Readers Question: I was wondering, what are some of the policies and possibilities a country can use to increase the value of their currency? Specifically countries who would be trying to “overthrow” the US dollar like China, India, Brazil, Russia etc.
To increase the value of their currency, countries could try several policies to cause an appreciation.
1. Sell Dollar Assets and Buy Their Own Currency.
China has over $1.4 trillion of US government bonds. If the Chinese sold these Treasury bills and brought back the proceeds to China, this would cause a depreciation in the dollar, and the Chinese Yuan would appreciate. (supply of dollars would rise, and demand for Chinese Yuan would increase) Because China has substantial dollar assets, they could cause a reasonably significant fall in the value of the dollar.
In fact China could appreciate the value of their currency simply by not buying any more dollar assets. Currently China has a large current account surplus with US. This flow of money into China would usually cause an appreciation. However, China has deliberately decided to use its foreign currency earnings to buy US assets. They do this to keep the Yuan undervalued and therefore keep their exports more competitive.
In the case of Russia and Brazil, they only have relatively limited dollar reserves. Therefore, there is only limited scope for selling dollars and buying their own currency.
2. Higher Interest Rates
Higher interest rates would attract some ‘hot money flows’. Hot money flows occurs when banks and financial institutions move money to other countries to take advantage of a better rate of return on saving. Given interest rates are close to zero in the US, higher interest rates in developing countries give a significant incentive to move money and savings there. However, higher interest rates may reduce the rate of economic growth (though higher interest rates will also reduce inflationary pressures)
3. Expectations
At the moment, it is hard to find a country which wants to have a stronger exchange rate. For example, Switzerland was once seen as a ‘safe haven’ currency. This caused investors to buy Swiss Francs. However, the Swiss government and Central Bank were worried about the appreciation in the Swiss Franc causing problems for exporters. If a country gave a credible assurance that they were targeting a higher exchange rate, this may encourage speculators to move money into that country.
4. Long Term Policies
In the long term, a strong currency depends on economic fundamentals. To have a stronger exchange rate, countries will need a combination of low inflation, productivity growth, economic and political stability.
For example, if India increased interest rates, this might not be enough to cause an appreciation in the exchange rate. This is because despite high interest rates, investors would be concerned about the high inflation in the Indian economy.
Do Countries want a Stronger Exchange Rate?
I don’t agree that these countries are targeting a higher exchange rate or trying to overthrow the dollar. China in particular is targeting a lower exchange rate. They believe a weak currency is essential to promoting strong export growth and strong economic growth. They may be trying to make their economy bigger than the US, but this is different to targeting a stronger exchange rate.
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Good analysis – there’s a mistaken impression that countries other than the US want a “strong” currency and associated deflation. In reality, no one really does – hence why the Swiss acted. Nice to see someone accurately debunk that.