ECONOMYNEXT – Washington-based International Monetary Fund has claimed that the external position of Vietnam was too strong and appeared to support false US allegations of undervaluation by ignoring a sharply appreciating real effective exchange rate index.
Instead the IMF used another model based on the external current account to support the charge and advocated a non-credible ‘flexible’ exchange rate for Vietnam.
Sri Lanka followed unusually discretionary policy involving a ‘flexible exchange rate’ (no credible external anchor) and ‘flexible inflation targeting’ (no credible domestic anchor) and is now on the brink of default and balance of payments deficits after repeated currency crises.
Sri Lanka was hit by credit downgrades in several ‘flexible exchange rate’ episodes involving call money rate targeting with excess liquidity and over-sterilizing outflows and under-sterilizing inflows which led to steep currency falls and foreign reserve depletion.
Sri Lanka’s troubles partly came by targeting REER, which analysts had warned was a wild goose chase as East Asians nations, from Singapore to Hong Kong (currency boards), and Thailand to China (tighter than currency boards but not as credible) usually had high real effective exchange rates.
Credible and Consistent Policy
The State Bank of Vietnam has been running a fairly credible peg with the US dollar around 23,000 dong since the last currency collapse during the start of the ‘Great Recession’ where the country was misled into ‘stimulus’ as a Fed fired bubble collapsed.
The SBV in general has been running credible domestic operations involving sterilizing inflows and only partially sterilizing outflows through a wide policy corridor and two way simultaneous lender of last resort auctions which allows the call money rate to go up and liquidity to tighten when the Fed tightens.
However the ceiling policy rate has come down since the last currency crsis.
Such a regime tends to be tighter than a currency board, which are policy-neutral and reserve accumulation is limited to domestic reserve money growth.
Unlike currency boards, such pegs can collapse after two or three Fed cycles when ceiling rate is too low to slow domestic credit or when central bankers who ran credible domestic operations retire and their replacements fall prey to relentless Keynesian pressure from the IMF and other interventionists.
“Vietnam’s external position in 2019 was assessed to be substantially stronger than warranted by fundamentals due to structural features,” an IMF staff report claimed.
The claim came shortly after the US Treasury labeled the country a ‘currency manipulator’ after a decade of currency strength, along with the Swiss Franc, one of the world’s strongest currencies.
The IMF has been pushing Vietnam to adopt a Sri Lanka style ‘flexible’ inflation targeting framework earlier claiming it would give better domestic stability than an external anchor, despite countries in Latin America turning into basket cases under similar arrangements.
US classical economist Steve Hanke from the John Hopkins university said the Amercian Treasury tended to make false charges about ‘undervaluation’ agaist trade partners with strong curencies all the time starting from Japan.
But labelling the Swissie, one of the strongest currencies in the world was a absurd, he said.
“The absurdity of putting the Swiss franc and the dong in the same basket brings back memories of May 1, 2002,” he wrote in December 2020.
“That’s when I appeared before the Senate Banking Committee, along with then-Treasury secretary Paul O’Neill, to testify on exchange rates and the Treasury’s “Report on Macroeconomic and Foreign Exchange Policies of Major Trading Partners of the United States.”
“I was highly critical of both the entire concept and the particular methods used to label a country as a currency manipulator. I indicated that the U.S. Treasury’s report was little more than an invitation for political mischief that would interfere with free trade.
“In short, I thought, and think, that the entire semi-annual currency-manipulator ritual is rubbish and should be trashed. The Swissie-dong odd couple certainly suggests that I am on to something.”
Vietnam had insisted that the strong Dong was for domestic stability and not to ‘undervalue’ the currency to boost exports.
Trump-style Mercantilists have long falsely blamed East Asia, which has pegged exchange rate central banks and currency boards for ‘undervaluing’ their currencies and creating a trade deficit with the US.
“Noting the staff’s assessment that Vietnam’s external position was substantially stronger than warranted by fundamentals and desirable policies, Directors called for steadfast reform efforts
to remove the remaining barriers to private investment and enhance social safety nets,” IMFs executive directors, one of whom is from the US said.
“At the same time, some Directors urged caution in interpreting EBA model results, which may not
adequately capture Vietnam-specific structural factors and measurement issues. ”
The US Treasury believes that ‘price effects’ are responsible for East Asian export performance, in the Keynesian tradition, and refuses to acknowledge that the American trade and current account deficit is caused by US deficit spending and FDI receipts and instead blames East Asia for ‘undervaluation’.
Cherry Picking Models
The IMF conveniently ignored Vietnam’s Real Effective Exchange Rate Index (REER) which is currently around 130 percent (as the US had always done) and instead points to the current account surplus, cherry picking the model to support a pre-conceived conclusion.
Vietnam’s current account surplus spiked in 2019, after policy automatically tightened in 2018 in response to US tightening (quantity tightening and rate hikes) slowing domestic credit, an apartment and property bubble.
Domestic credit slowed sharply to 12.8 percent in 2018 and 2019 from around 18 percent earlier, as the call money rate rose (without a formal rate hike) and liquidity tightened.
Reserve accumulation slowed sharply in 2018, and reserves were sold to keep the peg around 23,000 giving domestic stability.
The external current account balance which was a negative 0.6 percent in 2017 with 17.4 percent credit growth expanded to 1.9 percent in 2018 and 3.8 percent in 2019. Vietnam stocks collapsed as liquidity tightened and then recovered.
The property bubble moderated allowing the economy to grow steadily with low inflation only a little higher than the US.
The IMF however has been pushing the SBV to adopt a ‘flexible exchange rate’ which reduces credibility, panics domestic and foreign investors and ultimately generates credit downgrades and political instability as had happened in Sri Lanka and Malaysia.
“In the context of reserve adequacy, Directors welcomed efforts to allow greater two-way exchange
rate flexibility and modernize the monetary policy framework, which would help the economy
to adjust to the changing external environment,” IMFs executive director said.
Vietnam’s REER is now around 130 percent.
Price Effect Mercantilism
However the IMF – as it had done to other countries in the past – focused instead on a current account based model to bash the country to claim that Vietnam’s external position was “substantially stronger than warranted by fundamentals due to structural features.”
The IMF was set up by an arch New Dealer Harry Dexter White. New Dealers devalued the US dollar as part of several economic shocks (Regime Uncertainty) that delayed and killed the first US recovery from the Great Depression.
“There is no structural feature in the Vietnam other than prudent domestic operations,” EN’s economics columnist Bellwether said.
“This goes backs to Keynesian/Mercantilist mis-understanding of the balance of payments and central banks involving the German reparations payments.
“Keynes in 1929 claimed in several intellectual debates made similar arguments placing price effects over income, which he did not appear to grasp very well.
“He also believed that there were ‘structural features’ that doomed countries.”
Keynes has written among other things that ‘the economic structure of a country in relation to the economic structure of its neighbhours permits of a certain natural level of exports.”
Swedish economist Bertil Ohlin (and French Economist Jacques Reuff) explained in 1929 that a current account surplus (or any net position) is triggered by income effects (outflows) rather that price effects warning that a focus on ‘price effects’ would have unfortunate consequences in the future.
He warned that the apart from clearing up theory, it was a “matter of considerable practical importance not only for handling of the reparation payments, but also for central bank policy in the future.”
Prophetically countries like Sri Lanka in 2015 to 2020 is facing Weimar Republic style default, amid a relentless push to run ‘flexible exchange rates’ while pumping liquidity to target an output gap and create deficits of not just the current account but the overall balance of payments. (Colombo/Mar03/2021)