Category Archives: euro

Mnuchin and Manipulation of Money

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US Treasury Secretary Steven Mnuchin already finds himself hemmed in on all sides.

Domestic constraints come from the promises that he and President Trump have made and the laws of arithmetic.    How, for example, is he ever going to be able to reconcile the specific tax proposals that candidate Trump campaigned on with the promise of the “Mnuchin rule” that taxes won’t be cut for the rich?  That is even harder than the traditional conundrum that faces Republican Treasury Secretaries: having to explain how massive tax cuts (to which they are truly committed) can be reconciled with a reduction in the budget deficit (to which they claim to be committed).

Many of his predecessors found that they had more latitude in the international part of their job than the domestic part.  Their voice would often receive more respectful hearings from their foreign counterparts on the international stage, at multilateral meetings like the recent G-20 gathering in Baden-Baden, than from domestic political players in Washington.

But Mnuchin will have a harder time in the international context.  To begin with, the current Administration has indicated in many ways that it no longer wants the job of leader of the global system.  The leader is the one who persuades other countries that certain agreed-upon rules, such as an open trading system, are in everybody’s interest.  The Trump administration has no interest in playing that role.  Its view is that the appropriate thing to do in international negotiations is to make unilateral demands.

It is fortunate that Mnuchin realized that the scheduled opportunity to name China a currency manipulator comes in April, when the biannual Treasury report to Congress is due, rather than, the day that Trump assumed the presidency as promised.  But he should pass on the opportunity.  He needs to explain to his boss that China is no longer manipulating its currency, preferably in time for Trump’s meeting with Chinese President Xi Jin Ping, scheduled for April 6-7, at Mar-a-Lago.   President Trump has explicitly re-asserted his earlier campaign allegations of manipulation by the Chinese.

“Deal-makers” don’t do well with ill-informed bluster that they are subsequently forced to back down on.  This principle was illustrated when Trump challenged the “One-China” policy in December but was then unsurprisingly forced to reverse himself, in a February 9 phone call with President Xi.  Unpredictability is not always an advantage, as he seems to think.  Chinese know the difference between a bargaining chip and loss of face.  Trump is now that much weaker in dealing with China.  A leader who has a very good brain should learn the lesson.

Is China manipulating its currency?  The language regarding “manipulating exchange rates” originated in a 1977 decision by IMF members. Of the various criteria to determine whether a country is guilty of intentional manipulation to gain competitive advantage and frustrate balance of payments, the sine qua non is the systematic purchase of foreign exchange reserves to push down the value of the national currency (“protracted large-scale intervention in one direction in the exchange market”).  The other two criteria are the partner’s current account balance and the value of its currency (e.g., judged by international price competitiveness relative to an appropriate benchmark).

Those are the three criteria in international law.   The US Treasury’s biannual reports to Congress on foreign exchange policies of major trading partners were originally mandated in a 1988 law, later “intensified” in a 2015 law.  The Treasury is directed to include the country’s bilateral trade balance vis-a-vis the US as one of the three criteria, even though bilateral balances per se play no role in either the IMF rules or economic logic.  (That the US runs bilateral trade deficits with many countries has far more to do with factors other than their currency policies.  For one thing, the US runs a trade deficit overall because it has a low rate national saving.  This is bound to worsen under Trump fiscal policies.)  A statistical analysis of Treasury decisions regarding whether to name countries as possible manipulators in particular reports shows a significant role for the US unemployment rate in election years, along with the bilateral balances.

It is true that the RMB was undervalued in 2004 (by roughly an estimated 30%), according to a wide variety of criteria.  But as of today China no longer qualifies as a currency manipulator under any of the three internationally accepted criteria:  exchange rate level, trade balance, and use of foreign exchange reserves.  The RMB appreciated 37% between 2004 and 2014 (on a real broad trade-weighted basis).  Its trade surplus, after peaking at 9% of GDP in 2007, then adjusted to the receding price competitiveness: the surplus has been less than half that level each year since 2010.

