Interview with Martin Wolf-FT Chief Economics Commentator

By Zhang Feifei
Published: 2010-11-18

Martin Wolf is the Associate Editor and Chief Economics Commentator at the Financial Times.
This interview was carried out at Nottingham University at its Ningbo campus on November 10th, 2010.

Economic Observer: The DowJones Index fell 16 points last night, showing that people on Wall Street seemed worried about the effects of the Fed's Quantitative Easing (QE). Domestically speaking, do you think QE as a monetary policy will solve the US's problems?

Martin Wolf: The Fed's intention was to accelerate somewhat a very sluggish recovery. The QE policy they're pursuing is quite minor, nothing very dramatic. I would guess on balance it will probably accelerate the recovery a bit. There are risks that it will not do that, if the expectational effects are sufficiently adverse it might not work at all. But at best it will make a modest difference. In and of itself, the expansion of the balance sheet by 600 billion dollars is not a very significant economic event, it is 4 percent of GDP; this is not a big sum. My general expectation is, like the last round of QE, it probably will have modestly beneficial effects; it is not going to bring out a strong recovery on its own.

Economic Observer: A lot of people are worried about the jobless recovery of the US economy, and there are some experts from China saying that even if the US pumps more money into the system, companies and consumers do not have the desire to use that money which will stay in the banking system and pour into the emerging market. Is that one of your concerns?

Martin Wolf: Part of the answer to this question is who knows, but let us just think about what QE does. There are two effects of QE which are reasonably direct: it ought to have an effect in raising the prices and lowering the yields on government bonds in the US-that is the first effect; the second effect is it changes the portfolios of the people who sell the bonds, from bonds to cash. Those are the two things that happen. And it also increases the reserves of the commercial banking system with the central bank because of the second effect.

Now the interest rate effect ought, other things being equal, to raise the price of riskier assets in the US and the world, and make it easier for indebted people and companies to pay down their debt, and because asset prices rise, it will become more attractive to borrow and also to spend because wealth has risen, so that is the effect that goes through the interest rate effect. I think these effects will be pretty weak because I expect the impact on interest rates to be quite weak. Do not forget long-term bond rates are already very low in the US; if they lower them by another 10 or 20 basis points, this is not going to make a dramatic difference; you will have to do much stronger, much more QE than that to have a much effect on these interest rates. They have already indicated they're limited in the amount- 600 billion- everybody knows this is going to end, so I think the effects on long-term interest rates will be quite modest.

So these all are clear, those are roughly the things. Because the sums involved are quite modest, and the relevant interest rates are already very low, I expect the interest rates effect to be very small. It will not make much difference in the end to this market, and the effects on other asset prices will be quite modest. But these do reinforce one another, there is no question. So basically the direction you described is right.

I think it is almost completely wrong to think this is the main force driving the exchange rates of emerging countries. There is something bigger going on over here, which is that people around the world, including westerners who own western assets and were buying western assets have become disappointed with those assets; they want to shift their portfolios into emerging countries because they seem to have the most attractive opportunities. So private capital is flowing to emerging countries; this monetary policy will tend to reinforce that, because it is lowering the yields in the west, and increasing the attraction of riskier assts, so that is the big force. The big force that is working now is that people want to hold foreign assets. The dollar in real terms is getting back to where it was before the crisis. That is roughly what you'd expect. During the crisis when everybody was very frightened; a lot of wealth went into the dollar because it was seen as the safe haven. That's no longer so very relevant, so it is turning back to where it was before the crisis.

In other words, the world economy is trying to shift the current account deficits that were previously in the developed world into the emerging world. The emerging world does not want this to happen; they dislike this event and want to continue with the surpluses, so they are intervening, including in China. So they are resisting the flow of the economic water, but the Fed is not the dominant source of this flow, the dominant source of this flow is the private sector and no monetary policy will prevent that, in my opinion. So I think there is far too much attention being paid to QE which will turn out to be quite unimportant.

Economic Observer: Are you aware of hot money in China? Is hot money one of your concerns?

Martin Wolf: I don't know how porous the mainland is to inflows of capital. My impression has always been that the short-term inflows into China are reasonably well controlled. But I am not an expert on this. But there obviously are short-term inflows into China. It's clear that the yields on the conventional safe assets in the developed world are now very very low. So if you are an investor looking for returns, you go somewhere else, that's what hot money means.

Since interest rates are very low, it's very cheap to borrow, so those people who want to speculate can borrow, but there is so much borrowing going on and buying of other assets, Chinese assets, whatever. So there is no doubt and there is all this speculation. So it has nothing to do with QE, but there is no question that there is a risk of large inflows into those emerging markets that look attractive, which are open, like Brazil. It happened to Brazil and it would happen to China if China had no exchange rate controls, and allowed the rest of the world to buy Chinese assets. There would be a gigantic flood of capital into China, and the exchange rate would be pushed through the roof.

