capital flows

Officials from Taiwan’s central bank have rejected the implication of currency undervaluation in a chart used by Ben Bernanke. The offending graph – to the right – shows changes in the real effective exchange rate on its vertical (y) axis. Taiwan’s currency weakened by 2.8 per cent in real terms between September 2009 and 2010, according to this Fed chart. Taiwan says it fell by just 0.2 per cent, and argues that REER is not a good measure of undervaluation anyway.

At stake is responsibility for volatile capital flows that add to inflation in emerging markets and threaten to destabilise recovery. Emerging markets point to the Fed’s stimulus programme. But Mr Bernanke argued in his speech that the Fed’s $600bn stimulus programme was good for the world economy, refusing to accept responsibility for the extra inflationary pressure flowing through to emerging markets. In spite of former chair Alan Greenspan’s comments to the contrary, the Fed also continues to deny any attempt deliberately to weaken the dollar.

Indeed, Mr Bernanke accused emerging market economies of spending their reserves to slow the appreciation of their currencies. Hot money, he argued, was flowing into emerging markets regardless of Fed actions, because investors expected currencies they were buying to strengthen further. Since – by this chart – Taiwan’s currency has strengthened the least (indeed, has weakened), the implication is that Taiwan is one of the worst ‘offenders’. Read more >>

Former Fed chair Alan Greenspan has an article in today’s FT. It’s quite blunt about China and the US. “Both may be right about each other,” he says. “America is pursuing a policy of currency weakening,” while China’s reserve accumulation has caused exchange rate suppression for “competitive export advantage”. China and the US aren’t just hurting each other: the joint effect of their policies is to strengthen other currencies, placing those countries at a disadvantage.

Unlike most pundits hand-wringing over the current state of play, Mr Greenspan proposes a solution. It is quite radical. The G20, he says, can propose a new rule through the IMF that “limits the accumulation of reserve assets and sterilisation of capital flows”. “It would be easier to maintain and control than a stability and growth pact,” he says, referring to the “failed” eurozone agreement.

Well, yes, it would be easier. But the fact he has considered a stability and growth pact for sovereign states with separate currencies is staggering. The monetary proposal is also radical. Read more >>

Hot money? South Korea isn’t encouraging any more – the central bank on Thursday held its base rate at 2.25 per cent. The decision has surprised Reuters analysts who had expected a 25bp raise.

Bond prices have risen to record highs on the news and the won has also strengthened, though not as much as it would have done had interest rates risen. Read more >>

‘Unsustainable growth in credit’ has prompted the Peruvian central bank to raise its reserve requirements. Banks will need to hold funds equivalent to 75 per cent of borrowings abroad maturing in less than two years, up from 65 per cent, reports Bloomberg.

The economy shows some signs of overheating, with rising inflation and a strengthening currency that consistent recent forex interventions have slowed but not reversed (see chart; source). The Reserve bank has increased its reference rate steadily during 2010, the most recent rise taking the rate to 3 per cent.

China continues to divest its dollar holdings of US debt, latest data show. Mainland China, Hong Kong and Taiwan all reduced their net holdings during June. Between them, at the peak they held $363bn in May 2009; as of June they hold less than half that amount, $170bn. Germany, France and the UK also divested during the month.

It’s a great time to sell for those with risk appetite. High demand has pushed yields to record lows (and prices, correspondingly, to highs) as widespread risk aversion makes US debt attractive to many. Read more >>

Growing concern amongst Asian central bank governors about capital inflows, which have seen a number of countries embrace once-dreaded capital controls, appears to be spreading to Latin America. Chile’s unflappable central bank governor, José De Gregorio, today expressed his concern about the growing number of foreign investors piling money into emerging markets. He says it is time to keep an eye on capital inflows.

According to El Mercurio newspaper, this is what he had to say at a seminar:

Capital flows are worrying me . . . This is not yet a problem in the Chilean economy, but we have to remain relatively alert and thinking about what implications this will have for monetary policy.

High copper prices, global stock market gains and the expectation that Chile’s central bank will continue to raise rates regularly have helped push the peso currency higher – it recently touched a five-month high. It has eased a little today against the dollar, trading around 513 to the greenback.

If De Gregorio is concerned, Bertrand Delgado, a senior analyst at Roubini Global Economics, says he has a few options to manage dollar liquidity. Read more >>

Growing risk aversion among investors is slowing foreign capital flows to emerging markets such as India, potentially choking inflows needed to fund the nation’s widening current account deficit, India’s central bank said.

Duvvuri Subbarao, the governor of the RBI, told the FT that the expectations of the world’s senior economic policymakers about the volume of capital inflows in emerging markets had dramatically changed over the past three months. “Even three months ago, we were talking about a possible flood of capital flows,” he said. Read more >>

Advanced economies' reserves

Advanced economie' reserves, by currency

Emerging economies reserves

Emerging economies' reserves, by currency

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Rates have been lowered another 50bp in Iceland, justified by a rising krona and lower risk premia. Since the last MPC meeting, the krona has risen 5 per cent against the euro, “slightly more than assumed” by the central bank in its last forecast. Unlike last time, inflation is currently falling.

The central bank has also been repurchasing 2011 and 2012 euro-denominated bonds – €160m and €32m, respectively. The move is an effort to reduce reliance on external funding. Bilateral credit lines with Denmark, Finland, Norway, Poland and Sweden totalling €639m are being used to supplement the bank’s foreign exchange reserves.

On the subject of reserves, the bank explained:

Over time, the Central Bank will have to replace borrowed reserves with non-borrowed reserves. The appreciating króna and lower external risk premia could allow modest regular purchases of foreign currency. The timing and quantity of such purchases will be conducted so as to minimise the effect on the króna. No decisions on such purchases will be taken before the August MPC meeting.

 Read more >>

Having strengthened yesterday, the renminbi has opened sharply down against the dollar – indeed by the largest weakening since December 2008.

Market talk suggests Chinese state-owned banks bought dollars to save the central bank from having to intervene. If the currency is seen as a one-way bet, ‘hot money’ will likely flow into China – potentially interrupting monetary policy transmission and causing inflation. Read more >>