From UBS’s Tao Wang on what, post China’s surprise revaluation, is now an oft used phrase, the impossible trinity — AKA the corner China finds itself in:
The impossible trinity says that a country cannot simultaneously have an open capital account, independent monetary policy, and stable tightly managed exchange rate. Some academics (such as Hélène Rey) argue that since capital controls are no longer as effective in the current day world, complete monetary policy independence is still not possible without some degree of exchange rate flexibility, even without a fully open capital account – or impossibly duality.
Regardless of whether it is an impossible trinity or duality, the fact is that in recent years, as a result of substantial capital controls relaxation, China has found it increasingly difficult to manage independent monetary policy while simultaneously maintaining a fixed exchange rate.
Nobody knows China like Michael Pettis, and his latest post on the RMB doesn’t disappoint.
Before we get to the crux of his argument we should point out that FT Alphaville has long argued that the RMB was probably over rather than under valued, based on its capital account position.
Understandably we were feeling a bit chipper with our analysis following last week’s depreciation, until we read Pettis this morning.
The Beijing-based academic argues convincingly that the RMB is still under valued because there’s a big difference between a technical misvaluation and a fundamental one. Read more
If you accept the standard textbook view of central banking — roughly, that employment near its “natural” level coupled with accelerating wage growth will lead to faster consumer price inflation, whose pace should be kept moderate — UK domestic conditions would seem to merit significantly higher interest rates.
The number of hours worked is booming at the fastest rate in decades:
Nominal private sector wage growth has recently accelerated to its fastest pace since the crisis even as price inflation has slowed to a crawl: Read more
So on Wednesday, we got this from the ECB as the Battle of the Drafts between the Eurogroup and Greece rumbles on — it’s in the FT’s words (we still can’t find a press release):
On Wednesday evening ECB policy makers approved a €3.3bn increase in ELA to the Greek banking system. Lenders will now have access to up to €68.3bn of emergency loans from the Bank of Greece, after members of the ECB’s governing council sanctioned the increase, from €65bn, at its regular fortnightly meeting.
The Bank of Greece had asked for more emergency funding, according to a person familiar with the matter. The approval is for a two-week period.
And this… Read more
The ‘Cypriot precedent’ and experiment with capital controls, a first for the eurozone, are still reverberating around the EU. Gilles Thieffry, a Partner at GTLaw, Geneva, writes on possible legal implications.
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Even if the barn door is closed before the horse bolts, the horse will find another way to escape. That’s essentially the point made by John Dizard over the weekend:
Capital controls turn into trade controls, as the locals attempt to find ways to turn hard assets or non-banking services into foreign exchange. At some price, for example, you can buy a boat in Cyprus with post-haircut, capital-controlled local deposits, sail it to Lebanon, and then sell it for real, usable money. The same with antiques, jewellery, or anything else you can think of. Even capital goods such as fork lifts can be motored off in the middle of the night.
From an engaging speech by Robert Jenkins — former F&C chairman, now a member of the Bank of England’s interim Financial Policy Committee — to the “trillion dollar generation” of hedgies at the Gaim conference in Monaco…
My third and final observation is that the days of instant market pricing and limitless liquidity may be fading. The “great moderation” conditioned many to underestimate credit risk. It also bred a generation of traders, money managers, bankers and risk officers to presume an unfettered flow of capital and instant access to narrow bid/offer spreads. Those of you who operate in less liquid instruments do not need reminding. You deal with it daily. Those of you who traded asset backed securities in 2008 can testify to the speed with which liquidity can disappear. Yet despite these examples, many continue to assume that at the currently liquid end of the trading security spectrum “liquidity” is free and will be freely available. Short term traders count on it; algo-trading depends on it. Long/short strategies presume you can short. Stop-loss disciplines demand you can cover – and cover quickly.
The Swiss have made it abundantly clear that they will defend the 1.20 floor against the euro no matter what:
So much for learning to play nice.
According the Wall Street Journal on Monday morning, the tentative consensus on capital controls found last week has already unraveled (or was never there to begin with): Read more
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
Brazil has stepped up its “currency war”, a day after the International Monetary Fund tacitly endorsed the use of capital controls, with the announcement of the fourth set of measures within a month to help control its exchange rate, the FT reports. Guido Mantega, the finance minister, said the government would extend a 6 per cent tax on repatriated foreign borrowings to loans or bonds with a maturity of up to 720 days, compared with the previous limit of up to 360 days. “The government has to take action to avoid any type of excesses,” said Mr Mantega. The IMF proposed its first guidelines this week on the use of measures to control inflows of speculative capital, in a move seen as legitimising a tool it had once staunchly opposed. Brazil has been fighting to keep its currency, the real, trading at about 1.65 to the US dollar – a level that is almost 40 per cent higher than two years ago. But in recent weeks, the currency has strengthened further.
