The costs of intervention outweigh the short-term benefits
USUALLY THE pre-eminence of the dollar is a source of pride for whoever occupies the White House. But for weeks President Donald Trump has been grumbling about the consequences of its status and its current strength. He sees other countries’ trade surpluses with America as evidence of a “big currency manipulation game”. He has dropped hints that it is a game that America ought to play, too. If that hurts foreign holders of dollars, so be it.
So far this is mostly a war of words, but it could easily escalate into something worse. If America concludes that its trade partners are using unfair tricks to weaken their currencies, it may claim the right to do the same. There is even speculation that direct intervention to weaken the dollar might be countenanced. A cold-eyed assessment says this would involve lots of trouble for at best a transient benefit. It would also undermine one of America’s key assets—its open capital markets.
Many of the conditions for a currency war are in place. The world economy is sluggish. The IMF this week revised down further its forecasts for GDP growth in 2019. Interest rates in the rich world are low and cannot fall much lower. There are real or imagined constraints on the use of fiscal stimulus. As a result, a cheap currency is one of the few ways left to gin up the economy.
The shock of intervention would probably take the dollar lower—for a while, at least. But interventions have a better chance of working in the longer term if the currency is way out of whack. That is not obviously the case. Currencies roughly reflect economies’ relative strengths. America’s has proved the most reliably resilient. Yields on Treasuries are still the highest in the rich world. Global investors look to America’s capital markets as the place to find the digital firms of the future, rather than to Europe, whose bourses are heavy with banks and carmakers.
Without a surge in GDP growth outside America, it would probably take a hefty intervention to keep the dollar down. Standard Chartered, a bank, puts the required commitment at $200bn-400bn. Printing dollars to sell would complicate monetary policy, but that is a trivial objection. The Federal Reserve is set to cut interest rates in any event (which might itself weaken the dollar a bit). A bigger headache is which currencies to buy. It is hard to put a lot of money to work quickly in non-dollar assets. The most liquid markets are in euros and yen, where the safest bonds have negative yields. Of those, the one large market with positive yields is Italy. If America bought Italy’s bonds, it would help cut its borrowing costs—an odd kind of punishment.
An advantage that America has over China, its strategic rival, is its open capital markets. A one-sided intervention to weaken the dollar would undermine that. Foreign investors would think twice about betting on dollar assets if Washington reserved the right to bet against them when it sees fit. Though Mr Trump is an unlikely history student, it may be wise for America to recall Britain’s dilemma in 1967. It had dawned on Britain that having one of the world’s main currencies was at best a mixed blessing. Allowing the pound to weaken would be a salve to an economy that had trailed the rest of Europe, but it would also hurt the many foreign allies who kept their reserves in sterling. When devaluation came, there were feelings of relief but also of regret. These days sterling is a shadow of its former self.
The best remedy for the dollar’s strength is stronger economic growth outside America. Fiscal stimulus across the euro zone would help, of course. But one policy is in the gift of the White House. An end to the trade wars would lift the fog over the world economy. Sue for trade peace, Mr Trump—and watch the yuan and the euro rally against the dollar.