Transcript Euro Dollar Yuan and Yen

The Euro:
Considerations
The Feldstein Thesis

Turning over monetary authority to the
ECB removes an important component of
macroeconomic policy from individual
European governments.

If a recession comes in Italy (but not in
the EU generally), the Italians cannot run
deficits (EU rules) and cannot increase the
money supply to stimulate the economy.
What will happen when a serious
recession hits in part of the EU countries?
The Feldstein Thesis

Feldstein thought the EU would unravel.
The Maastricht rules. (No excessive
deficits, debt or inflation.)
 Krugman thought they made no sense.
They’re like hazing to get into a fraternity
at some local university.
 Did they have any purpose?

The ECB transparency issue.
Why doesn’t the ECB publish its minutes?
 So individual countries can’t get upset
when their central bank representative
votes in the interest of the community
rather than their particular, narrow
national interest.


So is transparency sufficient in the ECB?
Chinese And Japanese
Purchases of US Bonds
(Shifting from the US Dollar to
the Euro as a country’s
reserve currency)
The value of Yuan,
Yen, US$ and the Euro
What are China’s trade policy objectives?
Keep the value of the Yuan low to
promote exports.
 Keep the U.S. export market open.
China has 50 million jobs dedicated to its
U.S. trade, and rural Chinese continue to
pour into manufacturing areas seeking
work.

How has China kept the Yuan price low?
Sell Yuan in foreign currency markets.
 Buy dollars.

Dollars become foreign currency reserves.
How can you make money on reserve
holdings?

Purchase U.S. treasury bonds.
Why do we sell so many bonds?
To finance the war in Iraq, to fund Katrinarelated projects, to fund medicare
prescription benefits,
 Etc.,
 Etc.,
 Etc.

In purchasing our bonds, China supports the
maintenance of the U.S. trade-finance system.
We need the foreign funds to sustain our import
deficits.
 Why does China want to sustain our system by
purchasing treasury bonds?


The Chinese have around two hundred billion
dollars invested in it. They want to retain our
export markets. U.S. bond yields, somewhat low
by historical standards, are still higher than
those of the other major countries.
What happens if China were to sell off their
bond holdings?
The increase in supply would drive the price down.
S1
S2
$96
$92
So the interest rate
rises from 4% to 8%.
When China unpegged the Yuan, they
purchased Euros to support their new
market basket pegging.
Interest rates rose immediately as bond
prices fell (although only a little.)
 We panicked. China restructuring it’s
reserve portfolio?

A cutback can do the same job as a
selloff in the Treasury bond market!
Cutback
Selloff
Japan has been doing the same
thing, only they’ve got a lot more
bonds!
Why do they buy bonds?
 They want to sell Yen, so they buy dollars with
them in the foreign exchange markets.
 With the huge dollar reserves, they buy U.S.
bonds. 3-4% interest is better than just sitting
on the dollars. They have c. $740 billion in our
bonds and have lost c. $110 billion in value with
decline of the dollar.

Japan’s Interest in the Dollar

To maintain the bond market is to defend
the dollar. If the bonds sell big time, the
value of the dollar would fall. Even if China
stopped buying U.S. securities, Japan's
central bank probably would step in and
defend the dollar to protect its own huge
export trade with the United States.
Is a selloff likely?

Nobody thinks so at the moment, but
would it take a selloff to drop bond prices
and raise interest rates?

No, the cutback would do the job fine.
Could we raise the funds by selling
additional bonds to other parties?

Of course. How can we get other
investors to buy more than they currently
want?

Raise the interest earnings (drop the costs
of the bonds).
Could we raise the funds by selling
additional bonds to other parties?

Of course. But when these interest rates
go up, what else happens?
Other interest rates in investment markets
rise. Crowding-out occurs in private
sector investments.
 Interest rates on housing go up, so the
housing boom ends.

What happens if the housing boom
ends and all i rates skyrocket?
Fini
(The End)
Europe’s Labor Markets

“European Labor Markets and EMU
Challenges Ahead,” Soltwedel, Dohse, and
Krieter-Boden.

Members of the EMU must give up
 1.
Monetary policy
 2. Currency devaluations
Europe’s Labor Markets
With different regional structures, some
based on divergent development from scale
economies and specialization, regions are
subject to different asymmetric (regionspecific) shocks, those whose macro
impacts affect some regions more than
others.
 Such shocks are more pronounced in the
EU at the regional than at the national
level.

Europe’s Labor Markets

Unemployment also has a regional
dimension. The dispersion of regional
unemployment rates across the EU was
three times higher in 1995 than in the late
1970s. Unemployment in economically
troubled regions was three times higher in
1995 than in the late 1970s.
Europe’s Labor Markets

Unemployment is largely a result of the
inflexible labor markets in Europe.
 Workers
once hired are more or less permanent
acquisitions. (Legal, institutional impediments
to down-sizing.)
 West European workers are costly
(e.g., high, union-encouraged wages, payroll
taxes in Germany. Minimum standards for
working conditions in the EU’s social charter
of 1989.)
Europe’s Labor Markets

Conclude by discussing the quote on p.
348.