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Well, it seems true that a country can usually defend the upper bound of an exchange rate by just issuing new currency to buy foreign currency, for instance. Is that not what the Swiss Central Bank has been doing? It seems like there ought to be some negative consequences and chief amongst them would be the possibility of domestic inflation. If I have got that right that would be a serious problem for many Germans - allegedly their biggest nightmare. It would indeed be ironic.

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Thu Nov 28th, 2013 at 07:18:25 PM EST
[ Parent ]
It's looking increasingly likely that inflation is a fiscal, not a monetary phenomenon, as Chris Cook has been pointing out for a long time.

Also, central bank reserves don't circulate, so I'm not convinced "printing money" to accumulate foreign reserves to depress your exchange rate will "lead to inflation". If anything, it is an attempt to arrest deflation (explicitly in the case of Switzerland). But, if by depressing your currency you sustain your country's current account surplus (and Switzerland's is over 10% of GDP) then you get deflation anyway because a current account surplus is a drain on your money base.

A society committed to the notion that government is always bad will have bad government. And it doesn't have to be that way. — Paul Krugman

by Carrie (migeru at eurotrib dot com) on Fri Nov 29th, 2013 at 02:15:02 AM EST
[ Parent ]
"Also, central bank reserves don't circulate, so I'm not convinced "printing money" to accumulate foreign reserves to depress your exchange rate will "lead to inflation"."

I think you've got this backwards: the strategy would lead to increased reserve in foreign currency, but with more of the domestic currency on the open markets.
So, provided that those who exchange currency for DM are interested in spending them, it could lead to inflation/reduced deflation.

Especially if the quantities are huge.

Earth provides enough to satisfy every man's need, but not every man's greed. Gandhi

by Cyrille (cyrillev domain yahoo.fr) on Fri Nov 29th, 2013 at 02:24:48 AM EST
[ Parent ]
But if those foreigners were massively buying your domestic assets you wouldn't have a current account surplus.

Just look at Switzerland's last two years...

A society committed to the notion that government is always bad will have bad government. And it doesn't have to be that way. — Paul Krugman

by Carrie (migeru at eurotrib dot com) on Fri Nov 29th, 2013 at 03:43:03 AM EST
[ Parent ]
That's an entirely different argument from lack of circulation of central bank reserves.

Earth provides enough to satisfy every man's need, but not every man's greed. Gandhi
by Cyrille (cyrillev domain yahoo.fr) on Fri Nov 29th, 2013 at 05:16:33 AM EST
[ Parent ]
Maybe it's a different argument but it all boils down to the same thing: expanding the central bank's balance sheet is not inflationary.

A society committed to the notion that government is always bad will have bad government. And it doesn't have to be that way. — Paul Krugman
by Carrie (migeru at eurotrib dot com) on Fri Nov 29th, 2013 at 05:28:23 AM EST
[ Parent ]
But if those foreigners were massively buying your domestic assets you wouldn't have a current account surplus.

It might be possible for Germany to create a 'Euro- Deutschmark' funding market, analogous to the London Euro-dollar funding market, but such a market might be prone to more volatility and gaming as it would be a much smaller market. And then BuBa would acquire the same obligation of lender of last resort wrt Euro-Deutschmarks as the Fed has towards Eurodollars and Germans could have a major hissy over that. And the gaming possibilities could make the 'mark' the subject of a double entendre joke amongst FX traders.  

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Fri Nov 29th, 2013 at 10:32:16 AM EST
[ Parent ]
The Fed has no LOLR function with respect to Eurodollars, that's why Eurodollar deposits pay higher yields than dollar deposits...

A society committed to the notion that government is always bad will have bad government. And it doesn't have to be that way. — Paul Krugman
by Carrie (migeru at eurotrib dot com) on Fri Nov 29th, 2013 at 12:06:35 PM EST
[ Parent ]
None-the-less the Fed did support the Euro-dollar in 2008 and since by swaps with foreign central banks and the ECB as well as by being LOLR for the US arms of banks in London that needed dollar funding - indirect support but very real support. This came out very clearly in Perry Mehrling's Money and Banking course which I am just finishing.

The basic fact is that only the central bank for a given currency can perform LOLR functions for holders of debt denominated in that currency. It is important that this be done not so much for the sake of the bank but for the sake of the various derivative dealers that might be in departments of that bank.

The basic assumption of the assets being financed is:

Risk-less Asset = Risky Asset + Risk Insurance.
or
Risk-less Asset = Risky Asset + CDS + IRS + FXS

But risk insurance must be priced. If the derivative dealers in CDSs, IRSs and FX swaps are not supported in a crisis then they will not make markets. If they do not make markets risk insurance can no longer be priced and the risky assets get liquidated in a very disorderly and damaging fashion.

So it is the job of the Central Banks to provide liquidity as required until the panic is controlled. They effectively become dealers of last resort and have to begin to issue CDSs, IRSs and FXSs themselves and carry these instruments on their balance sheets. It is to be hoped that, seeing that they HAVE to perform such functions that they jointly agree to regulations that will make such an eventuality less likely. But that is very much a work in progress, if that is not too generous a term. Have a helping of Hopium.

"It is not necessary to have hope in order to persevere."

by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Fri Nov 29th, 2013 at 01:07:49 PM EST
[ Parent ]
Adding, of course, that it is in the futures market that a lot of the risk arbitrage is performed, so that they also need support in crisis.

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Fri Nov 29th, 2013 at 03:35:58 PM EST
[ Parent ]
Migeru:
It's looking increasingly likely that inflation is a fiscal, not a monetary phenomenon, as Chris Cook has been pointing out for a long time.

Well, to all but die-hard austerians, it is becoming increasingly obvious that deflation is a fiscal phenomenon.

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Sun Dec 1st, 2013 at 08:02:58 AM EST
[ Parent ]
No, immediate negative effect necessarily, but it would be active exchange rate management to stop appreciation, which is not what we expect to go down well with the German psyche.

Anyway, if all countries start doing that sort of thing, nothing stops the periphery (and France) countries to do the same... but with a lower exchange rate! Then we'll get central banks printing and printing, ad libitum, with no limit.
Then, once the periphery central banks have accumulated enough to essentially purchase Germany, a nice bout of inflation could ensue. Of course, the game would stop long before that.

Earth provides enough to satisfy every man's need, but not every man's greed. Gandhi

by Cyrille (cyrillev domain yahoo.fr) on Fri Nov 29th, 2013 at 02:22:34 AM EST
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Anyway, if all countries start doing that sort of thing, nothing stops the periphery (and France) countries to do the same... but with a lower exchange rate! Then we'll get central banks printing and printing, ad libitum, with no limit.

In principle, yes. In practice, if two central banks commit to doing this at the same time, then they will fix the exchange rate instead.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Sat Nov 30th, 2013 at 08:48:28 AM EST
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