And There It Is.. New Political Leadership Tempted to Depreciate the Dollar

March 4, 2021

An extensive article appearing on the front page of the New York Times business section two days ago and entitled To Revive Manufacturing, Weaken the Dollar? cites several economic policy advisors in the Biden administration being in favor of a carefully controlled slide in the dollar. One theme running through their thinking is the assertions that the dollar is currently overvalued and that this condition has been responsible in large part for the declining share of the U.S. economy devoted to manufacturing. A sub-theme not espoused directly in the article but repeated oftentimes elsewhere equates lessening importance (value?) to the services sector than to manufacturing. Skilled manufacturing jobs generally pay more than many service sector jobs such as ones in retail or hospitality. Manufacturing jobs oftentimes spawn whole supportive functions to service manufactured items, but such lines don’t generally run in the reverse direction. Also manufacturers can mine a global market for potential buyers, whereas many service-sector businesses must inevitablyrely on a local audience only.

If no other factors change, a depreciation of the dollar cuts prices on exports, raises the dollar-translation cost of imports, and thereby makes import competing domestic goods more competitive. As the logic goes, currency manipulation offers a comparatively painless and politically expedient means for making a trade deficit smaller or a surplus even larger.

The temptation to promote growth through currency depreciation is hardly a new idea. In the United States, the fact that discussion of such a strategy is being discussed early into a new administration is practically inevitable.

  • Fixed dollar exchange rates were imposed after World War II and abandoned in March 1973. The dollar had been devalued for the second time in 14 months just three weeks after the second Nixon inaugural. The post-WWII arrangement obligating the U.S. government to undertake dollar-gold transactions with other monetary institutions as offset to external imbalances had been strained in the 1960s. Super-charged U.S. growth powered by Great Society programs and funding for the Vietnam War had weakened the balance of payments and was generating accelerating inflation in the latter part of the decade. In mid-August 1971, dollar convertibility into gold was suspended, and a formal devaluation of dollar parities was agreed upon that year. Those moves were a response to changing economic forces but motivated equally by political reality. As then U.S. Treasury Secretary Connolly said to his Group of Ten counterparts, “the dollar is our currency, but it’s your problem.”
  • After the switch to floating dollar exchange rates, the United States planned initially to observe a perfect float with no U.S. intervention (dollar sales or purchases by the Fed or Treasury to influence the dollar’s external value) but that abstinence lasted less than four months. Still early in Nixon’s second term, it was decided that intervention would be justified when market conditions become disorderly and when values depart significantly from perceived fundamental economic realities.
  • In 1977 early in the Carter administration, Treasury Secretary Michael Blumenthal launched a verbal campaign complaining about the size of the U.S. trade deficit, the stinginess of growth-promoting policies by America’s western allies, and welcoming dollar depreciation as a measure to boost U.S. growth and strengthen the trade balance.
  • The result of that gambit was a vicious cycle of mutually reinforcing dollar depreciation and accelerating U.S. domestic inflation. It didn’t help that monetary policy under Carter-appointee Fed Chairman G. William Miller was kept way too accommodative. A dollar rescue plan was launched November 1, 1978 that included an unprecedented full-percentage point hike in the discount rate and aggressive currency market intervention.
  • The incoming Reagan administration in 1981 turned the U.S. government’s approach to currency policy on its head once again. A monetarist framework to Fed policy had been introduced in 1979, using the opposite of quantitative stimulus and allowing interest rates to be set by the market. A sharply upward move in nominal and real interest rates resulted that also strengthened the dollar dramatically. As inflation fell, Reagan and Treasury Department officials interpreted the dollar’s appreciation as a market vote of confidence in the administration’s supply-side and deregulatory policies. And it was hands-off regarding any consideration of intervention in the foreign exchange market.
  • The next about-face in U.S. currency policy occurred at the start of Reagan’s second term when Chief of White House Staff James Baker and Treasury Secretary Donald Regan swapped jobs. The trade-weighted dollar peaked late in February 1985, 93% above its low seven years earlier and even 33% above the level prior to the first of two devaluations early in the 1970s. Baker and his counterparts in the G5 signed the Plaza Accord in September 1985 that telegraphed to the world a plan to foster significant additional dollar depreciation in order to reduce the U.S. current account deficit and the excessive surpluses of other economies.
  • When Democrats led by Bill Clinton recaptured the White House eight years later, the incoming Treasury Secretary, Lloyd Bentsen also paid considerable attention to the U.S. trade deficit but focused his concern on Japan. President Clinton and he both verbalized that an undervalued yen was hurting the U.S. trade balance and manufacturers. The dollar lost ground against a broad range of currencies and by April 1995 found itself all the way down to the trade-weighed low from the summer of 1973.
  • As in the late 1970s and mid-1980s, U.S. officials came to the realization that what started as a good plan of nudging the dollar to a more competitive lower value to aid manufacturing¬† had generated some bad side-effects could not be tolerated. In came Robert Rubin to head the Treasury Department. Rubin restated U.S. currency policy in a way that left little room for interpretation. Stated completely, a strong dollar is in the best interest of the United States because it reduces inflation and¬† nominal and inflation-adjusted interest rates. This policy also will promote inflows of foreign capital and thereby lift growth and preserve the centrality of the dollar in international finance, which bestows priceless intangible benefits for the U.S. economy.
  • Rubin’s view more or less explained U.S. dollar policy for the ensuing 25 years. The dollar would again exceed its 1970 trade-weighted value in early 2002 and days before the election of Donald Trump in 1916 was more than 20% above its 1995 low.
  • Trump had a lot of complaints about perceived currency manipulation by other nations, and he voiced these both as a candidate and after taking office. Rather than a blatant campaign to cheapen the dollar, Trump’s remedial tool of choice involved import tariffs, which he raised significantly and erratically to address both economic grievances and foreign policy ones. At 91.6 currently, the dollar is a little more than 10% weaker now than at the time of the 1916 election and 44% below its 1985 high.

