Click here  for the Fed statement of August 21, 2001, accompanying the latest interest rate cut

Click here  for the latest "Beige Book" of the Federal Reserve, August 8, 2001

Click here for the latest (and unusually interesting) G7 statement on the world economy and on the reform of the international financial architecture, Genoa, Italy, July 20,2001

Click here  for the latest reform proposal how to make the private sector share the costs of emerging market financial crises (Joint Economic Committee of the U.S. Congress, May 10, 2001)

Click here  for the IMF's critical report on "Monetary and exchange rate policies of the euro area", April 20, 2001

Click here  for the G7 statement on the Turkish crisis (March 19, 2001)

Click here  for the latest G20 statement on the reform of the international financial architecture, incl. on the need for early-warning currency risk indicators like ours, on the need for domestic-currency-denominated local bond markets in emerging market countries and on some disagreement among G20 members what type of exchange rate regime emerging markets should seek to adopt (Montreal, October 25, 2000)

Click here  for the Congressional expert report on the reform of the IMF (IFIAC = International Financial Institutions Advisory Commission, Washington DC, March 8, 2000, also known as "Meltzer report")

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CURRENT TOPICS are topics we tend to focus on both in our proprietary research and in our online advisory support at any given point in time depending on the global market environment.

   Until not too long ago, a key market causality used to run from domestic real bond yields to the exchange rate in the case of the United States (the global reserve currency country) and from the exchange rate to domestic real bond yields almost everywhere else (with Germany and Japan occasional borderline cases). European Monetary Union has obviously been designed to break this pattern. Will therefore the U.S. bond yield equation need to be re-specified? Or will G3 exchange rates become indeterminate (hence, volatile and disconnected from fundamentals incl. interest rates)? We think, both the strange ups and downs of the Japanese Yen and the surprising weakness of the Euro (as well as the recent evolution of the U.S. yield curve) may have already been shedding some first light on this challenging analytical puzzle.

   What does the change of Administrations in the U.S. imply for the dollar exchange rate? Will the "strong dollar" policy survive? And why did Treasury yields rise in the first half of 2001, when Chicago futures markets anticipated a fall of US short-term interest rates to some 3 1/2 % by September? Many have interpreted recent comments by members of the Bush Administration against official foreign exchange market intervention as a preference for further dollar appreciation. One could also interpret them just the other way round . . .

   Until recently, Central European countries had faced the tricky task to lower interest rates because of domestic cyclical requirements, but without destabilizing their exchange rates. Luckily, the weakness of the Euro allowed them to do exactly that. With economic growth in Central Europe now taking off again (already prompting a string of sharp interest rate increases in Poland) and with the Euro still at a helpfully low level, a new Central European "convergence game" should start soon, similar to the one that had involved Southern European currencies a few years ago in preparation of European Monetary Union. Under the medium-term perspective to enlarge EMU eastward, falling bond yields and spreads and stabilizing, possibly even appreciating exchange rates in Central and also in Southeastern Europe look like a reasonably safe bet.

   We are constantly monitoring the consistency between emerging market bond spreads, credit agencies' sovereign debt ratings and countries' monetary fundamentals, following the agreed-upon changes to creditor banks' risk-weighted capital requirements as defined in the "Basle Standards" by the BIS (see Basle Committee on Banking Supervision, A New Capital Adequacy Framework in PDF, see also in this context Steven B.Kamin and Karsten von Kleist, "The Evolution and Determinants of Emerging Market Credit Spreads in the 1990s" in PDF, BIS Working Papers No.68, May 1999, but see also the critical response to the Basle reform proposals by the Washington-based, global commercial banking sector think-tank, the Institute of International Finance - IIF -, dated April 12, 2000). Once these changes become effective, the mere fact of borrowers' OECD-membership will no longer reduce the required risk-weights of loans to emerging market countries such as Mexico, Korea, Poland, Czech Republic and Hungary. As a result their international bond spreads could potentially widen as well and become more similar to those of other non-OECD countries. An alternative possibility: leading rating agencies may offset this equalizing effect by upgrading, for example, Mexican sovereign debt while downgrading, say, Colombian debt at the same time, a correction which has already got underway. Over the last year, both Moody's and Standard & Poor's have promoted Mexico to investment grade, but lowered their Colombian rating (still investment grade in 1999) twice to now BB. Moody's also upgraded Hungary from Baa1 to A3 last November. [Note, however, that standard sovereign credit risk measures for Indonesia and the Philippines have recently gone off track on a cross-spread basis.]

