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Home Publications Blogs Beat the Press Currency Values Are Not Determined by the Market When Central Banks Buy Currencies

Currency Values Are Not Determined by the Market When Central Banks Buy Currencies

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Tuesday, 12 February 2013 06:06

A NYT piece reported on concerns by the French government and others over the rising value of the euro. They were concerned that a higher valued euro would make French and other euro zone goods less competitive in world markets. In response the piece included two statements that are at best misleading. 

It presented the views of Jens Weidmann, the head of Germany's central bank, who said,  "warned that an exchange rate policy aimed at weakening the euro would 'in the end result in higher inflation.'"

The inflation rate in the euro zone has been below even its 2.0 percent target. While anything that increases in demand will lead to somewhat higher inflation, other things equal, it is implausible that modest declines in the euro will lead to serious problems of inflation in the euro zone economies. 

After telling readers that "a number of ministers agreed Monday that intervention would be wrongheaded," the piece then presented the view of Maria Fekter, the Austrian finance minister:

“'This is mainly decided by the market, ...I find an artificial weakening unnecessary.'”

In fact exchange rates are not currently being decided by the market. Many countries, most notably China, are buying up large amounts of foreign currency. This has the effect of keeping down the value of their currencies against the dollar and the euro.

In a normal market situation we would expect that the wealthy countries would have trade surpluses with the developing world, which means that they are lending them capital. However due to the malfunctioning of the international financial system, the capital flows have gone sharply in the opposite direction over the last 15 years.

Comments (3)Add Comment
...
written by skeptonomist, February 12, 2013 9:25
If you are going to decrease the value of your currency and if you have significant foreign trade (if you don't there is no point in fooling with the exchange rate), you will have effective inflation - that is the price of foreign goods will go up. This is how currency manipulation works, at least half of it (the other half being a reduction in the price of your goods to foreigners). To put it in a domestic context, if the value of the dollar against the Chinese yuan goes down, the price of all the Chinese-made goods in Walwart goes up. Hopefully in the long run such devaluation would lead to increased domestic employment, but the immediate inflationary effect can't be avoided.
"anything that increases in demand...higher inflation?"
written by pete, February 12, 2013 10:55
Suppose we have an increase in production, perhaps a great crop year. This will lead to higher real income, and higher demand. And holding money growth constant will actually cause deflation, or disinflation....ooops..more demand and no inflation. Similarly, decreasing growth...and subsequent decreasing demand, with constant money growth, results in stagflation a la 70s.

What the Germans and Austrians are positing is that if they keep their money targets, then the currency markets will find a value. There is only one degree of freedom, and that is the money supply. Playing wackamole with interest rates, currency rates, inflation rates, is interesting, but there is only one hammer.

Currency manipulation
written by kayjay, February 13, 2013 12:36
Chinese currency manipulation is a very small piece of the story. Currencies are manipulated by the banks with huge portfolios of borrowings at lower interest rates from some countries and investments for a few seconds to hours, days and maximum a few months into other currencies.

Huge, Too-Big-to-Fail banks,fully supported by the Fed, the U.S. Treasury and the EMU are the chief culprits in this arena. On a purchasing power parity basis, without including the European VAT, the USDollar is about 20(Germany) to 33%(Italy) off the Euro depending upon the country. Foreign currency manipulation and betting is just a source of income for the banks, just like mortgages, futures markets, credit cards and loan- sharking, investing in the stock markets.


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About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.

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