To Peter Dorman: The effect of having Korea and Taiwan pegged
to the $ was offset by having most of Latin America also pegged
to the $.
I agree with Tom Weisskopf's last posting (was going to make
same point myself) about role of interest rates. Clearly that
depends on MS constant and we know you reject that. But as you
have noted we are discussing logic not facts.
To Dodd (the Lone Wonker):
Yes, the DM traded consistently at a premium. It is a mystery.
I think you have confused 1981-82 with 83-84. Prior to August 82
real interest rates were clearly rising in the US relative to elsewhere,
but not later, except possibly some long-term rates (most traders
think it is short-term rates that drive FE markets). Short-term
interest rates in the US plunged _6%_ in about 3 months after Aug.
82 (when the Fed loosened under pressure of a Mexican default).
This was not matched anywhere, nor was it matched by any decline in
the $ which rose.
Your arguments about trade and budget deficits do not hold water.
Trade deficits were rising but that is a fundamental that augurs a
decline in currency value, not an increase (despite J-curve effects).
Indeed it, along with the declining interest rates, were why all the
forecasters, models, and forward markets were forecasting such a decline
in the $ at any moment.
Budget deficits did most of their increasing prior to Aug. 1982.
Anyway, their expected effect on ER is mostly through interest rates.
If those are not rising then there is no further effect. In fact what
there is cuts the other way, budget deficits stimulating imports and
thus a trade deficit and thus currency depreciation.
For a more detailed discussion of the $ in the early 1980's I
suggest Jeffrey Frankel's "The Dazzling Dollar" in _Brookings Papers on
Economic Activity_, 1985, No. 1. He reviews all of this and after
summarizing the complete lack of any explanation via fundamentals does
a test for bubbles. Actually he does a test for a "rational bubble"
in which the asset price would have to accelerate upward (like gold in
1980) to provide a risk premium for the investors facing a possible crash.
Frankel rejects this because the $ just rose steadily. Irrational
bubble? Probably.
Barkley Rosser
James Madison University
