from Follow the Money

If the US Treasury doesn’t think the dollar is overvalued, can it also think that RMB is undervalued?

August 23, 2007

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Christopher Swann of Bloomberg noticed the line in the IMF’s most recent Article IV report indicating that senior US officials objected the IMF’s conclusion – based on their model for equilibrium real exchange rates – that the dollar is overvalued (hat tip, Naked Capitalism).

Swann quite rightly notes that the US is shooting itself in the foot.   The US – led by former Treasury Under Secretary Tim Adams and his deputy for IMF affairs Mark Sobel  -- spent a lot of time trying to get the IMF’s surveillance to focus more on exchange rates.   That was the right thing to do as well. 

But if the US government isn’t prepared to accept that the IMF’s assessment that the dollar is overvalued, China certainly isn’t going to accept the  IMF’s assessment that the RMB is undervalued.    

Now the US will likely argue that it argued that the dollar’s value is determined in the market, while the RMB’s value is not.   Thus, the IMF’s model is far more germane for China than the US.

Swann reports

Treasury officials criticized the IMF analysis for relying too much on trade in goods and services and not enough on capital flows. While the U.S. has run record trade deficits in recent years, foreign capital also continues to flow into the country at an even stronger rate.  The Treasury also was ``skeptical about the notion of overvaluation for a market-determined exchange rate such as the dollar,'' the report said.

But, alas, while the value of the dollar against say the euro is determined in the market – albeit a market shaped by the portfolio decisions of China and a host of oil exporters – the dollar’s value against the RMB and a host of emerging currencies is not set in the market. 

And I am pretty sure that if the IMF rejiggered its model to account for fact that the majority of net capital inflows in the US in the first of half of 2007 came from the official sector, it would conclude that the dollar is even more overvalued.   The US hasn’t been attracting large enough (net) private capital inflows to finance a 6% of GDP current account deficit for a long time.    

Mike Mussa, the IMF’s former chief economist noted:   

``The U.S. Treasury has cut the legs from under the IMF before it even started the race … This was foolish and unnecessary when they could have just said nothing.''

I agree.

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