U.S. Foreign Exchange Policy—The Trump Administration and the Dollar
November 18, 2019
The Trump administration has pursued a unilateralist and bilateralist vision for foreign exchange policy, vastly different from the multilateralist approach of its predecessors over the prior 25 years.
Treasury secretaries in the Clinton, Bush, and Obama administrations avoided commenting on currency markets, and when forced to do so simply backed a “strong dollar.” This gave administrations the moral high ground to criticize others, especially Japan, when they sought to weaken their currencies. That high ground is gone.
The United States led the G7 and G20 in 2013 in developing new currency commitments—orienting macroeconomic policies toward achieving domestic objectives using domestic instruments; not targeting exchange rates for competitive purposes; and refraining from competitive devaluation.
Now, the president and some advisers tweet to promote dollar weakness, alleging that foreign monetary policy accommodation, for example by the European Central Bank (ECB), is tantamount to currency manipulation. Monetary policy transmission works through a number of channels—lending, asset prices, yield compression, and confidence, for example. Exchange rates are also a key monetary policy transmission channel. But the administration disregards that euro-area growth is anemic and inflation persistently well below target, giving the ECB strong internal reasons to pursue accommodation.
U.S. growth performance has been superior to that in Europe and Japan, and thus U.S. rates are higher. The administration’s trade wars and tariff threats reinforce a risk-off market environment, further supporting dollar appreciation. Massive U.S. fiscal deficits also push the U.S. current account deficit higher, while boosting the need for capital inflow. If the president wishes to see a weakening in the dollar, the best way to achieve that is not to tamper with U.S. outperformance but to work with others to boost their performance, while ending trade wars.
In August, as the renminbi (RMB) fell below 7.0 per dollar after an intensification of U.S.-China trade tensions, the president ordered Treasury to designate China for “currency manipulation.” The designation was unwarranted. The RMB is managed, not “manipulated.” China could prevent the RMB from falling by drawing down reserves. But the currency fell in large part because market participants viewed depreciation as offsetting the competitiveness hit from higher tariffs.
The designation contradicted the Treasury’s own criteria for assessing whether “manipulation” and harmful currency practices were being pursued. China’s current account surplus in 2018 was around 0.5 percent of GDP, a relatively small surplus; on a net basis, China sold a small amount of dollars in market intervention. To be sure, China has a large bilateral surplus with the United States, but economists dismiss the relevance of bilateral balances.
A country “manipulating” its currency to gain an unfair competitive advantage in international trade would be expected to purchase dollars to hold its currency down and run large current account surpluses as a share of GDP. China does not fit that bill.
More generally, Treasury is undermining the integrity of its Foreign Exchange Report. It recently cut its current account “monitoring” threshold from 3 to 2 percent of GDP in order to pick up more countries, but this level is too low given economic structures. At one point, it placed India on its monitoring list, even though India ran a current account deficit. Italy and Ireland, too, were placed on the list. Prior to the manipulation designation, China was on the monitoring list, even though it only tripped one (the bilateral balance) trigger, whereas placement on the list requires triggering two criteria. On the plus side, Treasury has acted to expand the report’s country coverage, encompassing a number of smaller Southeast Asian surplus nations.
According to media reports, the administration has debated intervening in currency markets to push the dollar down. For example, the United States could buy euros or RMB, pushing up their values and thus the dollar down.
In the rare instances when the United States intervened in the past two decades, it did so on a concerted basis with G7 partners. There is little reason to believe any current U.S. operation would be concerted. A solo U.S. euro operation would not likely succeed—unless the Fed stood ready to print unlimited dollars to intervene, U.S. resources are highly constrained; the euro/dollar market is vast; the ECB could buy as many dollars as the United States could sell.
Such considerations would pertain to intervention in the Chinese currency. The Chinese authorities can exert a strong influence over banks operating in the on and offshore markets. Even if such an operation occurred, the United States would confront difficult operational issues about investing the currency proceeds.
The administration put forward a Commerce Department rule proposal to treat currency undervaluation as a countervailable subsidy, an idea the Bush administration rejected.
The proposal is problematic. Currency values are determined by balance of payments flows, not just trade accounts, and in turn by monetary and fiscal policies. There is no precise way to assess currency undervaluation. Even if one could, that would not address whether undervaluation was attributable to that country’s policies, or perhaps the flip side of policies in the overvalued currency country. The undervaluation of a country’s multilateral exchange rate also does not tell one the amount of bilateral undervaluation versus the dollar. For example, the subsidy would differ if the optimal bilateral balance deficit between the United States and China were $400 billion or zero.
The administration is aggressively pursuing trade provisions in currency deals, and this trend started under the Obama administration. The Trump administration amped up, pushing welcome side understandings on intervention alongside the revised United States-Korea Free Trade Agreement (KORUS) deal. The United states-Mexico-Canada Agreement (USMCA) provisions, though, allow certain exchange rate transparency and reporting issues, unrelated to monetary policy, to be included in dispute resolution. While the practical import of the USMCA currency provisions is minor, their inclusion in dispute resolution sets a precedent that could errantly allow trade authorities to stray into macroeconomic policy settings.
Some in the administration have also discussed taxing foreign inflows, consistent with a draft Senate bill of Senators Hawley and Baldwin. Such policies would stand in strong opposition to the longstanding openness of U.S. capital markets.
The administration’s robust unilateral use of financial sanctions could also corrode the dollar’s future global use. Past administrations sought to build multilateral coalitions for deploying financial sanctions. In doing so, officials balanced considerations on using sanctions with the implications for the dollar’s financial and reserve currency roles.
The Trump administration has used financial sanctions far more aggressively and unilaterally. While there is no realistic alternative to the dollar for the foreseeable future, our traditional allies have been put off by the administration’s unilateralism, as best reflected in Europe’s effort to create the Instrument in Support of Trade Exchanges or INSTEX, a plan to circumvent the dollar’s use to allow Europe to trade with Iran.
The Trump administration’s views on the dollar, foreign exchange policy, and external developments are a major departure from the practices followed by the United States over the past 25 years. These policies and practices are alienating allies and eroding the multilateral fabric underpinning the international monetary system.
Mark Sobel is U.S. Chairman of OMFIF and a senior adviser (non-resident) with the Simon Chair in Political Economy at the Center for Strategic and International Studies in Washington, D.C. He was deputy assistant secretary for international monetary and financial policy at the U.S. Treasury from 2000 to 2014 and subsequently U.S. representative at the IMF through early 2018.
Commentary is produced by the Center for Strategic and International Studies (CSIS), a private, tax-exempt institution focusing on international public policy issues. Its research is nonpartisan and nonproprietary. CSIS does not take specific policy positions. Accordingly, all views, positions, and conclusions expressed in this publication should be understood to be solely those of the author(s).
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