real appreciation

In addition, the supply of global savings will likely decline. Aging demographics in developed countries will likely depress savings, even though governments may flirt with fiscal austerity and households may try to reduce their debt. In the emerging world, the accumulation of reserves will likely taper off, allowing resources to be diverted toward other needs, such as spending on investment, boosting consumption, and building social safety nets. Reserve holdings may not fall in absolute terms, but the pace of hoarding may slow. For capital markets to reach equilibrium given these shifts, global real interest rates will have to rise worldwide; otherwise, investment will exceed the supply of savings. The era of a so-called savings glut will thus end, and the impetus for capital to move downhill from developed countries to emerging ones will strengthen. Finally, adjustments among emerging countries will require the surpluses of emerging markets to fall or even reverse on net. But as history shows, such shifts from surpluses to deficits are accompanied by stronger currencies in real terms. To run current account surpluses, emerging markets have had weaker currencies for years. As these imbalances correct themselves, emerging economies’ currencies will tend to strengthen in real terms one way or another, either as local prices rise or as currencies appreciate relative to developed markets. A new era with less capital flowing uphill and stronger emerging currencies is therefore within the realm of possibility. But when and how can it happen? There are signs that this process of correction is already under way. Emerging-market currencies began strengthening against the U.S. dollar around 2004– 05, approximately when China loosened its currency’s peg to the U.S. dollar, and the trend was only briefly interrupted by the subsequent financial crisis. Now, this trend is continuing and perhaps even accelerating. As they emerge from the financial crisis, emerging countries face a stark policy choice in terms of how to approach real appreciation: raise interest rates and let their currencies appreciate or else continue to fix their currencies and risk importing inflation. Short-term pressures — reflationary cyclical rebounds; larger than average differentials in productivity growth; and idiosyncratic commodity price shocks affecting oil, food, and key imports — are pushing policymakers from emerging countries to consider allowing their currencies to appreciate.

Yet this transition to global rebalancing cannot be taken for granted, and a supportive policy environment in both the developed and the emerging worlds will greatly influence its course. In particular, the shift toward currency appreciation will prove easier if it is led by China. Although China, a key potential leader in this process, is gradually allowing the yuan to appreciate, Chinese Vice Premier Wang Qishan admitted in May that the “biggest challenge” for Beijing was to reach internal consensus on rebalancing China’s economy, a process that will slow appreciation. In those countries where appreciation has advanced, such as Brazil, the discomfort felt at having moved first as other countries retain the trade advantage of a weak currency has stoked anxieties about currency wars.

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real appreciation was first posted on October 24, 2019 at 6:13 am.
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