The International Monetary Fund has proposed its first ever guidelines for using controls on flows of speculative capital, legitimising a controversial tool that it once campaigned against, the FT reports. The guidelines – which are not yet official Fund policy – say that countries can control capital inflows when their currency is not undervalued, when they already have enough foreign exchange reserves, and when they are unable to use monetary or fiscal policy instead. The IMF said that around one-quarter to one-third of a group of countries that it studied are “currently likely” to meet its criteria for the use of controls. The framework is the IMF’s attempt to recognise the short-term use of capital controls to manage inflows of “hot money” but distinguish them from long-term barriers against foreign capital.
The IMF has proposed its first ever guidelines for using controls on flows of speculative capital, in effect endorsing a controversial tool that it once campaigned against, the FT reports. The guidelines – which are not yet official Fund policy – say that countries can control capital inflows when their currency is not undervalued, when they have sufficient foreign exchange reserves, and when they are unable to use monetary or fiscal policy instead. The WSJ adds that some IMF board members opposed the plan, warning it could result in more restrictions than assistance. The move could stoke debate about the causes of “hot money,” or short-term, capital inflows.
In a previous post about the efficacy of capital controls, we interpreted a passage from Reinhart & Rogoff’s epic This Time is Different by saying “there remains an awful lot we simply don’t know about the consequences of capital flows, capital controls, or, more generally, about the appropriate pace and nature of financial liberalisation in developing economies.”
Well, the crisis-expert duo is back, joined by Nicolas Magud of the IMF, with a new paper summarised at VoxEU that explains why such a prominent economic topic brings so much confusion — though their conclusions include more questions than answers about the ability of capital controls to successfully manage flows. Read more
From the IMF’s latest World Economic Outlook (emphasis ours):
At the same time, monetary accommodation needs to continue in the advanced economies. As long as inflation expectations remain anchored and unemployment stays high, this is the right policy from a domestic perspective. Furthermore, it seems to have had an effect: following the news in August that a second round of quantitative easing was imminent, long-term rates fell to new lows in the United States. Although U.S. Treasury yields have since increased, particularly in the last quarter of 2010, this seems primarily attributable to the improving outlook for the U.S. economy, a fact corroborated by the strong performance of equity markets. From an external perspective, however, there is concern that quantitative easing in the United States could result in a flood of capital outflows toward emerging markets. The recent slowdown in capital inflows to emerging markets suggests that such effects may be limited so far. Read more
Worries about capital flows and the potential side effects of poorly designed capital controls (trade wars, market inefficiencies and distortions) are all the rage these days.
But some economists are sceptical (here’s one) as to whether capital controls even work, or if the market — in the form of investors using fancy bank-contrived derivatives — will simply find a way around them. Perhaps they’re inconvenient but ineffective? Read more
Indonesia’s central bank governor, Darmin Nasution, is in no mood to slam the brakes on foreign capital flows, reports the FT. He describes capital controls to combat currency volatility – such as those announced last week by Brazil and Chile – as simply pouring “sand in the wheel” while foreign investment continues to grow apace. Other large Asian economies such as South Korea and Thailand are seeking a similar lightness of touch in their first moves to impede foreign capital flows. Markets have largely viewed their tentative initial capital controls as shows of willingness to take harder action should appreciating currencies prove a greater threat to exports in 2011.
Brazil has launched a fresh attempt to limit the appreciation of its currency, as fast-growing economies renew efforts to restrict damaging inflows of “hot money”, reports the FT. In a bid to curb speculative trading, the central bank announced that domestic banks would have to hold higher reserve requirements against foreign exchange positions. The move followed Chile’s decision this week to intervene in currency markets to hold down the peso. Chile has traditionally taken a hands-off attitude to its floating exchange rate. The Brazilian currency fell sharply on the news. By midday in New York, the real had fallen 1.1 per cent to R$1.6912 against the dollar.
Unbalanced, and thus blisteringly honest.
Fred Goodwin, “Mr Macro” strategist at Nomura, unplugged: Read more
The latest moves by South Korea and China — not to mention India, Malaysia, Thailand and a swag of other countries — to impose capital or price controls show that the hype over ‘currency wars’ is mutating into a low-intensity battle being waged by countries through a series of unilateral, ‘micro-management’ measures.
