You can stop worrying that the euro is on the verge of extinction. The new worry in Europe is that it may instead be too strong. But the ability of European leaders to remain calm will determine whether we in the U.S. need to worry as well.
For the second G-20 meeting in a row, French finance minister Pierre Moscovici suggested support for actively resisting euro strength. Euro area colleagues to the north certainly disagree, but cracks in euro policy are showing. This follows months of Japanese flirtation with the idea of deliberately driving the yen down, a policy they now disavow. Of course the Swiss have been intervening heavily since the start of the global financial crisis to resist the impact of financial inflows seeking a safe haven in Alpine banks. Even the U.S. is sometimes accused – if inaccurately – of attempting to use monetary policy to devalue the dollar.
The G-7 consensus on the benefits of market-determined exchange rates appears to have weakened in the face of a major realignment of the yen – regardless of whether yen weakness was deliberate or a byproduct of domestic aims. How many finance ministers in the current economic environment are bold enough not to blink if the 20 percent improvement in Japan’s competitive position persists?
Yen weakness is a superficial excuse, especially because it may not last. The two existing quantitative easing programs in the U.S. and U.K. have not shown any medium-term correlation with currency movements. Neither did smaller monetary expansions in the euro area and Japan. They all failed to generate noticeable increases in bank lending, and hence have not impacted inflation or exchange rates.
Recent yen strength is more likely due to market hopes that a little inflation may return to Japan. But unless the new monetary policy breaks the pattern and ignites bank lending, recent yen weakness may fade as inflation fails to materialize.
The deeper cause of fracturing commitment to floating exchange rates is the China model, which for years has combined deliberate currency weakness with tremendous economic success. Witnessing China getting away with bad exchange rate practices while growing phenomenally appears to have corroded the resolve of G-7 finance ministries that are under pressure to boost their own growth.
The exchange rate is arguably the most important single price in an economy, so a breakdown in the consensus among major free market economies to allow currencies to float arguably deserves more concern than the prospect of any “currency wars” that could ensue.
So many countries now considering the same strategy suggests a Lake Wobegon effect, where all children are above average and all currencies are competitive. This is impossible, of course, as currencies are only valued against each other and cannot all weaken at once.
For this reason currency wars are futile. At this point, fortunately, a true currency war also seems unlikely. The U.S. and U.K. show no inclination to fret about their own currency values.
A bigger concern than a currency war is policymakers’ indulgence in thinking they know better than markets what value their currency should have. These officials would hesitate to interfere with the prices of individual products, so why would they effectively interfere with the prices of all goods, via the exchange rate?
Currency manipulation is a slippery slope to favoring exporters over consumers, building up economic imbalances and a false sense of financial security that often result in bad outcomes. China may yet prove this point as they struggle to rebalance their economy towards greater domestic consumption.
With so many countries thinking about weakening their currencies, the U.S. Treasury strong-dollar mantra that dates back to the 90s appears positively antiquated. Do we ever really mean it when our treasury secretary repeats ad nauseam that a strong dollar is in the U.S. interest?
It certainly never means the Treasury would prop up the dollar. Rather, by force of mind-numbing repetition, the mantra indicates a commitment to totally eschewing currency intervention, even via verbal guidance. Unlike the Japanese, for instance, or most recently the Swedes, the U.S. does not talk down the dollar.
Europeans have never been as wedded to free markets as Americans, but their approach to the euro has been unimpeachable so far. The serious implications if the temptation of currency manipulation takes hold suggest that Jack Lew, our new treasury secretary, will need to vigilantly maintain exchange-rate-policy discipline in the G-7. The “strong dollar” no-intervention policy needs a strong voice to repeat it (over and over and over…).
Russell A. Green, Ph.D., is the Will Clayton Fellow in International Economics at the James A. Baker III Institute for Public Policy. Green spent the past four years in India, where he served as the U.S. Treasury Department’s first financial attaché to that country. His engagement in India primarily focused on financial market development, India’s macroeconomy and illicit finance, but included diverse topics such as cross-border tax evasion and financing global climate change activities.