The Current Currency Situation

Policy Brief
November 2011

The latest semiannual estimates of fundamental equilibrium exchange rates (FEERs) by Peterson Institute researchers William R. Cline and John Williamson find that modest appreciation of the renminbi against the dollar, combined with higher inflation in China than in the United States, has narrowed the undervaluation of the Chinese currency from 16 percent in April to 11 percent in late October. However, the bilateral undervaluation of the renminbi against the dollar still amounts to 24 percent; this is the rise in the renminbi that would be required to achieve multilateral equilibrium if all currencies were to move to their FEERs.

The dollar remains at about the same overvaluation as in April, about 9 percent.  The Mexican peso has become more undervalued than the renminbi.  The safe-haven effect boosted the Japanese yen and the Swiss franc, and both countries intervened to resist appreciation.  Because the yen had become overvalued but the franc remains undervalued, Japanese intervention was justifiable but Swiss intervention was not.

In the case of the euro, the currency was approximately at equilibrium by late October at $1.41 (although it would need to appreciate by 6 percent bilaterally against the dollar if all currencies moved to their FEERs). A key implication is that steep depreciation of the euro in an attempt to boost European growth would be destabilizing globally; it would move the euro area into major undervaluation and provoke even greater dollar overvaluation. A special examination of imbalances within the euro area shows that both Greece and Portugal might need to depreciate in real effective terms by 20–25 percent to cut back their current account deficits of more than 8 percent of GDP (2011), although in an alternative diagnosis they might not need real depreciation if the International Monetary Fund's forecast of current account equilibrium for both by 2016 is valid. Statistical tests confirm that for euro area economies under stress, however, public debt levels rather than current account imbalances have greater influence on government bond spreads.