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Economics 285
  Fall 2000
              Exchange rates
• Current rate is ¥107 per US dollar
  – Depreciation of yen means more ¥ per $
     • At ¥107, an item costing ¥107,000 is US$1,000
     • At ¥214 that item costs only US$500
  – Appreciation means fewer ¥ per $
     • In the mid-1980s, the rate was ¥240
     • The yen peaked at ¥80 in 1995
      Impact of ¥ appreciation
• Query: what happens to Nissan’s exports?
• What brand TVs do Japanese buy?
• What happens to GDP?
     • Y=C+I+G+X-M
• What happens to Japanese life insurers who
  bought US Treasuries & real estate?
     • ¥240 x $50 bil = ¥12 trillion becomes ¥4 trillion
• Fixed exchange rates
      • Trade dollars (baht) at a fixed rate (B22.0=$1)
• Choice of pegs
      • Single currency (e.g., US$)
      • Basket (e.g., by % of trade against ¥, $, E)
• Government must be able to control
      • Supply dollars to meet demand or
      • Make holding baht more attractive to attract dollars / shift S&D
• If the rate is really fixed, where do you borrow?
      • Query: can you have an independent monetary policy?
• Under a fixed rate
  – What happens with inflation?
     • Example: Prices double B22 per shirt to B44
     • How does the price change in US$?
     • What happens to exports? Imports?
  – What happens to reserves?
       Exchange rate pressure

• How keep from running out of reserves
  – Raise interest rates?
  – Slow domestic demand?
  – Supply more dollars?
     • Requires being able to borrow dollars
     • But who will loan?
     • The IMF!!
• In July 1997 the Thai Baht fell 50%
     • What happens to the number of baht a Thai bank
       would need to repay a US$ loan?
• Thai banks were rendered insolvent in one
• So should they use a crawling peg?
     • Adjust for inflation?
     • Adjust for shifts in ¥/$ rate, since Japan is a major
              Japan’s case
• Under the Dodge Plan, the yen was fixed in
  1949 at ¥360 = $1
• Modest inflation and rapid growth produced
  chronic trade deficits
• When Japan began running out of US$ they
  slowed domestic demand rather than
  depreciating their currency
• The tool? - raise interest rates!
       But raise interest rates?
• Yes, because capital controls didn’t let
  people freely buy / sell yen

• So in the 1997 currency crisis, Malaysia
  imposed capital controls and avoided the
  full brunt of the crisis
      How to use a hedge fund
• When you see a country in trouble:
     • Borrow lots of baht
     • Use it to buy US$
     • Wait!
• If you’re lucky
     • The exchange rate collapses
     • You buy back baht on the cheap
• Overnight profit
     • $100 mil gives $50 mil profit
• However for Japan accession to the OECD
  in 1964 required that they gradually remove
  capital controls
• Process largely completed in 1980
• Residual controls remained until 1998
  – 34 years, start to finish!
  – But what happened to the yen?
     Response to US inflation
• Bretton Woods collapsed in 1971
• ¥360 to ¥308
• How respond?
  – Lower interest rates
  – Increase fiscal expenditures
     • Tanaka Kakuei’s Rebuilding the Japanese
  – Don’t “sterilize”
              Bottom line
• Double-digit inflation in mid-1973
• Then the oil crisis hit!
• Deep doo-doo

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