On Fri, 24 May 2002, Rakesh Bhandari wrote: > Fred, > In terms of your prediction about a flight from the dollar, I would > put the same three questions to you: > > 1. What is your general theory for the determinants of exchange > rates? Do you rely on Shaikh for example? I don't have a full general theory of the determination of exchange rates. But I think capital flows are the main determinant of short-run movements these days. Capital flows in turn depend on many factors (relative returns, relative risks, reserve currency, etc.) I am not necessarily predicting a flight from the dollar. But I do think that there is a good chance that capital inflows will diminish in the months ahead, due to higher returns elsewhere and loss of confidence in the US economy. If so, the declining surplus on the capital account and the still growing deficit on the current account will put downward pressure on the dollar. If the dollar starts to decline, this could trigger a capital flight, which would cause the dollar decline to accelerate. > 2. Does the dollar play a unique role in the world economy, e.g., in > terms of meeting liquidity requirements? Yes, I do think that the dollar plays a unique role in the world economy today and that this is one of the things that has kept the dollar up in recent years, and could continue to do so in the future. But it would also mean that a significant decline in the dollar would wreck more havok on the world economy, as the reserves of many countries would decline in value. Jane D'Arista has some good articles on this unique role of the dollar at www.fmcenter.org. > 3. Can single country or even coordinated political actions affect > exchange rates? Only in relatively calm situations for temporary periods of time. Usually not in the case of capital flight. There is a small test case happening right now - this week the Bank of Japan has intervened to lower the value of the yen. Comradely, Fred
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