Where Oh Where Is My Foreign Exchange Uncovered Interest Parity?
Uncovered interest parity. The world would be a much more comprehensible place if uncovered interest parity held.
Mark Thoma quotes Brad Setser:
The club of puzzled dollar bears grows bigger, by Brad Setser: I am -- and probably always will be -- a big Robert Rubin fan.... [A]ll those of us who thought there was a big risk that the US would have a Wile E. Coyote moment two years ago can take comfort that both Bob Rubin and Paul Volcker thought so too....
I share Rubin's deep sense of puzzlement. Not about the dollar. Central banks are clearly responsible for propping it up.... [W]hat really puzzles me is the absence of volatility in the foreign exchange market.... I would expect, based on the collapse of capital flows to emerging economies in the 1990s, that a more unbalanced world will prove, over time, to be a more volatile world. But so far, though, it has been -- at least in some key markets -- a less volatile world. That puzzles me....
But at least I seem to be in good company...
Could the U.S. continue to spend $800 billion a year more than it makes for a long time to come? Yes. Is that the way to bet? No. The market should be pricing in a high probability of a steep fall in the U.S. trade deficit over the next five years--and if the trade deficit does fall, being short dollars will be a very good bet.
But uncovered interest parity does not hold in the world we live in. And that makes life so very confusing.
