By Brendan Brown*
The publication of the latest Treasury semi-annual report on foreign exchange manipulation (under title of “Macroeconomic and Foreign Exchange Policies of Major Trading Partners of the United States”) got its usual big reception in the media even though its analysis is so flawed as to be farcical.
Treasury Secretary Mnuchin signed off on the findings which concluded there is no manipulation anywhere. Yes, there is a list of countries including Japan, Germany, and six other countries, where standard test results merit their inclusion in a list for special monitoring, China not included. That country is singled out for a separate ongoing monitoring based on wider concerns, and recommended reforms are wide-ranging (including dismantling of handicaps to foreign investors in China).
By contrast, the general prescription for countries on the regular monitoring list is to take measures, budgetary and structural, to boost domestic demand. The currency manipulators in Berlin, Frankfurt, Tokyo, Zurich, London and yes, Beijing, must secretly be laughing at this ineffectiveness of the US Treasury. The most powerful means of waging currency war — first monetary policy and secondly various forms of financial repression — are largely unmentioned in, and non-threatened by, the report. This is bizarre.
Take the economic policy of Japanese Prime Minister Abe: His central bank chief holds down the yen by administering negative interest rates, notwithstanding a domestic capital spending boom, while strictly pegging long-term interest rates at a few basis points above zero. This is all ostensibly for the greater purpose of driving CPI-inflation up to 2 percent in defiance of a continuing powerful rhythm of prices downward. That weakness of goods and service prices reflects integration with East Asia, digitalization, and metamorphosis in the labor market (de-regulation and waning of the seniority pay system). Simultaneously financial repression diminishes further the attractions of Japanese monetary assets, thereby boosting the strength of capital outflows. The US Treasury Report does not criticize any of this.
Separately, Chief Mnuchin has said that the US-Japan FTA (free trade agreement) must include a chapter outlawing currency manipulation. But there should be no excitement either about its content or more broadly the speed of reaching an overall deal. Tokyo, like Bern, is a master of delaying tactics.
Does no senior official in the Trump administration economics team get the monetary plot?
Well, non-inspired and — some would say — crony influenced officials tend to stick with the guidelines and established protocol. And the Obama administration already put this in place here. Very belatedly Chief Mnuchin has hinted at (in Jerusalem, October 21) a review of all this, dissatisfied with its lack of teeth with respect to China. But there is no basis for expecting the essential issue of monetary weapons to top any re-vamped anti-currency manipulation policy framework.
The Trade Facilitation and Trade Enforcement Act of 2015 calls for the Treasury Secretary to monitor the macroeconomic and currency policies of major trading partners and engage in advanced analysis of these partners if they trigger certain objective criteria that provide insight into possibly unfair currency practices. The Obama Treasury (under Secretary Lew) accordingly established three objective criteria.
- First: is the bilateral trade surplus of the given country with the US above $20 billion?
- Second: is the current account surplus above 3 percent of GDP?
- Third: is foreign exchange intervention persistent and one-sided, cumulating to over 2 percent of GDP over a 12 month period?
In both theory and in practice, these tests are nonsense.
Bilateral trade surpluses with the US may be large — and indeed offset by other bilateral trade deficits — without any currency manipulation being present. Rather international supply changes and comparative advantage could be the chief explanatory variables.
A large current account surplus could be fully consistent with underlying divergences in savings and investment behavior between countries as under a sound money regime; students of history know that France and Britain ran current account surpluses of near 10 percent of GDP in the two decades leading up to World War One under the full gold standard.
And as regards foreign exchange market intervention, this should surely be expressed in stock terms rather than flow. Japan has not intervened significantly for many years in currency markets. But why is that country still holding massive foreign exchange reserves accumulated during previous bouts of intervention to keep currency markets orderly, rather than gradually reducing this to normal levels? (And who did it specifically at times when the yen carry trade was imploding as most recently in the early part of this decade?)
If meaningful tests for currency manipulation were applied — such as to detect monetary weapons and financial repression — actual charges (not just placement on monitoring list) would be justified not just against Japan, but also China and Europe.
China defends persistently aggressive easy-money policies by the pursuit of its 3-percent inflation target (with measured inflation usually somewhat below this). But why should an emerging market economy with fairly rapid productivity growth aim for 3 percent inflation rather than say stable prices? And as regards financial repression, the reality of state control of financial institutions and regulations which depress returns to savers are so well-known as to explain elevated demand for foreign assets (notwithstanding exchange restrictions) and only weak foreign demand for Chinese financial assets.
In Europe we still have the Draghi ECB, with the all-important authorization from the Berlin Chancellery, administering negative interest rates and aggressive monetary base expansion despite the German economy in full long-time boom and inflation there at 2 percent. This is all on the pretext that the outer area of the eurozone requires a long period of relative downward price adjustment and this is easiest to effect if German prices are rising significantly. Alongside, financial repression means that German savings are in effect mobilized via domestic banks toward financing the weak sovereigns — most of all Italy.
Yes, this is what Sig. Draghi had in mind when he boasted about doing whatever it takes to “save the euro.” But should the US just passively accept the consequences of a super cheap euro and a giant German trade surplus? Don’t look to the Treasury report for an answer!
There is no basis for imagining that the Trump administration is preparing for a new more effective policy against the foreign currency manipulators even after the mid-terms. Any gearing up of anti-manipulation policy would mean bringing monetary and international monetary reform on to the policy agenda from where it has long been absent, Moreover, if the US is to censor foreign monetary policies which ostensibly could be justified by membership of the 2 percent inflation standard, then this latter has to come under question and scrutiny rather than enjoy uncritical respect.
At very least the US would have to take aim at the IMF and its exchange rate surveillance teams which justify all exchange rates as in line with “underlying equilibrium” if they are indeed the corollary of respective central banks scrupulously striving to attain their 2-percent inflation target. Bashing the IMF could have obvious appeal to the Trump administration. All will be sound and fury though if domestic and international monetary reform does not take place in earnest.
About the author:
*Brendan Brown is the Head of Economic Research at Mitsubishi UFJ Securities International.
This article was published by the MISES Institute