Furthermore in 2014 – as the Chinese economy slowed relative to the US economy — China’s capital inflows turned to capital outflow.  As a result the overall balance of payments went into deficit.  Foreign exchange reserves peaked in July of that year and have been falling since then.  The People’s Bank of China, far from pushing the renminbi down, has spent a trillion dollars of reserves over the last three years trying to support the currency in the foreign exchange market, by far the largest such intervention in history.  The authorities have also tightened controls on capital outflows, again with the objective of resisting depreciation. They have succeeded, in the sense that despite some adverse fundamentals the RMB has continued to be one of the world’s more appreciated currencies, second only to the dollar and a few others that are even stronger.

These points are not new.  True, it took a while for most American commentators to notice the sea change in China’s foreign exchange market.  By now it has been three years and most observers have figured it out.  But not the US president.

Some other Asian countries meet one or the other of the manipulation criteria.   Korea’s trade surplus has been running at around 7% of GDP and its current account even higher; but it is not piling up foreign exchange reserves the way it was several years ago.  Similarly with Thailand.  It is not clear if there is an Asian country that meets all the criteria.

Peter Navarro, director of Trump’s new National Trade Council points the finger at Germany, saying it “continues to exploit other countries in the EU as well as the U.S. with an ‘implicit Deutsche Mark’ that is grossly undervalued”.   It is true that Germany’s trade surplus is a big 8% of GDP and the current account surplus close to 9%, which is indeed excessive.   But Germany has not had its own currency since the mark gave way to the euro in 1999. The European Central Bank has not operated in the foreign exchange market in many years; and when it did, the intervention was to support the euro, not push it down.

Given the absence of direct foreign exchange intervention among G-7 countries, those who allege currency manipulation suggest that some governments are doing other things to keep their currencies undervalued, particularly expanding the money supply.  Of course central banks do engage in monetary stimulus knowing full well that one effect is likely to be a depreciation of its currency and a stimulus to its exports.  But one has to keep pointing out that:

  • Countries have the right to use monetary policy to respond to domestic economic conditions.
  • In normal cases, it would require a mind-reader to know whether currency depreciation was a major motivation for the action,
  • A successful monetary stimulus will also raise income through domestic channels and thereby raise imports, so that the net effect on the trade balance could go either way, and
  • If other countries don’t like the exchange rate and trade balance results, they are free to undertake monetary expansion of their own.

In 2010-11, these were the arguments that were given (correctly) in defense of the Fed’s quantitative easing and the dollar’s depreciation, when Brazilian leaders accused the US of waging “currency wars.”  They are just as valid when other countries are the ones needing monetary stimulus.

The Trump administration’s accusation against Germany is a uniquely foolish instance of manipulation allegations.  It is true that the European Central Bank responded to the 2008-09 global recession (belatedly) by lowering interest rates and undertaking quantitative easing, and that this contributed to a depreciation of the euro.  But it has been plain for all to see that Germany has consistently opposed the ECB’s monetary stimulus.  One does not have to read the minds of the German officials to see that a charge of manipulation would be nonsense.

Other forces have been working to weaken foreign currencies against the dollar.  Perhaps the biggest in the last five months has been Donald Trump  himself.  His talk of raising tariffs against Mexico, China, and other trading partners has worked to depreciate those currencies against the dollar.  The proposal for a Border Adjustment Tax has the same effect.  Finally, Trump has promised big tax cuts and they are likely to pass Congress — though he unintentionally delayed his tax plans substantially, by putting Obamacare repeal first.   The result (not promised) will be a rapid acceleration in the national debt, which will probably force up interest rates, the dollar, and the trade deficit.

The multilateral calendar includes a G-7 leaders meeting in Sicily in May and a G-20 summit in Hamburg in July.  Mnuchin’s unenviable task is to acquaint Trump with reality by then.

[A shorter version appeared at Project Syndicate, March 22, 2017.  Comments can be posted there.]

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Only Tsipras Can “Go to China”

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Alexis Tsipras, the Greek prime minister, has the chance to play a role for his country analogous to the roles played by Korean President Kim Dae Jung in 1997 and Brazilian President Luiz Inácio Lula da Silva in 2002.  Both of those presidential candidates had been long-time men of the left, with strong ties to labor, and were believed to place little priority on fiscal responsibility or free markets.  Both were elected at a time of economic crisis in their respective countries. Both confronted financial and international constraints in office that had not been especially salient in their minds when they were opposition politicians.  Both were able soon to make the mental and political adjustment to the realities faced by debtor economies.  This flexibility helped both to lead their countries more effectively.

