>Dollar, official reserves, capital flows, liquidity and exchange rate regime

In the exchange rate regime that prevailed before the crisis, the United States was affected
not only by a high external deficit, but also – and increasingly so - by capital outflows heading to emerging countries.

These countries (as well as oil-exporting countries) wanted to prevent an appreciation of their currencies against the dollar and accumulated huge official reserves, which led to a destabilisation of their domestic monetary policies (excess liquidity and credit, too low interest rates, etc.).

The situation seems to have evolved to a significant extent in the wake of the crisis:
− policies to stimulate domestic demand are being implemented in emerging countries; China in particular now has the will to replace exports - which are weakened by the crisis - with consumption; this is likely to reduce the savings glut in emerging countries;

− in the United States there is a rise in the savings rate due to household deleveraging, albeit only to a limited extent;

− moreover, we can see certain signs that international capital flows are returning to the United States, for different reasons: greater confidence in the US economy (perhaps mistakenly), excessive market valuation in emerging countries, preference for liquidity, crisis in the euro zone. These developments have important consequences if they persist and are confirmed:

− lower liquidity in Asian countries and worldwide, since it is no longer necessary to shore up the dollar;

− greater freedom of action for central banks in emerging countries, since they are less under threat of being flooded with liquidity if they hike their interest rates; accordingly, due to the economic recovery, tightening of monetary policies in emerging countries;

− depreciation of the euro, both against the dollar and emerging currencies.

It is not certain that the spontaneous support for the dollar will become a permanent feature. If that is the case, the winners would be the euro zone as the euro would return towards an exchange rate close to purchasing power parity, and emerging and oil exporting countries due to the regained monetary policy freedom; but there would also be a normalisation of asset prices in these countries due to the return of monetary policies that are suitable for their economic situations. The losers would be the United States, whose economic strategy in the aftermath of the crisis requires a weak dollar.

To read the full report: EXCHANGE RATE REGIME