U.S. Foreign Exchange Policy

April 10, 2017

The Treasury Department is the government agency responsible for establishing and enforcing U.S. currency market policy.  The Secretary of the Treasury, aided by the Under Secretary for International Monetary Affairs, is the chief currency policy spokesman and negotiator. Former Treasury Secretary James Baker, for example, represented the United States when the Group of Five agreed to weaken the dollar in what’s known as the Plaza Accord of September 1985. Another renowned former Treasury Secretary a decade later, Robert Rubin,  first pronounced the mantra that “a strong dollar is in the best interest of the United States” because such  promotes price stability, low long-term interest rates, and international confidence in the U.S. currency as a store of value. Rubin’s view remained official dollar policy not only for the balance of the Clinton administration but also throughout the ensuing Bush and Obama stewardships. As the monitor for currency market conditions, the Treasury Department on a semi-annual basis reviews economic and currency policies of America’s trading  partners in a comprehensive report released every October and April.

A key purpose of this report that goes by the title Foreign Exchange Policies of Major Trading Partners of the United States is to determine if any country meets all three quantitatively measurable criteria for declaration as a currency manipulator: a large global current account surplus, a big bilateral trade deficit, and persistent and heavy one-sided forex intervention that can be observed in changes in the country’s foreign exchange holdings. The last report from October 2016 found no countries meeting each of these conditions, and that finding has repeatedly also been highlighted in earlier semi-annual reviews. Designation as a currency manipulator would give the U.S. president powers to impose trade barriers without securing permission from the Congress.

The Spring 2017 currency review due this month will be the first one since Donald Trump’s election. As a candidate, fair trade was a top priority of his successful campaign. Trump has taken a rather unique approach in defining currency manipulation with a focus on bilateral relationships and an America First objective that promises to punish any nation practicing “unfair trade practices” and running a large surplus against the United States. In identifying and retaliating against U.S. manipulators, the administration and not any international organization will be prosecutor, judge and jury. Hearing what they want to hear and disregarding the rest, Trump and his like-minded advisers reject the economic tautology that a country’s global current account imbalance equals the difference between domestic savings and investment. When investment exceeds savings, and artificial barriers affecting the flow of commerce between a country with a current account deficit like the United States and a particular other country will merely rearrange the composition of the deficit among its trading partners but not change the overall size of America’s global imbalance.

Historically, when nations have undertaken blatantly protectionist trade policies as candidate Trump repeatedly threatened to do, other nations have retaliated in kind. The result is weakening two-way trade flows for everyone. Even if the U.S. in the current instance is affected less severely than other nations, it’s economy is nonetheless hurt on balance just like the others. A famous graph from 1929-33 of U.S. trade month by month that looks like a spider’s web depicts an inward spiral over time. Such illustrates the futile effort during the Great Depression to gain advantage in trade via steep tariffs. The desired overall impetus to economic growth never materialized.

In trade wars, it’s also useful to keep in mind that the currencies of nations with big balance of payments deficits tend to experience depreciating currencies, the implication being that the dollar probably will decline if  President Trump makes good on his trade policy promises. The dollar does not appear especially misaligned at the moment. For one thing, the currency’s trade-weighted value against other major traded currencies in an index compiled and published by the Federal Reserve hasn’t fluctuated dramatically of late. The index at the end of March 2017 printed at 94.01. That compares to monthly averages of 94.49 in March, 93.97 in February, 94.67 in January, and 95.43 in December. From August 2017 to December 2017, the monthly average rose 6.2%, but the current level is still close to its January 2016 monthly mean of 95.06.

The dollar’s trade-weighted value has not always been so steady. From a March 2009 average of 84.01 to an August 2011 mean of 69.06, the U.S. currency dropped nearly 18%, and between March 1985 and April 1988, it plunged 39%. The 6.1% rise of the dollar between last year’s averages in August and December was trivial juxtaposed against a 51.4% advance between means in January 1980 and March 1985. The index numbers of this data series are based in March 1973, when the U.S. abandoned fixed exchange rates. That is to say, the dollar’s value in March 1973 was 100 on average, and it is about 6% softer some 44 years later.

The comparative recent stability of the dollar also correlates with a stable and manageable size of the U.S. current account deficit. Like fiscal deficits, the sustainability of current account deficits is best assessed by looking at its size relative to nominal gross national product. When the U.S. external deficits in 2007 and 2008 equaled 5.0% and 4.7% of GDP, respectively, the situation was not a sustainable one. But after the Great Recession, the imbalance was almost halved to 2.7% of GDP in 2009. In the eight years from 2009 to 2016, the U.S. current account shortfall has averaged 2.65% of GDP, never exceeding 3.0% which was its size in both 2010 and 2011 or falling under 2.2% of GDP, which was its relative size in 2013. The deficit in both 2015 and 2016 was 2.6% of GDP, a tad smaller than the relative size in 2009. If the dollar were overvalued, one would expect to see the relative size of the external imbalance higher eight years deep into an economic upswing than at the start of the recovery, but that hasn’t been the case in the current business cycle.

Copyright 2017, Larry Greenberg. All rights reserved. No secondary distribution without express permission.





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