   Many have argued that the collapse of Turkey's IMF program in February 2001 had put the final nail into the coffin of any kind of exchange rate peg, "adjustable", "crawling" or otherwise. The UK Treasury even wants to make a country's potential access to IMF loans dependent upon a freely floating exchange rate. However, we would conclude that fully market-determined exchange rates, while clearly one, is not the only viable exchange rate regime that has emerged from recent experience. "Dollarization", currency boards (effectively approved at the June 1999 G7 summit in Cologne) and multinational currency unions may be just as viable (the latter now also under official consideration by Mercosur governments with Brazil and Argentina already co-ordinating their macro-economic targets, as well as by six West African nations - see the "Accra declaration" of April 20, 2000 - and by the ASEAN countries together with China, Japan and South Korea, see the Chiang Mai Initiative of May 6, 2000). In light of similarly devastating experiences with a broad range of exchange rate policy regimes - fixed, freely floating and anything in between -, perhaps the only way left to bring greater stability to today's uncontrollable currency markets is to reduce the number of currencies in the world. We are particularly interested in the question, whether an orthodox, Euro-anchored currency board might offer a useful shortcut for Turkey to bring its monetary stability standards more closely in line with those of the European Union, following the recent admission of Turkey as an official "EU candidate". To irrevocably fix the exchange rate of the Turkish Lira at a timely depreciated level, consistent with a price level target one year out and subsequently guaranteed by a water-tight currency board regime, may provide a safer path to force inflation down to European Union standards than the "controlled depreciation" policy which the IMF had tried to impose on Turkey until its predictable collapse in February 2001. We monitor the performance (and current crisis) of the IMF's Turkish program on a continuous basis in our password-protected member area.

   One key issue on the agenda of reforming the international financial architecture is a "stronger involvement of the private sector" in the prevention and resolution of emerging market currency crises. In addition to Argentine-style private sector credit lines "on demand" for emerging markets' Central Banks, we follow with particular interest the spreading use of Structured Notes - instruments of credit during the duration of which credit terms including redemption value and maturity vary endogenously and counter-cyclically depending on economic developments such as commodity price changes. The strategic question here is whether for better dealing with emerging markets' supra-national contagion risk some public lender-of- last-resort mechanism at the global level, or, alternatively, a new market instrument, such as Structured Notes including some form of currency risk insurance (a kind of private sector lender-of-last-resort mechanism), will eventually be needed. See also our adjacent page Market Reform.

   Monitoring the build-up of underlying monetary pressures which typically precede the abrupt eruption of currency crises remains central to our work. As indicated on our Currency Risk page, we do not subscribe to models which suggest an always expansionary net effect of exchange rate depreciation on aggregate output or a contractionary net effect of exchange rate appreciation. These conventional, naive models tend to neglect increasingly dominant wealth effects associated with exchange rate changes in today's global financial markets and foster the illusion, an exchange rate depreciation "allowed" a capital-constrained country to have lower real interest rates than otherwise. According to a growing body of empirical evidence, one does not observe any equilibrating influence from exchange rate depreciation, but rather a destabilizing spiral of depreciation and capital outflows. We classify short-term "profitability gains" which a depreciating country perceives to reap in its tradeable goods sector as a mere counter-booking to simultaneous capital losses on the real value of its capital stock - negative wealth effects which tend to lower potential output much more permanently than temporary export price discounts might raise certain industries' actual output for a short while. In other words, the bigger the imported component of a country's real capital stock, the more dominant will the contractionary supply-side effects of an exchange rate depreciation be compared to any "expansionary" demand side effects (so-called "improved international competitiveness" or: "the poorer, the more competitive"). Open-economy macro-models still built on the assumption of only limited international capital mobility need now to be scrapped. We work on an alternative, more contemporary external adjustment model, tailored to the new world of unlimited international capital mobility.




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