On the other hand, if you allow Chinese people to put their money abroad, there might be a large outflow too. So who knows what would be bigger, I suspect actually the net flow would be into China, not from China. If China has no exchange rate controls, the flows would be enormous. In that sense, there is a very real risk of hot money. But I think structurally it's just a permanent feature of the world system. It is re-acerbated by the desire to reallocate portfolios.  

Economic Observer: What do you think of the risk of a competitive depreciation of currencies?

Martin Wolf: The US is not pursuing a deliberate exchange rate policy. The exchange rate is a byproduct of various other policies. But it's clear that there is a reallocation of the portfolios across the world and because a lot of people are nervous about dollar, the dollar is weakening against those currencies that are free to move.

I can't see any country at the moment that is deliberately pursuing a competitive depreciation policy. You could say that China is pursuing a competitive deliberate non-appreciation policy, but it's not trying to depreciate the currency. But the important point to my mind is that even though I am pretty convinced that the US is in no way pursuing a deliberately policy of depreciating the dollar, not everyone agrees with me, it's how it is seen outside the US. Many people in both the developed and the emerging world think the US is trying to depreciate its currency deliberately. They believe that's a principle consequence of the Fed's policy and they believe that the Fed intends it in some sense. It's their aim. I think it's not their aim, but it is just a small consequence of the QE. I think there is little doubt that US policy makers in the current situation are on the whole quite happy to have a weak dollar; I wouldn't say that's their deliberate policy. Given that they have a huge current account deficit, the biggest in the world, that they need additional demand, the domestic demand is weak. Anything that tends to strengthen external demand through increased competitiveness is helpful.

Economic Observer: How can you be so sure it is not deliberate?

Martin Wolf: There's a formal point and an informal point. The formal point is the Fed has no responsibility for exchange rate policy.

Economic Observer: But it seems as though the Fed is politicizing its role more and more...

Martin Wolf: It's always been political-ish. But it's absolutely clear …that's why it's so difficult to defend this. If you've got a floating currency, you've got a country with very weak demand, and external deficit; your aim is to sustain, to avoid falling inflation and to sustain demand in the US economy. It's no question that's the aim. You pursue a monetary policy which is expansionary; it's clearly one of the ways in which an expansionary monetary policy increases demand and raises inflation is normally by weakening the external value of the currency, there's nothing new about that. So it's almost perfectly plausible to say that one of the aims of the Fed is to weaken the dollar. But I would say the aim of the Fed is to expand the US economy. If one of the consequences of that and one of the ways that it works is via the weakening of the dollar, that's fine. So, we may not disagree in a way. All I'm saying is that the Fed is indifferent towards what happened to the currency, it's not its aim. It does not have an exchange rate target. Ben Bernanke certainly didn't get up in the morning, and say I would like the dollar to be X or Y or Z. In that sense, they really don't have an exchange rate policy. They have a domestic economic policy, and the domestic economic policy involves doing things which inevitably affect exchange rate. So the right way to think about this is that the exchange rate is simply part of the transition mechanism.

Now from the point of the view of the rest of world, it will be likely to feel like a deliberate policy to weaken the dollar. You can look at this, but the much more important point to understand this is that the Fed doesn't care about what happens to the dollar. It cares about what happens to the US, and as far as they’re concerned, the rest of the world sort of has to live with that consequence.

Economic Observer: But objectively speaking, do you think the US policy is affecting other parts of the world negatively, in other words, is there a need to change the international monetary system to ease this collateral damage?

Martin Wolf:  The monetary policies of all countries affect the world. The bigger the country, the bigger effect on the world, since we have an open world economy and money is traded and tradable. The monetary policy of all big countries affects the world. So by definition, the monetary policy of US affects the world. The monetary policy of the eurozone affects the world and the monetary policy of China affects the world. The monetary policy of even the Bank of England affects the world. Because the US dollar is the most important currency in the world, the impact of US monetary policy is larger than the impact of the monetary policies of other countries. So in that sense, it is obviously true that the monetary policies of every country and quite particularly the US and other big powers have global affects. There's nothing interesting about it. It's obvious.

Second, we could envisage other international monetary systems.

Economic Observer: Gold standard or SDR?

Martin Wolf: Yes. The SDR isn't a monetary system; the SDR is just a composite currency. So there are no rules for the issuance of this currency. There is no central bank behind this currency.

Economic Observer: Couldn't the IMF regulate the currency?

Martin Wolf: The IMF isn't a central bank; it doesn't have a government behind it. This is really very complicated territory. The question is what you mean by an international monetary system. The important point about any international monetary system is how it interacts with domestic monetary policy around the world. The SDR only becomes a part of a global monetary regime if it changes the monetary policies of every country in the world, or all the important countries in the world. The central changes would have to be that there would be some link. It's very problematic with the SDR, because it's a composite currency, between the supply conditions between the domestic monies around the world and their price against the SDR, and some policy to determine the global supply of SDR.