In the same week that China announced it would impose price controls to curb inflation comes news that South Korea will reimpose a 14 per cent withholding tax on foreign investors’ earnings from government bonds. Read more
A plan for a plan is not a plan, says HSBC on Friday.
And this is the reason why QT is the risk now, not QE. Read more
China is to force banks to hold more foreign exchange and will strengthen the auditing of overseas fund raising, Bloomberg reports, in an attempt to limit hot-money inflows. In a statement the regulator said that the government will regulate Chinese special-purpose vehicles overseas and sharpen controls on equity investments by foreign companies in China. The management of banks’ foreign-debt quotas will also be tightened. The news agency also reports that Asian economies may need to turn to capital controls to prevent asset bubbles, according to a World Bank managing director.
Are capital controls the most unwelcome comeback since the one-piece jumpsuit?
HSBC’s top analysts and economists look into the issue on Tuesday and slightly beg to differ. Not only have they been more common throughout the recent past than most would care to remember, even the IMF now admits the measures do have their uses. Read more
South Korea is considering imposing more capital controls to cope with surging investment flows, the FT reports. The steps would bring Asia’s fourth-biggest economy in line with defensive policies adopted in Brazil, Thailand and Indonesia. Kim Choong-soo, central bank governor, did not specify the measures being considered although officials suggested that options include a “Tobin” tax on forex transactions, a tax on capital flows and, most controversially, the reintroduction of a 14% withholding tax on foreign bondholders’ earnings. GDP data, also issued Wednesday, confirmed South Korea was on track to report 6% growth this year, up from almost flat in 2009. Third-quarter GDP grew a stronger-than-expected 4.5% yoy, but cooled from 7.2% growth in the previous quarter.
South Korea has raised the prospect of introducing more capital controls as it wrestles with surging investment flows, the FT reports. The measures would bring Asia’s fourth-biggest economy in line with defensive policies adopted in Brazil, Thailand and Indonesia. Kim Choong-soo, central bank governor, did not specify what action Seoul was considering but suggestions from officials include a “Tobin” tax on foreign exchange transactions, a tax on capital flows, further limits on derivative positions and, most controversially, the reintroduction of a 14 per cent withholding tax on foreign bondholders’ earnings. Gross domestic product data, also released on Wednesday, confirmed the country was on track to report 6 per cent economic growth this year, up from almost flat in 2009. In the three months to September the economy beat analysts’ forecasts to grow 4.5 per cent year-on-year but cooled from the second quarter 7.2 per cent growth.
Still fresh after his performance as the lone dissenting dove on the UK’s Monetary Policy Committee, Adam Posen has now used the expertise for which he is perhaps best known — Japan’s lost decade(s) — to argue in a speech that easy monetary policy doesn’t lead to asset bubbles. Not inevitably, anyway.
Posen’s targets in the speech are the world’s surplus countries, which he believes should embrace more accomodative monetary policy to stimulate domestic demand. Read more
South Korea is showing its uncanny knack for timing with its planned new steps to curb capital inflows, just ahead of its star role as host of the upcoming G20 meetings — which are likely to be dominated by discussions of “currency wars“.
G20 finance ministers, meeting from this Friday in the South Korean city of Gyeongju, are trying to lay the groundwork for the November summit of world leaders in Seoul. Their key concern is averting a round of competitive devaluations by countries hell-bent on shoring up their own tentative economic recoveries. Read more
South Korea is planning steps to curb capital inflows and counter the recent strengthening of the won amid growing efforts by emerging economies to stem the rise of their currencies against the US dollar, the FT reports. The government did not detail the new measures but analysts said it may revive a withholding tax on foreign investors’ bond holdings, and impose further limits on currency forward trading. Seoul’s move comes after Thailand last week reimposed a 15% witholding tax on foreign bond holdings, while Brazil recently doubled the tax on foreign investment in its government bonds.
The baht stops here — or so Thailand’s government hopes, after passing a tax aimed at foreign holdings of bonds. The cabinet approved a 15 per cent withholding tax on capital gains and interest payments on government and state-owned company bonds, the FT reports. The move is another shot fired amid signs of a mounting ‘currency war’ in international markets: the baht is at its highest against the dollar since just before the 1998 crisis. Analysts described the policy as a capital control that would fail in the face of a wall of liquidity headed towards emerging markets. The Thai foreign minister rejected the term, presenting the move as the ending of a waiver granted in 2005. He’s forgetting the disastrous result of a capital control introduced in 2006, Lex counters – noting that the baht wasn’t affected that time, either.