The two new presidents launched needed reforms.  Some of these were “conservative” reforms (or “neo-liberal”) that might not have been possible under more mainstream or conservative politicians.

But Kim and Lula were also able to implement other reforms consistent with their lifetime commitment to reducing income inequality.  South Korea under Kim began to rein in the chaebols, the country’s huge family-owned conglomerates. Brazil under Lula expanded Bolsa Familia, a system of direct cash payments to households that is credited with lifting millions out of poverty.

Mr. Tsipras and his Syriza party, by contrast, spent their first six months in office still mentally blinkered against financial and international realities.  A career as a political party apparatchik is probably not the best training for being able to see things from the perspective of other points on the political spectrum, other segments of the economy, or other countries.  This is true of a career in any political party in any country but especially one on the far left or far right.

The Greek Prime Minister seemed to think that calling the July 5 referendum on whether to accept terms that had been demanded previously by Germany and the other creditor countries would strengthen his bargaining position.  If he were reading from a normal script, he would logically have been asking the Greek people to vote “yes” on the referendum.   But he was asking them to vote “no”, of course, which they did in surprisingly large numbers.   As a result – and contrary to his apparent expectations — the only people’s whose bargaining position was strengthened by this referendum were those Germans who felt the time had come to let Greece drop out of the euro.

The Greek leadership discovered that its euro partners, predictably, are not prepared to offer easier terms than they had been in June, and in fact are asking for more extensive concessions as the price of a third bailout.  Only then, a week after the referendum, did Mr. Tsipras finally begin to face up to reality.

The only possible silver lining to this sorry history is that some of his supporters at home may – paradoxically – now be willing to swallow the bitter medicine that they had opposed in the referendum.  One should not underestimate the opposition that reforms will continue to face among Greeks, in light of the economic hardship already suffered.  But like Kim dae Jung and Lula, he may be able to bring political support of some on the left who figure, “If my leader now says these unpalatable measures are necessary, then it must be true”.  As they say, Only Nixon can go to China.

None of this is to say that the financial and international realities are necessarily always reasonable.  Sometimes global financial markets indulge in unreasonable booms in their eagerness to lend, followed by abrupt reversals.  That describes the large capital inflows into Greece and other European periphery countries in the first ten years after the euro’s 1999 birth.  It also describes the sudden stop in lending to Korea and other emerging market countries in the late 1990s.

Foreign creditor governments can be unreasonable as well.   The misperceptions and errors on the part of leaders in Germany and other creditor countries have been as bad as the misperceptions and errors on the part of the less-experienced Greek leaders.   For example the belief that fiscal austerity raises income rather than lowering it, even in the short run, was a mistaken perception.  The refusal to write down the debt especially in 2010, when most of it was still in the hands of private creditors, was a mistaken policy.  These mistakes explain why the Greek debt/GDP ratio is so much higher today than in 2010 — much higher than was forecast.

A stubborn clinging to wrong propositions on each side has reinforced the stubbornness on the other side.  The Germans would have done better to understand and admit explicitly that fiscal austerity is contractionary in the short run.  The Greeks would have done better to understand and admit explicitly that the preeminence of democracy does not mean that one country’s people can democratically vote for other countries to give them money.

In terms of game theory, the fact that the Greeks and Germans have different economic interests is not enough to explain the very poor outcome of negotiations to date.  The difference in perceptions has been central.  “Getting to yes” in a bargaining situation requires not just that the negotiators have a clear idea of their own top priorities, but also a good idea of what is the top priority of the other side.   We may now be facing a “bad bargain” in which each side is called upon to give up its top priorities.  On one side, Greece shouldn’t expect the ECB and the IMF to be willing explicitly to write down the debt they hold.  On the other side, the creditors shouldn’t expect Greece to run a substantial primary budget surplus.  A “good bargain” would have the creditors stretch out lending terms even further so that Greece doesn’t have to pay over the next few  years and would have the Greeks committing to structural reforms that would raise growth.