So the crucial point, I mean the SDR is peculiar because it's not a standard of value, it's just a composite entity, but in theory, you could create a global currency. Keynes proposed something called Bancor. You could in theory link the price of all the other currencies to that. You could have rules for the currency supply in all these other counties. And you could have a rule for determining how much this composite currency of the Bancor is created. This is a conceptually possible thing to do, but you would have to then change the monetary policies of all the member states.

So the crucial point is not the international monetary standard, but what happens to domestic monetary policy? Chinese monetary policy is not dictated by its exchange rate. It has a peg but the crucial monetary policy decisions are all domestic, and the reason that is possible is that China has exchange controls which allow China to operate a domestic monetary policy which is autonomous with regard to exchange rate intervention which has very large effects. Well, if in this new system, that would have to be negotiated, and it's pretty clear, it would have to be negotiated away, because otherwise, the system of adjustment of a global monetary system doesn't work. So China's system would have to change completely, and under this system the US would have to change. It would have to basically say that the Fed would now have to judge by the monetary policy by the price of the dollar against this reference entity.

The crucial point, these are not international system changes, these are domestic system changes and none of the major countries has the slightest interest. China, Europe and America do not have the slightest interest in changing their domestic monetary arrangements. This is why we are in the impasse. Gold doesn't change that either. It's in fact just another reference entity.

Economic Observer: But Zhou Xiaochuan proposed the SDR trans-sovereignty currency back in 2009, how do you explain that?

Martin Wolf: I read those articles very carefully, and I think it was a brilliant diversion tactic away from the discussion of RMB, but he was very careful. He proposed the creation of an international reference standard, and I think he proposed the creation of a new reserve asset which makes a lot of sense for China because it would mean that its reserves were relatively protected against the fall of the dollar. That's a completely different question. The SDR as a reserve asset is a completely different question.

We could perfectly well imagine internationalizing the reserve assets. That's separate from the monetary system. But he made no proposals for this as far as I can remember and I read these very carefully, they were very short speeches on how a new monetary system would operate. And in the essence of a new monetary system, you don't just change the reserve assets. You change the connection between the international money and the domestic money supply. He made no suggestions on that.

So all you could say, what I took from those speeches, is that he is saying: we are not satisfied with the existing international monetary system, we don't want to go to a free float so we would like a discussion on something different. Well I have no objection to discussing something different, but I think coming up with a monetary system which is different from the floating rates among the major currencies we have now is going to be very very hard. And those are fundamentally questions of politics, and they are about how monetary policy is determined. But I would say that at this stage today, China has not put forward a worked out alternative international monetary system. It's indicated its unhappiness with the dollar based system, that's quite clear, and it's indicated its desire for another reserve asset, that's clear. But it's not clear what China's views are on the international monetary system. In effect, it's not even clear for me what China's views are on the evolution on the Chinese monetary system and exactly how it should evolve over the next 20 years.

So all I can say is this is not yet a debate. We have not got to the point of a serious discussion of alternative monetary systems, and I think the reason is that there isn't even the agreement on what the problem is. This has happened before. This is not the first time. The last serious discussion was in the 1970s when we moved to floating. In that stage there was a very serious discussion, but mainly between the US and the French. The French wanted it, and they still do and I'm sure when they are chairing the G20 they will raise this, they want a new fixed rate system. The US is always rejecting it.

If I were predicting what will happen, it will all depend on how this crisis will end up. Ten years from now on, we could be in a very different world. But if we are in a different world it will be because everybody has finally decided this system doesn't work. It's possible.

Economic Observer: What can we get from the G20? Is the 4 percent proposal feasible?

Martin Wolf: We're going to get nothing at all. Zero. There will be something about IMF reform, that's been agreed. There is going to be some stuff on development, but on the international macroeconomic and the international monetary system, I expect as things stand now, I expect a complete and total impasse.

I'm assuming that China will agree to nothing. That's pretty clear. My reading of the situation is that it's Chinese policy not to accept international commitments which constrain Chinese sovereignty in these areas, and therefore China will not accept these proposals, and they will make counter proposals to the US, probably on fiscal deficits and monetary policies, which the US will also reject because they will never accept proposals affecting their sovereignty. So both sides will agree that they will not accept the proposals of the other side, so there will be no agreements.

Economic Observer: So, we are stuck there? What's the way out?

Martin Wolf: Yes. Not through an agreement. So if that's correct, either people will leave things where they are, which is where we now for many years, so each country will do what it wants and ignore what the other wants, or there will be some more direct confrontations. But I think the idea of getting an agreement that is effective through the multi-lateral discussion in a formal way, that's not going to happen. On the other hand, China's current account surplus has declined a lot. The Chinese government may have decided it has nothing to do with the G20 as the formal process is to reduce current account surplus further because it's in the interest of China. So maybe two, three years from now, the problem will just disappear and there will never be an international agreement because the Chinese government will never want to make that concession, but the problem will still be resolved, I think that's quite possible.