For more than two decades, American administrations, both Democratic and Republican, have followed the same currency playbook. They backed free floating, especially for the US, Europe and Japan, without intervention. They pressed G3 officials not to comment on currency market developments. When unavoidably pressed to do so, they stated rote support for a ‘strong dollar’. And they focused on curbing excessive global imbalances, especially surpluses.
Key motivations behind bipartisan dollar policy have been US interests in avoiding excessive reliance on America as the engine for world growth and in resisting protectionist pressures.
The Donald Trump administration is right to complain about countries seeking to weaken exchange rates, especially surplus countries that at times heavily intervene to limit appreciation. Furthermore, the administration correctly says that the health of the US economy will determine the dollar’s long-run value.
Yet, in important ways, through a series of missteps, Washington has been backing away from the traditional currency playbook. This erodes US credibility and the ability to pursue its interests.
The administration’s confused currency rhetoric is the most obvious symptom. There is one simple means to rectify this: restore verbal discipline. Only one person should speak on currencies – and as rarely as possible. That should be the Treasury secretary.
At present, communication comes through multiple voices. The president has interspersed comments on wanting a strong dollar with others suggesting the dollar is too strong. Presidential adviser Peter Navarro has commented on the euro’s valuation. Treasury Secretary Steven Mnuchin observed this January that a weaker dollar is good for US trading opportunities. Larry Kudlow, director of the National Economic Council, has commented on the dollar as well as on gold prices.
US currency comments may appear innocent and innocuous, but that is often not so. They hurt America’s ability to persuade others to practise verbal self-restraint. Japanese officials have a long history of talking down the yen. Only weeks after Mnuchin’s comments, the Japanese returned to fretting about one-sided currency movements – code for an aversion to yen appreciation. Chatty Europeans, while more artful than the Japanese, have never been slouches about wishing a weaker currency to support growth or boost inflation. Euro area officials quickly chimed in earlier this year to criticise Mnuchin’s comments, seemingly worried that a lower dollar would weaken Europe’s recovery.
Official open-mouth operations are a longstanding feature of currency markets. Others often try to push their currencies lower in the hope of boosting jobs at home through exports to the US. Conflicting G3 currency rhetoric can unsettle markets.
Following harmful discussions about ‘currency wars’ in the wake of the financial crisis, the US in 2013 forged G7 and G20 agreements that countries would not target their exchange rates, and more generally would refrain from talking down their currencies. Officials should do a better job of sticking to these agreements.
Another possible symptom is that something new has appeared in recent G20 currency language. Buried among long-standing refrains about not targeting exchange rates or seeking competitive devaluations is a new sentence: ‘Strong fundamentals, sound policies, and a resilient international monetary system are essential to the stability of exchange rates, contributing to strong and sustainable growth and investment.’ This comes from the communiqué of the meeting of the International Monetary and Financial Committee, which advises the International Monetary Fund’s board of governors, in October 2017.
The first part of the sentence is uncontroversial. But the second part is confusing. That stability of exchange rates contributes to strong and sustainable growth is seemingly incontrovertible. But it can also be read as implying that ‘stability of exchange rates’ should be a target or objective of policy to promote strong growth and investment.
That would go against G7 language about meeting domestic objectives with domestic instruments. And it would raise large questions about policy. Is the G3 as committed as before to floating rates? Are the Federal Reserve, European Central Bank and Bank of Japan ready to alter monetary policy to help promote currency stability? Could they be prepared to intervene in currency markets to foster stability?
The Treasury and Fed, along with the rest of the G7 and G20, have signed off on the new language. When G7 finance ministers and central bank governors meet at the end of May in Canada, they should explain why there is this new sentence and what it means. If they can’t tell us, they should erase it.
Confusion is exacerbated by the US policy mix. The US has long pressed surplus countries to bolster domestic demand and stop depending on export-led growth. This is part of efforts to foster a better-balanced world economy.
But we are now witnessing a procyclical US fiscal expansion, and the Fed is raising interest rates and winding down its balance sheet. Higher US growth and interest rates may sustain dollar demand and weaken foreign currencies, widening the US current account deficit. The IMF in April raised its US growth projection for 2018 and 2019 by 0.6 and 0.8 percentage points respectively compared with six months earlier, and projected similarly higher US current account shortfalls.
Other countries are poised to argue that higher US trade deficits are made in America. They will blame the US for widening global imbalances. While looking forward to increased exports to the US, they will ignore their own responsibilities for persistent excessive imbalances. Behind the scenes, they will hope that higher US trade deficits will not simply galvanise US protectionist pressure against them.
The Trump administration is rightly focusing on global imbalances, currency issues, and stronger global growth. However, its actions are weakening its ability to pursue this agenda, adding to world economic risks.
Mark Sobel is a former Deputy Assistant Secretary for International Monetary and Financial Policy at the US Treasury and until earlier this year US representative at the International Monetary Fund.