One hopes that the awful experience of the recent past has led both sides to clearer perceptions of economic realities and of  top priorities.   Such evolution is necessary if the two sides are to arrive at a good bargain rather than either a bad bargain or a failure of cooperation altogether. The non-cooperative equilibrium is that Greek banks fail and Greece effectively drops out of the euro. This may be even worse than a bad bargain, although I am not sure.

Admittedly, both Kim and Lula had their flaws.  Moreover, Korea and Brazil had some advantages that Greece lacks, beyond Syriza’s delay in adapting to realities.  They had their own currencies. They were able to boost exports in the years following their currency crises.

But a recurrent theme of the Greek crisis ever since it erupted in late 2009 is that both the Greeks and the Euro creditor countries have been reluctant to realize that lessons from previous emerging market crises might apply to their situation.  After all, they said, Greece was not a developing country but rather a member of the euro.   (This is the reason, for example, why Frankfurt and Brussels at first did not want Greece to go to the IMF and did not want to write down the Greek debt.)  But the emerging market crises do have useful lessons for Europe.  If Tsipras were able to shift gears in the way that Kim dae Jung did in Korea and Lula did in Brazil, he would better serve his country.

[An earlier version appeared in Project Syndicatecomments are welcome there.]

 

 

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Does the Dollar Need Another Plaza?

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We are at the 30th anniversary of the 1985 Plaza Accord.  It was the most dramatic intervention in the foreign exchange market since Nixon originally floated the US currency.   At the end of February 1985 the dollar reached dizzying heights, which remain a record to this day.  Then it began a long depreciation, encouraged by a shift in policy under the new Treasury Secretary, James Baker, and pushed down by G-5 foreign exchange intervention.  People remember only the September 1985 meeting at the Plaza Hotel in New York City that ratified the policy shift; so celebrations of the 30th anniversary will wait until this coming fall.

The dollar has appreciated sharply over the last year, surpassing its ten-year high.   Some are suggesting it may be time for a new Plaza, to bring the dollar down.   In its on-line “Room for Debate,” the New York Times asked, Will a strong dollar hurt the economy and should the Fed take action?”   Here is my response:

Any movement in the exchange rate has pros and cons.  When the dollar appreciates as much as it has over the last year, the obvious disadvantage is that the loss in competitiveness by US producers hits exports and the trade balance.   But if the dollar had fallen by a similar amount, there would be lamentations over the debasing of the currency!

Overall, the strong dollar is good news.  This is because of the macroeconomic fundamentals behind it.  Indeed textbook theories explain this episode unusually well.  The US economy has performed relatively strongly over the last year — compared to preceding history and to other countries).  This is why the Fed is getting ready to raise interest rates — again, in contrast to the preceding six-year period of monetary easing and also compared to other countries.  (“Divergence.”)   American economic performance and the change in monetary policy are both excellent reasons for the strong dollar.   These developments should be welcomed, taken as a whole, notwithstanding the effect on exports.

Nevertheless, the soaring dollar – especially if it goes much higher – would be a reason for the Fed to hold off past June on its long-anticipated decision to raise short-term interest rates, so as to avoid a growth slowdown or even a descent into deflation.  I believe the Fed would indeed respond in that appropriate way.   In that sense, although the dollar strength is bad for exporters, it will not be bad for output and employment in the economy as a while.

Might a more aggressive intervention to bring down the dollar be justified, in which central banks would get together to sell dollars in exchange for euros and yen?   The last major effort of that sort was the Plaza 30 years ago.  (They also did it in a more minor way, to help the undervalued euro, in 2000.)

But 2015 is not 1985.   Neither the US authorities nor those in other G-7 countries will intervene in the foreign exchange market.  (They agreed not to, two years ago.)  Nor should they, in the current context.   In the first place, the appreciation is not yet anywhere near as big as it was 30 years ago (or even 15 years ago).  In the second place, today’s dollar appreciation is fully justified by economic fundamentals, unlike in 1985.

[The response to the NYT’s question from me and the others can be viewed at Room for Debate: “The Fed and the Dollar.”]

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