Note to Trump: currency war is impossible to win
To President Donald Trump, and any other Group of 20 chief thinking about waging a currency war: it’s basically impossible to win. That’s partly because they don’t really happen in practice. If they did, everybody would lose because everyone would play.
The surest way to affect the relative value of an exchange rate is through nudging interest rates up or down. These days, monetary policy among most major economies is so aligned that any one country would be hard-pressed to notch up any kind of victory for very long.
Failing to grasp this risks misunderstanding how interconnected global capital flows and commerce have become — regardless of spats about tariffs and talk of a technological cold war between the US and China.
The term “currency wars” was popularised by former Brazilian finance minister Guido Mantega in 2010. It captured a global anxiety that gathered pace after the financial crisis, when the world’s biggest central banks pumped billions of dollars into their economies through quantitative easing. The concept has been in remission over the past few years, as monetary policy started returning to normal.
Leave it to Trump to revive it. He has railed against what he sees as the dollar’s strength. To his credit, an International Monetary Fund model suggests the dollar is overvalued by 8%-16%. This criticism has been compounded by his complaints that the Federal Reserve isn’t cutting rates — which tends to make the dollar less attractive. To this end, Trump slammed European Central Bank president Mario Draghi for flagging rate cuts, which could weaken the euro against the dollar. Trump then appeared to fantasise about hiring him to replace Fed chair Jerome Powell.
Trump’s condemnation of Powell obscures the fact that most central banks have tilted towards easing because economic circumstances, risks to growth and benign inflation warrant it. Trump will get his cut, economists predict, as soon as next month. But rate reductions are on the menu around the world for much the same reasons; when it comes to monetary policy, differences are largely matters of degree.
That’s not to say weaker exchange rates don’t have their benefits, or aren’t a byproduct of rate cuts. But it’s important to understand that currency management is rarely the sole motivation.
Exchange rates are an “important channel” through which easing stimulates growth, Reserve Bank of Australia governor Philip Lowe said this week. “But if everyone is easing, there is no exchange-rate channel,” he said. “We trade with one another, we don’t trade with Mars.”
As far-fetched as it may seem, Trump’s talk of currency manipulation has serious people considering the prospect that the US could directly and unilaterally sell dollars in the market, a practice mothballed years ago.
Direct interventions only tend to work when allies co-operate to achieve common aims. In 2000, the world’s major central banks bought euros to boost the common currency. A similar team intervened to stem the yen’s surge after Japan’s 2011 tsunami, and its slide during a banking crisis in 1998.
It’s hard to conceive of Europe or Japan going along with a Trump tantrum that serves no goal other than making the dollar cheaper against the euro, yen or British pound. If Trump’s target is China, the rest of the G7 have zero interest in being seen to gang up against Beijing. Solo manoeuvres don’t stand much of a chance of fundamentally altering a currency’s trajectory, or defying monetary policy logic.
Trump would do well to bear all this in mind. There’s no commerce on Mars. — Bloomberg