Crossing the Reuters tape a little while ago, it seems members of the G20 have learned to play nice(r) since their last meeting in November:
G20 CONSENSUS REACHED ON CAPITAL CONTROLS AND EXPANSION OF IMF CURRENCY BASKET FOR SPECIAL DRAWING RIGHTS
But more on this in a minute. First, this morning’s FT chronicles the recent détente in the currency wars:
The latest to move is Chile, which late on Tuesday raised interest rates by 0.5 percentage points for the second month running, and signalled that they could go higher – above the current 4.25 per cent – in coming months. Since the move had been expected, the Chilean peso rose only marginally on Wednesday against the US dollar, but at 472.80 it now stands 3 per cent higher than a month ago and 5.5 per cent higher than on January 1.
Earlier in the week, the South Korean authorities confirmed that they too were betting on currency appreciation to stem rising inflation (4.7 per cent in March). The central bank left interest rates unchanged, but did so only after the government eased up on earlier efforts to limit the won’s rise. The South Korean currency is now at 1,085 to the US dollar, 4.5 per cent higher in a month.
Last week, in the biggest surprise of all, Brazil retreated in its gruelling fight to limit the real’s appreciation. The authorities did nothing to prevent traders pushing the currency through the psychologically important R$1.60 to the dollar level, and the real now stands at R$1.58, about 6.5 per cent higher than in mid-March.
Meanwhile, even the Chinese authorities – foot-draggers on currency appreciation in US eyes – have allowed the renminbi to creep up by nearly 1 per cent since January 1 and 4.5 per cent since the currency peg was lifted last summer.
We interpreted the last G20 summit, in November, as a reaffirmation of something that was already happening — a move towards the broader acceptance of capital flow restrictions, especially by developing countries.
We were never too nervous about this — both because we thought the hot money flows story had been exaggerated this time round and because nowhere had capital controls been implemented to such a degree that they had become worth worrying about, whatever the headlines they always bring.
Not that we favour the widespread use of capital controls, but to be simplistic about it, there is evidence that in the right situations they can be temporarily useful at best (see Reinhart-Rogoff for more), altering the composition of the flows and buying central banks a bit of space — and completely ineffective but harmless at worst, at least in the kinds of mild cases we’ve seen since last year.
And we liked the IMF’s nicely balanced framework, released last week, which argued that capital controls were acceptable but should be used only after proper fiscal adjustments and macro-prudential policies had been applied. Some emerging market governments pushed back, wanting to maintain maximum flexibility, but the framework seemed to us a judicious compromise between advocating for totally free flows (which ended in tears in the 1990s) and over-legitimising their frequent — instead recommending caution that these tools should be employed only in specific circumstances.
We’ll put those arguments aside for now. We come away with two lessons from the recent activity described in the FT and, assuming it holds, the reported agreement at the G20 — neither of which we’re entirely confident about given how quickly these developments can be reversed.
First, countries that are (for now) allowing their currencies to appreciate are doing so not because of international diplomatic pressure, but because of their own domestic economic considerations. It’s true that China often allows the RMB to appreciate when the US congress starts making noise about protectionist bills, but for most of these countries the real pressure comes when inflation starts to override their other efforts and they realise the need to deploy everything in their arsenal.
(Of course, if they’re successful, then they might again revert back to their previous export-led growth strategies.)
Second, and here we’re on especially unsteady ground, it seems the political equilibrium on capital controls, and currency intervention more generally, has shifted just since the end of last year. Whatever has happened this week, the world is still becoming a more controls-friendly place after all.
Related links:
More on uncertainty and capital controls – FT Alphaville
Uncertainty and capital controls – FT Alphaville
A G20 “victory” – FT Alphaville
EM debt markets and capital flows freak-outs – FT Alphaville
When capital controls are the only QE antidote – FT Alphaville