Daily Archives: December 8, 2011

With the renminbi depreciating for six straight days starting last Wednesday, debate about its value has been renewed. Markets are fixated on whether Beijing will allow or even encourage the renminbi to depreciate further although diplomatic pressures remain strong for continued appreciation.

Although the global economy has deteriorated, paradoxically, conditions are better than a year ago for moving to a more flexible exchange rate system. A prolonged slowdown in global economic activity from the eurozone crisis, coupled with a sluggish US recovery, is now likely. With China’s key export markets under stress, its trade surplus will decline to about 1.5 per cent of gross domestic product this year from around five or six per cent several years ago. Coupled with the efforts to liberalise imports, China’s trade surplus may soon evaporate.

In recent months other east Asian currencies have become more volatile and on balance have depreciated significantly. Given the strong interlinkages in regional currency movements due to their shared production network, China will also be pulled into greater flexibility. And since inflation in China will remain relatively higher than its key western trading partners, its real exchange rate may appreciate marginally even if nominal rates decline. All this will create a conducive environment for China to develop a more flexible exchange rate system where the prospect of a decline is the same as of an increase – as it should be. Continue reading »

European leaders will meet on Thursday and Friday for yet another “historic” summit at which the fate of Europe is said to hang in the balance. Yet it is clear that this will not be the last meeting convened to deal with the financial crisis.

If public previews from France and Germany are a guide, there will be commitments to assuring fiscal discipline in Europe and establishing common crisis resolution mechanisms. There will also be much celebration of commitments made by Italy, and a strong political reaffirmation of the permanence of the monetary union. All of this is necessary and desirable, but the world economy will remain on edge.

Given that Europe is the largest single component of the global economy, the rest of the world has a stake in helping to avoid major financial accidents. It also has a stake in aiding continued growth in Europe and ensuring that the European financial system supports investment around the world – particularly as cross-border European bank lending dwarfs that of banks from any other region.

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The European Central Bank responded on Thursday to the eurozone’s deepening crisis but it fell short of a game change.

The ECB is clearly worried about Europe’s darkening economic outlook, and rightly so. Talk of a “mild recession” is accentuated by recognition that the balance of risks has shifted, especially given the possibility of “disorderly corrections”. This, coupled with a calming inflation outlook, warrants the 25 basis point cut in interest rates, and would have even supported a 50 bps point cut.

Markets initially welcomed the increased support for banks, but this enthusiasm largely disappeared once they realised that the ECB was not intentioning to directly help European countries struggling with debt issues.

What is clear is that Mario Draghi has shifted the burden of solving this crisis back to Europe’s heads of state. It has reminded them, and all others, that its willingness to provide a bridge is dependent on greater assurances that this would be a path to stability, not another bridge to nowhere. Continue reading »