On June 13, U.S. Senators Baucus, Grassley, Schumer, and Graham introduced the Currency Exchange Rate Oversight Reform Act of 2007. The Act would require the Treasury to identify twice a year those countries whose currencies are “fundamentally misaligned”, of which a few ones would be given priority status if misalignment is deemed to be “caused by clear policy actions by the relevant government”. Such “priority” countries would be potentially subject to a variety of sanctions.
On June 18, Rodrigo de Rato announced a “major revision” of the IMF’s framework for the surveillance of exchange rate policies. The revision is to provide “clear guidance to our members on how they should run their exchange rate policies, on what is acceptable to the international community, and what is not”. And its key provision is that surveillance will add a new principle to the existing ones regarding the acceptability of foreign exchange intervention: “A member should avoid exchange rate policies that result in external instability”. And apparently the IMF, too, would chastise the bad boys. According to Reuters, “the IMF might be prompted to summon an individual country for talks if its policies are seen overstepping the rules”.
These two obviously related policy moves have been widely assumed (correctly, in all likelihood) to be directed at China. But I cannot help but imagine the long line of central bankers that would have to be summoned for a mea culpa in Washington, including several Latin ones.
For instance, Colombia’s central bank, Banco de la Republica, bought US$ 4.9 billion between January and May this year, as a result of which its net foreign reserves increased by almost a third. As to whether this is a “clear policy action” to keep the Colombian peso at an artificially undervalued level, one could note that the Banco de la Republica’s foreign exchange purchases have occurred simultaneously with interest rate increases aimed at preventing overheating.
Similarly, Peru’s Banco Central de Reserva purchased US$ 8.7 billion between July 2006 and May 2007, also increasing its international reserves by about a third. According to the Banco’s latest Inflation Report, the purchases are needed in case of “eventual negative external shocks in the future “. But if so the Banco’s degree of risk aversion must be clinically high, given current world perspectives and the fact that the Banco’s international reserves are already sufficient not only to purchase the monetary base five times over but also almost the total liquidity of the banking system.
The cases of Colombia and Peru are particularly interesting as tests of the new Treasury and IMF measures because they are performing exceptionally well. Moreover, they are both on the verge (we hope) of signing a free trade agreement with the United States, and their credit ratings are being considered for upgrades to investment status. So they could argue that their monetary policies have served them well, in spite of substantial foreign exchange intervention and strategic manipulation of the exchange rate. Yet they emerge as clear candidates for public embarrassment by the new surveillance policies of the Treasury and the IMF.
This is all to say that the devil of those new policies will be in the details, such as defining what exactly constitutes misalignment, or whose external instability exchange rate policies should be concerned with. Unfortunately, or perhaps fortunately, we economists can disagree forever about those details.