currency fundamentals

[Rosser Jr, John Barkley]

     First let me note that Marty L.-H. is right that more 
of the troubled tigers were running current account 
deficits than just South Korea, especially Thailand, the 
alleged epicenter of the crash.  But if current account 
deficits are what determine currency fundamentals, then the 
US is a sitting duck with its long-entrenched and now 
rapidly expanding current account deficits.  I can hardly 
wait for Michel Camdessus to take a helicopter from the IMF 
building over to the US Treasury to tell the US what to do 
with its fiscal policy.
     Also, despite having high current account deficits in 
many cases, most of these nations have had actual budget 
surpluses or low deficits, have had relatively low rates of 
inflation, high rates of savings, and very high rates of 
real GDP growth and productivity growth.  Of course these 
were exactly the kinds of elements that led all kinds of 
commentators to drool at the mouth over these econmies, 
many of these same commentators now huffing and puffing 
about how these countries need fiscal austerity and other 
parts of the IMF package that was developed for 
hyperinflationary/budget deficit Latin America.  Duh...
     As regards currency fundamentals, since I brought this 
up, there is no universally agreed upon model of currency 
fundamentals.  There are several competing models, some of 
them differing on their time horizons.  
     The traditional long-run model is purchasing power 
parity which ignores capital movements and sees everything 
determined by trade.  Productivity and inflation drive this 
model.  By that model most East Asian currencies are now 
severely undervalued.  However this model generally 
explains little in the short-run, latest estimates showing 
about a 15% per year convergence toward PPP.
     Shorter term models bring in capital movements, but 
even there there are differences between stock models and 
flow models.  The latter generally involve interest parity 
conditions.  Thus, higher interest rates should raise the 
value of currencies and we frequently see this.  That's how 
Hong Kong is "defending" its currency.
     But on a wealth/asset model higher interest rates 
damage present values of assets and may hurt a currency.  
This may have happened to the US dollar several years ago 
when the Fed raised US interest rates with the dollar 
falling as a result.  Foreigners feared further interest 
rate increases and declines in asset values in the US and 
fled the dollar as a result.
     Thus, I was sticking my neck out in saying the East 
Asian currencies are undervalued.  But they certainly are 
on PPP grounds (determined by productivity and price 
levels).  And old models by Dornbusch and others show that 
with fixed prices and wages a shock in the foreign currency 
market usually leads to an overshoot.  This looks like one. 
The devaluations have gone too far.  How long it will take 
for them to go back is another question.
Barkley Rosser

-- 
Rosser Jr, John Barkley
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