Yellen and dollar diplomacy

Treasury has much to fix

The US Treasury takes the lead on US currency policy. A Treasury led by former Federal Reserve Chair Janet Yellen has much to do in shoring up US exchange rate policy.

President Trump’s currency policy has been confusing. His administration talked down the dollar while pushing it up through an imbalanced policy mix and harmful trade actions. It undermined Treasury’s lead role and used unilateral financial sanctions so aggressively that US allies began questioning the dollar’s global role. The administration’s emphasis on bilateral trade accounts and protectionist tariffs failed to recognise that overall current account positions heavily reflect macroeconomic developments. Trump errantly designated China for currency manipulation in a moment of pique.

Past Treasury secretaries took the view that the dollar floats against major currencies, the US is a relatively closed economy, and their focus should be on improving domestic economic performance. In evaluating foreign exchange markets, they kept a close eye on whether trading was orderly and liquid. Perceived misalignments attracted attention more for what markets might be telling officialdom about policy. They examined Federal Reserve trade-weighted indices as a US competitiveness gauge.

At times, currency movements were sufficiently large that US policy-makers couldn’t adopt a hands-off approach. In such cases, they could use tools at their disposal – open mouth operations, rarely used intervention, and even fundamental action.

A Yellen Treasury will probably – rightly – return to these traditional perspectives.

It seemed at times as if the entire Trump administration wished to speak about currency issues. To restore verbal discipline and avoid cacophony, the secretary should be the sole administration spokesperson.

Yellen’s team should stick with longstanding G7/G20 exchange rate commitments – especially the G7 commitment on meeting domestic objectives through domestic instruments, and the G20’s on refraining from competitive devaluations and not targeting exchange rates for competitive purposes. They should immediately dump a contentious G20 currency message formulated in 2018 as a result of the intervention of David Malpass, then Treasury under secretary (now World Bank president). This message suggested that holding exchange rates stable is key for strong growth and investment – rather than that sound policies are key for exchange rate stability.

A continuing challenge is managing relations with Congress, including on currency legislation, while pushing large surplus countries with significant reserve accumulations to end harmful currency practices. This was a hardy perennial of US-China currency diplomacy. In recent years, China has ceased intervention and its current account has been close to balance. The renminbi has lately been appreciating. There is scant basis now to allege Chinese currency manipulation.

Others in Asia – Taiwan, Korea, Thailand and Vietnam – still pose challenges. While individual surpluses and intervention may be modest, the aggregate is considerable. Switzerland and Singapore are difficult cases.

To address these dilemmas, deft engagement with the Hill is needed. The first-rate Treasury international civil service team must maintain its behind-the-scenes pressure on Asian surplus countries to cease intervention, enhance transparency about foreign exchange practices, build domestic demand, tackle saving and investment distortions, and reduce reliance on export-led growth models. Forceful writing of Treasury’s foreign exchange report offers a critical lever to prod countries. Additionally, Treasury can continue to associate currency provisions with trade deals, but keeping them separate and not within the deals themselves.

This administration allowed the Department of Commerce to impose countervailing duties for currency undervaluation and the US Trade Representative to launch Section 301 investigations. No Treasury secretary from James Baker through Jack Lew would have accepted this. ‘Undervaluation’ cannot be precisely measured, let alone bilaterally. Trump’s fiscal expansion helped push up the dollar, as did hostile trade rhetoric, increasing other currencies’ ‘undervaluation’ through no fault of their own. US efforts to dismantle Chinese-based global value chains also caused producers to shift operations elsewhere in Asia, pushing up Asian surpluses.

Trade balances and exchange rates are driven by saving and investment balances, monetary and fiscal policies, and confidence factors, among others. Commerce and USTR have no expertise nor domain on macroeconomic and exchange rate policies. Other countries may retaliate, setting in motion currency discord. While America’s tools for addressing harmful currency practices are hardly ideal, the CVD/301 approach is not the way forward. A Yellen Treasury should reassert full Treasury primacy over exchange rate policy.

The administration aggressively and unilaterally imposed financial sanctions. This increasingly caused other nations – including close European allies – to question the dollar’s global financial role. The dollar’s worldwide reserve and financing roles entail costs for America, but on balance, the US benefits. Washington bears a special responsibility for the smooth functioning of the international monetary system. While no administration should foreswear unilateral use of financial sanctions, a Yellen Treasury should better seek to build multilateral backing for sanctions. The dollar’s global role needs to weigh more heavily in Treasury’s thinking on sanctions policies.

Less relevant, but more eye-catching, should Treasury revert to the ‘strong dollar’ mantra? Laurence Summers, Treasury secretary under President Bill Clinton, made this point.

Summers’ predecessor Robert Rubin ushered in the ‘strong dollar’ policy when it was low. Team Trump abandoned the mantra. Over the years, the ‘strong dollar’ policy often became a distracting media rhetorical cat and mouse game. If the dollar depreciated, the media asked if Treasury stood behind the ‘strong dollar’ to elicit a ‘yes’, and then ask what was to be done. If the dollar appreciated, they would ask seemingly to ascertain if the administration had a pain threshold. The markets danced on the slightest utterance.

Another option would be to simply refuse to comment on the dollar and save jawboning for rare cases when a message needs to be sent.

Managing currency issues is a seemingly esoteric and extraneous duty of a Treasury secretary. If mishandled, it can quickly damage a secretary’s credibility and legacy. A Yellen Treasury needs to right the ship.

Mark Sobel is US Chairman of OMFIF.

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