Re: FX/Money Supply/Banking System - harkness thread

[Leigh Harkness <leigh@xxxxxxxxxxx>]

Greg

You put the case:

>A country runs an export surplus.  As a result, the
>banks of that country (say, Japan) find themselves
>recurrently coming into large quantities of FX.  They
>CAN turn around and resell that FX, get their own
>currency, and the effect would be, as Leigh says,
>not to increase the money supply.

Under the floating exchange rate system, banks are suppose to sell their
foreign exchange receipts.  In Japan, for example, their receipts from
exports is sold to pay for imports and for Japanese investors to invest
overseas.   If Japanese investors did not invest overseas (and there was no
net capital flows), exports would equal imports.

>But what if said banks use the FX to add to their
>portfolios *foreign assets* such as
>Tbills, Wilshire Blvd, or skyscrapers in NY?  What
>would prevent their being able to use this long-term
>asset base as "backing" for additional deposit
>liabilities (subject to the usual gradations
>of "highly liquid" vs. "less liquid" assets) in
>their domestic currency?  Might that not have
>an expansionary effect, *unless* there were some
>kind of regulatory stipulation putting a limit
>on the number of foreign assets that may be used
>to balance domestic demand deposit liabilities?

If banks hold onto foreign exchange, they will add to the money supply
directly.  That is, the bank has given the Japanese exporter a Yen balance
in their account and the bank holds the corresponding foreign currency
asset.  But that is behaviour associated with the fixed exhange rate system.
It may happen but it is not significant to the system.  If it were, we could
say the country was using a hybrid system, not the floating exchange rate
system.

Of course, some countries are already using hybrid systems.  For example,
the US has a policy of stabilising the currency.  Europe is trying to get
around it with a single currency.  While many neo-classical economists still
preach floating exchange rate system, there appear to be many professional
economists running away from the system in one way or antother.

Regards


Leigh

______________________________________________________________________
Leigh Harkness                                      leigh@xxxxxxxxxxx