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Review: Affairs In Currency
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John Maynard Keynes used to stay late in bed, reading newspapers; then he would get up, ring up his stockbroker and place bids. He used to speculate in shares, but was luckier in the foreign exchange market. He became rich, and he made his college (King’s College, Cambridge) rich. Surjit Bhalla also speculates in the exchange market; every once in a while he writes a serious book. His last one came out in 2002: Imagine There’s No Country: Poverty, Inequality and Growth in the Era of Globalization.
For this book, he ran hundreds of regressions on countrywise data, some of them going back to the 19th century. He wanted to show that exchange rates influenced growth rates. But then, economic variables are interrelated, and many economists have championed other growth determinants. He begins with a survey of their theories before settling down to proving his thesis.
David Ricardo showed in 1817 that countries could get richer by exchanging goods they produced more cheaply for those in which production costs were higher. But people became aware that prices in rich countries were permanently higher than in poorer countries. Balassa and Samuelson wrote papers in 1964 attributing this to the absence of international trade in services; a haircut in Harrow could cost ten times one in Hyderabad. Still, price differences do lead to trade, which may lead some countries to accumulate and others to lose foreign currency. The lower the prices in a country — or in other words, the cheaper a country’s currency — the greater its exports and the lower its imports. By manipulating their exchange rates, countries can influence their balance of payments.
To show this, one has to measure how much a country’s currency is overvalued or undervalued. Bhalla does this by comparing countries’ GDPs at current exchange rates and purchasing power parity; the ratio is the real exchange rate. The ratio of the RER to the actual exchange rate gives an index of relative prices.
If devaluing its currency could lower a country’s relative prices, it would be able to improve its balance of payments. Some economists think that such improvement can only be temporary — that devaluation would lead to inflation and soon restore the original ratio of relative prices. Bhalla shows that devaluation often did not lead to inflation and that the improvement in the balance of payments lasted for decades. If a country could make exports more profitable by devaluing, it might thereby spur an investment boom. Bhalla also shows a negative correlation between exchange rates and investment ratios. He then shows that, as is to be expected, devaluation raised growth rates. The correlation coefficients are pretty low, but the signs of regression coefficients are in the right direction.
Bhalla then goes on to argue that China raised its growth by devaluation, and that its policy of raising its own growth entailed lower growth in those countries whose balance of payments worsened as a result. Japan did the same thing after World War II. The reaction of other countries was strongly hostile; in the 1980s, Japan had to reverse its policies and appreciate the yen, with terrible effects on its economic growth. China’s policy of currency undervaluation has been more severe, and yet the world has not objected to it in the same way. In Bhalla’s view, the world should.
Bhalla has tackled many questions with statistical guns blazing. But in his haste, he forgot to add one chapter — on why the trading partners were so harsh on Japan 30 years ago and are so forgiving towards China. I suspect there are two reasons: China keeps its payment surpluses in dollars, so the US does not have to pay for its deficits in foreign exchange; and China gives the US cheap credit by investing in treasury bills. It has got the US addicted to payments deficits. Bhalla should give it a thought.
(This story was published in BW | Businessworld Issue Dated 06-05-2013)