CURRENCY WAR OR CURRENCY PEACE: THE DOLLAR AND RENMINBI IN A WORLD OF PORTFOLIO AND CURRENT ACCOUNT IMBALANCES

This paper analyzes the stability of foreign trade, currency markets and international portfolio balances with the help of a model which captures the interactions between current account balances and the international asset portfolios for domestic and foreign investors. The model is used for policy analysis based on numerical simulations for the interplay between the US and China in terms of exchange rate, foreign exchange reserves and foreign debt. Conditions for the existence of dynamic equilibria, and whether they can be attained, are derived under alternative policy assumptions. Simulations of the model show that "trade space" (the range of trade and foreign liability imbalances that can be absorbed without triggering an unstable sequence of adjustments) is sensitive to the policy regimes in place; and to the preferences of investors and particular strategies employed by policymakers within those regimes. Our benchmark scenario, representing today's conditions for the US and China, shows trade space is comfortably larger than the adjustments usually said to be necessary. That would be satisfactory if we start from equilibrium. Unfortunately, we do not. But the result does suggest that currency peace rather than currency war is likely to be a more productive strategy for reducing existing imbalances.