One word appears to be dominating the news cycle of late: war. With the U.S. government potentially coming to blows with Iran, and the White House entrenched in a trade war with China and others, conflict is on the minds of Americans. But Washington could become embroiled in an entirely different war; there are growing concerns in the market that a currency war is on the horizon. Otherwise known as committing suicide by every nation that participates in this race to the bottom, competitive devaluations could obliterate the global economic order.
Powell and Draghi Get Trumped
After criticizing Federal Reserve Chair Jerome Powell for aggressively normalizing monetary policy for months, President Donald Trump has set his sights on another central banker.
Recently, European Central Bank (ECB) president Mario Draghi spoke at a forum in Portugal. He conceded that the ECB was prepared to slash interest rates into subzero territory and reignite another round of quantitative easing to support the anemic eurozone economy. The remarks sent the euro plunging against the U.S. dollar, causing a seething Trump to take to Twitter. He wrote:
“Mario Draghi just announced more stimulus could come, which immediately dropped the Euro against the Dollar, making it unfairly easier for them to compete against the USA. They have been getting away with this for years, along with China and others.”
Draghi dismissed Trump’s concerns, noting that the ECB’s mandate is price stability, not focusing on the exchange rate.
Under the current international monetary order, governments and central banks are incentivized to debase the nation’s money to be able to sell their goods and services to foreign markets. When a currency is worthless compared to another one, those goods become more attractive – if the currency has appreciated, then importers may search elsewhere to acquire footwear or steel.
Since the financial crisis, the ECB has unleashed a tsunami of stimulus efforts that have achieved very little growth in the eurozone. These measures have weakened the euro against the buck by roughly 20%. Trump may have a point, too. In the last decade, eurozone manufacturing output has averaged 5% and exports have topped 200 billion euros. In the same amount of time, the U.S. dollar has appreciated 20%, though manufacturing output and exports still surged, likely because of what America produces, mainly advanced technology and energy.
President Trump, as seen in his tweet, has long accused China of partaking in this practice. But the data does not back up his allegation that the yuan has depreciated because of the People’s Bank of China (PBOC) interfering in forex markets. In fact, it had been the opposite: The yuan gained in value up until Washington ignited a trade war with the world’s second-largest economy. Since then, the yuan has plummeted against the Federal Reserve Note and is on the cusp of the psychologically important 7 threshold, something top regulators have hinted they plan to prevent.
The Treasury Department recently published a report that did not name any countries as purposely debasing their currencies. However, it did recommend nine trading partners that should face scrutiny over currency practices, including China, Germany, Japan, South Korea, and Singapore – India and Switzerland were removed from the list.
From a pro-trade perspective, if America’s trading partners were purposely suppressing their currencies, then that is a boon for American consumers. In addition to cheap goods, it requires fewer dollars to import these products. While this policy hurts the people who use the currency on a daily basis, it helps middle-class Americans expand their purchasing power.
A Noteworthy Affair
So, what would happen should a full-blown currency war occur? Nothing good. Like a military conflict and a trade war, there aren’t any victors. It can be difficult to determine when central banks fire the first shots, but these bullets are usually pointed at their own heads because a currency war is more like currency suicide. The act of destroying any semblance of value will inevitably harm a nation and its economy in myriad ways, from slashing rates to creating price inflation.
In the United States, politicians of all stripes have mulled over killing the dollar’s resurgence. President Trump has not been clear on whether he supports a strong-dollar policy, but if exports are his endgame, then he may need to advocate for a weak-dollar policy. Senator Elizabeth Warren (D-MA) is also exploring the idea of “managing” the buck to make U.S. goods cheaper and boost sales to foreign markets.
Other countries have been open about concerns over the rising value of their currencies. Switzerland, Japan, Sweden, and Denmark have adopted subzero or near negative rates to both spur growth and stimulate exports, while Brazil is thinking about reducing rates. Should the Federal Reserve move ahead with a rate cut, then it would send the dollar lower. But all of this central planning, micromanaging, and manipulating suggests one thing: The modern international monetary system is in shambles.
Because so many central banks have employed unconventional monetary tools (QE, ZIRPs, and long-term rate pegging) since the Great Recession, it is unclear who is actually trying to destroy their currency and who is just attempting to grow their economy with unwise monetary policies. This is further evidence that central banks need to get out of the business of artificially strengthening or dissipating currencies and setting interest rates.
There are a few things that Trump could do to win a potential currency war:
- Eliminate the 2% inflation standard.
- Support bills that would stop the Fed from thinking price stability is 2% inflation for eternity.
- Agree that non-traditional monetary stimulus measures are meant to manipulate currencies.
- Pledge to not use these tools in any economic situation.
While this is not a perfect libertarian solution (free market currency is the way!), it is a step in the right direction and would clear up uncertainty and confusion in this realm. The best realpolitik action would be to ditch fiat money and reintroduce gold-backed or establish commodity-supported money.
Pot, Meet Kettle
What makes this discussion fascinating is that the United States should never accuse others of manipulating their respective currencies. This is what the Federal Reserve has done for more than a century. The buck has lost much of its value since the central bank was instituted in 1913. The Fed prints money out of thin air, monetizes the debt, and maintains a $4 trillion balance sheet. The Eccles Building typically acts against the interests of a strong-dollar policy. Lambast the PBOC or ECB all you want for their incipience, but these entities are only mirroring the behavior of the Fed.
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