In the broad scope of the flexible dollar rate era, the argument that the dollar is fundamentally overvalued is not terribly compelling. In the late-1960s when dollar rates were still fixed, a dollar could be exchanged for four Deutsche marks, which had a theoretical euro translation value of $0.49. The euro’s current value is roughly 2.5 times more expensive now than then. The dollar is 70% cheaper now against the yen than its pre-1970 level and has depreciated by 79% versus the Swiss franc.

The assertion that U.S. economic growth has been chronically disadvantaged by other countries’¬† manipulative policies to strengthen the dollar also loses some credibility when comparing U.S. economic growth to growth in Europe or Japan. U.S. GDP has expanded on average over the past 25 years by about 1.0 percentage point a year faster than growth in the euro area and about three time faster than Japan’s pace. A methodical use of Forex intervention to weaken the dollar would be borne primarily at the expense of economies that do not match the U.S. performance. The argument of currency manipulation seems most appropriate for currencies that have fixed dollar parities or highly controlled floats.

The last part of the argument that faster U.S. growth can be achieved by weaponizing the dollar seems at best a temporary one. America’s external deficit is caused by the imbalance between U.S. domestic savings, which chronically fall short of domestic spending. The difference is made up by net inflows of foreign capital, which aren’t necessarily a bad thing. As long as international investors maintain a lot of confidence in the dollar, the dollar’s hegemony among reserve currency assets and the priceless benefits that go with that role will go unchallenged.

All this is not to argue that the Biden Administration will take overt and covert actions to guide the dollar downward. Repeated currency policy shifts at times of a change in the governing administration suggest that where there’s smoke regarding a possible new dollar policy, there may indeed be fire. The point here is that efforts to weaken the dollar before haven’t made a permanent change in America’s economic performance and at times produced costs that outweighed the benefits.

It may yet be worth risking a dollar drop. Low inflation this century has been a bigger problem than high inflation was in the 1970s and 1980s. And from a 50-year-long perspective, aberrations of inflation being too low seem to capture what is a normal situation, making the high inflation of the late 20th century more of an exception than the rule.

Copyright 2021, Larry Greenberg. All rights reserved. No secondary distribution without express permission.

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