President Trump has flirted with talking down the dollar. He has repeatedly called China a currency manipulator, and prominent voices like Robert Zoelick have even suggested the US could intervene in the currency market to counteract manipulation. Except that China is currently pushing the dollar down, so it’s no surprise that confusion abounds.
Trump may not have much ability to push the dollar down. Direct intervention in the foreign exchange market is not presently a realistic threat, which means jawboning will ultimately prove fruitless, too.
First consider the most extreme case, U.S. intervention in the yuan-dollar market, because it is informative about the limits of less direct dollar management. The U.S. has not engaged in unilateral exchange rate intervention since the mid-1990s. Clinton Treasury Secretary Robert Rubin’s “strong dollar policy”—limiting currency action to a mantra about the value of a strong dollar in order to avoid even verbally moving markets—reflected frustration with the ineffectiveness of dollar management. By 2013, the U.S. had convinced the entire G-20 to refrain from competitive devaluation, an agreement that subsequently deterred Japan from deliberately driving down the yen.
Today, no matter how the U.S. government frames it, unilateral U.S. intervention would be roundly viewed as unacceptable currency warfare. The U.S. would lose the moral high ground, opening the door for other countries to depreciate their own currencies.
The U.S. does not need to act unilaterally. Since 2014, China has actually helped U.S. competitiveness by actively intervening to strengthen the yuan. Frustratingly for Chinese authorities, its efforts have not succeeded. The currency has depreciated 13 percent in three years, despite China sacrificing external liberalization plans, tightening capital controls, and depleting foreign exchange reserves by 25 percent. China might welcome an offer to coordinate intervention to keep the yuan’s value from falling further.
Even if “welcome” is too strong a word, China’s hesitation about coordinated intervention must be weighed against the looming threat of protectionism. This resembles the U.S. position with Japan at the beginning of Reagan’s second term. The Plaza Accord among the G-5, coordinating intervention to depreciate the dollar, was clearly against Japan’s interest as an export power. But Japan showed the most enthusiasm for the Accord because it hoped to pre-empt protectionist legislation that was advancing in Congress.
China’s cooperation would be essential to achieve any effect. The yuan is not a fully convertible currency; access to onshore markets remains heavily restricted. Three-quarters of yuan trading occurs in offshore markets, but it is unclear what sorts of assets the U.S. could hold in yuan. Naturally, this concern vanishes if the U.S. acts with China’s consent. A handful of other countries already hold Chinese government bonds as foreign exchange reserves.
Echoing the Plaza Accord, other countries would likely support a U.S–China currency pact. Everyone has an interest in staving off a trade war between the world’s two largest economies. The Plaza Accord’s outsized impact on the dollar occurred because intervention represented a dramatic change in U.S. policy, but the other G-5 countries helped by reassuring markets that they were on board, that there would be no pushback.
The biggest hurdle is domestic: Trump cannot do much without the Fed’s cooperation, but Fed participation would disrupt the current path of monetary policy.
The Treasury simply does not have the resources to act without the Fed. It currently has $22 billion available in its Exchange Stabilization Fund to buy foreign currency. Congress could appropriate more, but what magnitude would it need? According to Brad Setser of the Council on Foreign Relations, China is spending roughly $30–40 billion per month. Will Congress grant Trump, say, $200 billion to park in Chinese government bonds with no guarantee that intervention will make a difference? Not likely.
The Fed, on the other hand, can simply print dollars to buy those yuan, and historically it has intervened alongside the Treasury. But in 1990 it refused. Understanding why it refused helps explain why the U.S. largely stopped intervening a few years later.
Printing dollars increases the money supply. This runs at odds with contractionary monetary policy, as in 1989 and today. Fed intervention in foreign exchange markets is “sterilized” by removing an equivalent amount of dollars from the domestic market, but it can still cause problems. To the extent that sterilized intervention works—an open question among economists—it may do so by signaling future monetary policy. Central bankers worry about “signal risk,” that markets will get confused when their actions run at cross-purposes.
So intervention requires the help of either Congress or the Fed, and neither are likely to be enthusiastic. Unilateral intervention would be foolhardy without enough reserves to move the market. The U.S. could propose coordinated intervention with China, but would be unable to commit more than a token amount to the effort. Despite Trump’s penchant for bold actions, intervention is one policy option that will remain off the table.
This conclusion sheds light on less-direct dollar management. Jawboning, like sterilized intervention, only works if markets fear it will be backed up by real action. If intervention and Fed policy changes are off the table, markets will quickly learn to ignore hollow threats. So long as the administration respects Fed independence, the dollar will prove largely unresponsive to its wishes.
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