Donald Trump’s administration should be careful about what it is seeking from the International Monetary Fund. In his first contact with IMF Managing Director Christine Lagarde, Steven Mnuchin, US Treasury secretary, has indicated that the Trump administration expects candid exchange rate analysis from the Fund of member countries’ policies.
The thought has apparently not crossed Mnuchin’s mind that, if the IMF carries out its exchange rate policy surveillance function, it might single out the US as a major obstacle to reducing global trade imbalances.
In asking for more frank analysis, one must presume that Mnuchin would like the IMF to provide the Treasury cover from which it can declare countries with large bilateral trade surpluses with the US as currency manipulators.
He probably has foremost in his mind China and Germany. If the Treasury declared such countries as currency manipulators, that would trigger bilateral negotiations as to how they might adjust their policies to reduce trade surpluses.
The IMF might exhort Germany to adopt a more expansionary fiscal policy and to be more willing to accept higher inflation to reduce its current account surplus of around 9% of GDP. However, the Fund is likely to remind Mnuchin that Germany is a member of the euro area, and as such does not have a currency or monetary policy of its own. It is also likely to alert him to the financial market dangers of having Germany leave the euro.
The IMF is also likely to disappoint Mnuchin in its analysis of the Chinese economy. While the IMF might impel China to rebalance its economy towards greater reliance on domestic consumption, it is highly unlikely to criticise Beijing for manipulating its currency to gain an unfair competitive advantage.
Rather, the Fund would probably point out that it considers the renminbi to be trading at around fair value. The IMF may also remind Mnuchin that, over the past 18 months, Beijing has spent more than $1tn of its international reserves to prevent the Chinese currency from unduly weakening.
If the IMF is even-handed in its exchange rate policy surveillance, Trump’s proposed domestic policies would almost certainly attract serious criticism. The Fund would be expected to note that his policies would aggravate global trade imbalances and lead to an overly strong dollar. This would be of particular concern at a time when emerging market corporations are holding high levels of dollar-denominated debt. If the dollar strengthens further and capital flows reverse, these corporations would find it difficult to service the debt.
Mnuchin would not relish being told by the IMF that two basic pillars of Trumponomics are more than likely to strengthen the dollar and worsen trade imbalances.
The first pillar is the US administration’s intention to move to a more restrictive trade policy. This would include higher import tariffs and possibly a border tax adjustment. To the degree that those policies restrict import demand, they would tend to boost the dollar.
The second is Trump’s proposed budget policies, involving large tax cuts in addition to substantial increases in defence and infrastructure spending. Those policies would, in all probability, lead to a widening of the US budget deficit. That would risk the re-emergence of a twin-deficit problem, as the US savings rate would decline. When the US economy is close to full employment, such a budget policy is likely to force the Federal Reserve to raise interest rates faster than intended. That, in turn, must be expected to propel the dollar higher.
Mnuchin should reconsider what Trumponomics might do to global trade imbalances. Rather than trying to enlist the IMF to help the US berate its trade partners, Mnuchin might be better advised to engage those trade partners in a constructive dialogue
All countries, including the US, need to discuss suitable policy action to reduce the world’s trade imbalances. Dialogue, not confrontation, is the way to achieve that goal.
Desmond Lachman is a resident fellow at the American Enterprise Institute. He was formerly a Deputy Director in the International Monetary Fund’s Policy Development and Review Department and the chief emerging market economic strategist at Salomon Smith Barney.