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.