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Thursday, April 20, 2006

The IMF and Dollar Depreciation

I have a post on Demography Matters which while ostensibly being about Iceland is in fact unavoidably about the global imbalances situation and how such imbalances may or may not 'correct' in the light of our current demographic realities. The heart of this issue is really whether there is any straightforward and 'classic' way to address the US current account deficit. Brad Setser and Nouriel Roubini have of course been in the forefront of urging the 'dollar correction' remedy. I see from the FT this morning that the IMF has now added its voice to the chorus:

"The International Monetary Fund on Wednesday stepped up the pressure for far-reaching shifts in exchange rates, declaring that the dollar will have to depreciate “significantly” over the medium term if global economic imbalances are to be resolved in an orderly fashion."

I guess this would be the point: "if global economic imbalances are to be resolved in an orderly fashion".

I seriously question whether any such shifts are possible, especially in the medium term where Geramny Italy and Japan's problems can only increase not decrease.

The IMF obviously mention the Asian currencies, but as the FT notes "it shied away from giving any specific figures as to the extent of appreciation required".

My personal feeling is that they are wise to refrain from so doing. Clearly *some* Asian currencies can steadily appreciate, but at a rate which will not resolve the imbalances issue appreciably, others (like the Tigers) are themselves rapid agers, and will have their own issues.

What, I think, we need to keep very clearly in mind here is not the relative size of the various populations, but the relative values of the GDPs (both per capita and in absolute terms).

I think a lot of people are now way out of their depth in all of this. A key component of the current IMF view would seem to be this:

"The IMF sharply increased its estimates for growth in Japan, to 2.8 per cent this year and 2.1 per cent next, declaring that the expansion there is now “well-established”."

Of course, if the IMF are right that the Japanese expansion is now 'well established' then the picture begins to change, but I think there are plenty of grounds for serious doubt that it is, and if it isn't, then it'll be another kind of correction that we are about to see.

I think the core of what I am saying is that many of these problems are fairly complex and hard to handle. Simplistic solutions, and platitudes (which is what I think the IMF are going in for) just don't contribute anything useful.

There is always a trade-off.

If what you really think is the most important thing in the short to mid term is correcting the US CA deficit, then Bernanke simply needs to continue doing what he is already doing and keep raising rates. In the short term this will push the dollar even higher, but as it grinds down growth in the US it will begin the correction in the CA deficit. The issue is whether or not you think the price is worth paying.

Ditto the Federal Deficit, reducing this may or may not help the CA deficit, but it would reduce growth in the US, which would indirectly help, but only at the cost of making those who are already worried about a weak labour market even more worried.

Bottom line, the IMF WEO was on a much better level when Rogoff was Chief Economist, and the BIS publications seem to be a much better read these days, as they seem to be getting much nearer the core of what globalisation really means.


jwenck said...

Hi Edward,
this year my forecasts prove to be way better than yours.
Joerg Wenck

Edward Hugh said...

The year is still young. On 31 December we can begin to draw our respective conclusions :).

jwenck said...

I must say that I hate your habit of posting to different blogs in a rather disorganized manner. I don´t know if I´m ever going to try to follow all those posts and write up a response. I think I will just wait for you to finish your book.
The basic problem is the completely ahistorical and evolution-blind "fertility trap"-hypothesis. There is a wealth of anthropological, biological, historical and sociological material that one has to ignore to stick with that hypothesis - which seems to serve the purpose of zooming conventional mainstream economics up to the level of a megatheory instead of using the insights of sciences that address a much larger timeframe than economics - evolutionary biology, ethology, anthropology etc. - to anchor economics in the real world.

I just cannot fathom why one would brush aside whole libraries of knowledge just so one can avoid rethinking Robert Solow, growth theory etc. (I do see, however, how the problems growth theory has must make a specific version of demographics - that which reverts to pure extrapolation and puts opinions, "modeling" and speculation above empirical research - híghly attractive to some economists. Some fallacies do have a high degree of "connection selectivity" towards each other built into them.)
I really fear, though, that you have no idea which results from biology and history I am thinking of. And even after having read up on them, you´d perhaps still try to base anthropology on economics - instead of the other way around.

In addition, there is a purely economic fallacy involved here.
You say "I seriously question whether any such shifts are possible, especially in the medium term where Geramny Italy and Japan's problems can only increase not decrease." Assuming that they do - significantly more likely to happen sooner rather than later in the case of Germany and Italy as compared to that of Japan (which, in itself, contradicts your theory, since Japan is the fastest-aging society among them) - then the NATURAL RESULT of these aggravating problems will be the shifts you claim can´t happen because of them.
Many 19th-century economists would have realized that. It´s truly
amazing that some 20th-century economists seem to think that there is an arrow of causality just like the arrow of chronological time that through some kind of magic always features the same orientation as the other one, never returning the results of human intentions on those who harbour them like a boomerang?

There are so many things you need to ask yourself. Why did Mankiw mispredict the long-term development of the U.S. real estate market, although he based his prediction on demographic facts (which, by themselves, he did get right)? What about the aging-related work of Robert Fogel? What about the fact that all of Eastern and Southern Asia (including Japan) follows the same development path in agriculture - which is vastly different from that of Europe and the U.S. on the other hand? This agricultural divide cuts across the "aging divide", rendering it unlikely that the study of aging will offer privileged access to insights into the future.

Jörg Wenck

The whole history of the Roman Empire would be a complete mystery if demographics were the one cause of historical effects that never reverted to being an effect itself. What you do is blank out the "effective" part of demographics. Everybody understands that a half-empty glass is half full as well, that an egg is also a hen etc. How come that we are asked to accept demographics as always being a determinant and never an outcome?

How come that, with Chinese debt being higher than Japanese debt, Indian debt accelerating quickly and European debt being roughly in the middle between U.S. debt and Asian debt, the U.S. is considered to have a debt problem? This is an absurdity that renders 95% of economic forecasts obsolete - just like Alan Blinder´s pre-crash contention (which an overwhelming majority of his co-professionals subscribed to at the time) that the American economy had become similar to the Mississippi - "rolling along smoothly" was the phrase used, I believe? And now, 30 years after having been alerted to problems in the model - and admitting that it might need some rethinking -, he is instead busily researching the cognitive biases of those who can point to having a better forecasting record.
There are so many questions orthodoxy leaves unanswered. Comparisons of performance independent of underlying growth potentials provide an example. I always thought that realizing a growth rate that is equal to one third of potential qualifies as performing worse than realizing a growth rate that is equal to 100% of a potential that is only one half of the other country´s potential. 10 out of 10 people in the street would likely agree with me. (Oh, and 10 out of 10 people in the street would likely identify Dr. Lutz´s elusive "lowest theoretical bound on fertility" as being none other than zero. Hey, wait, that is a practical limit as well, not just a theoretical one - I guess it´s been disqualified from consideration by virtue of being empirically undeniable. Theorists often have a fertile imagination, though - maybe we are going to be treated to a discourse on the possibility of negative fertility rates next.)
And then there are all the genuine problems in the world, the problems of the people who are really around us - rather than just populating the imagination
as a future possibility. What happens when Jeffrey Sachs looks at some of them? He gets chided for being naive, for not being willing to emigrate into an intellectual dreamworld where collecting an imaginary demographic dividend has taken the place of the buying of indulgences that Luther and the Calvinists objected to so fiercely, in due course creating a revolution in European ethics that initiated a new phase of European economic development - the one that, following Max Weber, we have come to call industrial capitalism.

Jörg Wenck