Germany the Currency Manipulator

Paul Krugman points out that even within the most extreme version of a fixed exchange rate regime - a currency union - one can think about the misalignment of the underlying currencies (even if their are no underlying currencies).

The general point is that if we imagine a euro breakup, I think everyone would agree that the new mark would soar in value, making German manufacturing much less competitive. The German public imagines that it is being cruelly exploited for the benefit of lazy southerners; arguably, what’s really happening is more like China’s purchases of dollars, which are intended not to subsidize America but to boost industry.

Chinese Manipulation?

House Passes Bill Aimed At Chinese Currency: Listen here and read article here.

"The Chinese ought to be aware that Congress is serious about confronting their currency manipulation," Schumer said in a statement.

Apparently when China engages in active monetary policy it is called manipulation. What is it when the US does it? I do not believe currency interventions can persistently affect the real exchange rate for long periods. If the Chinese currency is truly undervalued, the process of selling RMB and buying dollars has to dramatically increase domestic Chinese inflation.

But maybe the currency isn't really that undervalued? Here is one paper which suggests that its not. Here is a more recent paper by Menzie and others. Their conclusion:

To sum up, absolute PPP suggests (log) undervaluation of about 50% (67% using Mac
parity). The Penn Effect suggests essentially no misalignment (our estimates), or between 13.5% to 38.8% undervaluation (according to Subramanian). The Goldman Sachs BEER implies slight undervaluation against the dollar, and 23.1% against the euro. The Cline-Williamson FEER based estimate implies a 33% undervaluation, while the Goldstein-Lardy estimate is for 22.3% to 28.8% (for zero current account surplus), or 12.8% to 17.4% (for halving the surplus). These estimates are summarized in Figure 3.

The real test? If you think the RMB is undervalued have you mortgaged your house to go long on it?

Questions and Answers

I have long wondered why if China's exchange rate policy (ie. their peg) is so far away from the "true" market exchange rate, then how has that monetary expansion not lead to a rapid pick up in Chinese inflation? James Hamilton offers an explanation. Its there, just hidden in relative prices:

So why hasn't domestic inflation in China undone the stimulus from the exchange rate? I've been forming the opinion that U.S. inflationary dynamics may be more governed by relative price changes than was historically the case, and raise the possibility that China could be ground zero for this phenomenon. Specifically, I'm wondering if the pent-up inflationary pressure takes the form of inducing consumers and businesses in China to try to acquire any hard assets they can, with the result that rather than overall inflation we see remarkable increases in the relative prices of such items. I've commented before on this interesting account from last September: