[PEN-L:691] Re: Re: Re: Re: What are we doing here

["Ellen T. Frank" <frank@xxxxxxxxxxxx>]

At 12:18 PM 10/26/98 -0800, Colin wrote:
>This is a false dichotomy.  You can argue that there are
>real forces acting on exchange rates without adopting
>an equilibrium model or asserting that markets are
>efficient.  (Jim D makes a similar point.)   I would strongly agree with
Ellen that
>equilibrium models, especially of the PPP variety, are
>misleading.  But this is not the same thing as saying
>that the thing is "purely" speculative.
>

To say that exchange rates have widespread economic effects and to believe
that, in some perfect world, exchange rates would equilibrate imports and
exports or match the price of beans in Mexico to the price of beans in
Texas, should not blind us to the fact that, in the actual world of 1998,
the proximate cause of exchange rate behavior is speculative trading in
international currency markets.  In this world,the predominant forces
acting on the exchange rate are the supply and demand of bets made by
traders in international banks and hedge funds.

Nor is this an academic point. It is precisely because the "free-market"
system in international finance provides no room for the exchange rate to
moderate the very real strains and stresses of international trade that
countries find themselves in the situation of Brazil.


In the case
>of Brazil, for example, you can simply point out that
>substantial real exchange rate (RER) appreciation has
>hurt exporters and encouraged imports, and that the
>country?s ability to get foreign credit to plug this gap
>is limited.  The fact of RER appreciation and its effects
>on trade do not rely on a notion of equilibrium or market
>efficiency.

Recognize here that Brazil's efforts to stabilize it's dollar exchange rate
was DEMANDED BY SPECULATIVE INVESTORS who would hold funds in real only if
the government promised to "fix" the nominal exchange rate.  Those very
same investors also demanded that Brazil allow full and free convertibility
the better to flee the country when and if the government reneged on its
promise.  When the economic stresses of a hard real became obvious,
investors blamed the government for "overvaluing" the real and presented
themselves as the hapless victims of GOVERNMENT mismanagement. The
identical scenario has played out over the years in countries too numerous
to mention.

>This is a larger debate that we may not want to rehearse,
>but again on my dichotomy point: the fact that speculators
>are the proximate cause of a collapse does not mean they
>are fundamentally responsible.  Any time you have large
>RER appreciation with a fixed exchange rate, and the
>central bank has limited foreign reserves, you become
>easy pickings for speculators.  But this is like walking
>out of your house and leaving the front door wide open ?
>sooner or later you?ll get robbed.  So you have to start
>by asking what policies created this extreme vulnerability.

My point exactly.  What policies created this vulnerability?  Full and free
convertibility and the lack of a international, non-market agency to assist
in trade finance.  Countries have nowhere to go but to the rentiers and
speculators, who then demand both full convertibility and fixed exchange
rates.  The combination is impossible to manage -- even with big reserves
-- look at Korea.
>
>Further, the majority of capital flight ? or the looting
>of the central bank?s foreign reserves if you like stronger
>language ? is in most cases carried out by domestic wealth-
>holders, not by people like Soros.  Discouraging the
>activities of the Soroses, even if you could do it, would
>have little effect on this.
>
Right.  This is why capital controls (inward and outward) are ultimately
more useful than Tobin taxes.  Though as Jim points out, Tobin taxes could
generate lots of revenue.

Best, Ellen Frank