. And Friday's astonishing letter from Robert Chote, chairman of the non-partisan Office for Budget Responsibility, contradicting the prime minister and reminding him of the ambiguous impact of spending cuts on deficits, has lent further weight to the opposition argument.

In reality, though, the coalition government isn't as stupid or stubborn as it appears. It is sticking to its plan A because spending cuts are not about deficits but about rolling back the welfare state. So no amount of evidence is going to change its position on cuts.

Lost in this cross-wired debate is the issue of the long-term future of the economy. Britain has been finding it difficult to recover from the financial crisis not just because of its austerity policy but also because of its eroding ability to engage in high-productivity activities. This problem is most tellingly manifested in the country's inability to generate a trade surplus despite the huge devaluation of sterling since 2008.

Compared with its height in 2007, the pound has been devalued about 30% against the dollar, 50% against the yen, and 20% against the struggling euro. Yet despite the huge incentive to export created by such devaluation, Britain is still running trade deficits because it has lost the productive capacity to respond.

Despite the devaluation, Britain's service exports have fallen – average annual service exports for 2008-11 were 8% lower than for 2005-07. This may be understandable, given the poor state of its financial sector – rocked by one scandal after another and hemmed in by a slow tightening of global financial regulation.

However, manufacturing exports, which were supposed to make up the shortfall created by the services sector, also fell by 8% after the devaluation. This is highly unusual. For example, back when South Korea had a devaluation of similar scale after its 1997 financial crisis (the won, its currency, was devalued by 35% against the dollar), the country's manufacturing exports were 15% higher (comparing the 1998-2001 average to 1995-97).

The only reason the British balance of payments situation has not been worse is the large increase in primary commodity exports – oil, minerals and food. These were on average 22% higher in 2008-11 than in 2005-07. In other words, since the crisis the British economy has been moving backwards in terms of its sophistication as a producer.

All of this means that, without addressing the underlying decay in productive capabilities, Britain cannot fix its ailing economy. To deal with this problem, it urgently needs to develop a long-term productive strategy through a broad-based public consultation involving not just the government and private sector firms, but trade unions, educational institutions and research institutes.

The strategy should first carefully identify the industries, and the underlying technologies, that will be the future motor of the economy and then provide them with the necessary support. This could be in the form of subsidies for R&D, loan guarantees for small firms, or preferences in government procurement, and should be targeted at "strategic" industries, although they could also be in the form of policies that are apparently not industry-specific.

For example, infrastructural investment needs to be co-ordinated with the broader industrial strategy. Infrastructure is by definition location-specific, so depending on the industries you want to promote, you will have to build different types of it in different places. Similarly with education and skills. Without there being some national strategy, it is difficult for educators to know what kinds of engineers or technicians to produce, and for potential students to know what professions to study for.

John Maynard Keynes once famously said that in the long run we are all dead. But a lot of us have to live for a while yet. A series of short-run policies, whether based on the coalition policy of spending cuts and loose monetary policy or on the opposition policy of increased government spending, isn't going to address the challenges facing the British economy. It is time to think for the long term.