Several people directed me to a John Cochrane post that has an amusing critique of the US government’s recent attempt to label Germany and Italy as “currency manipulators”. The most obvious objection raised by Cochrane is that neither Germany nor Italy has a national currency to manipulate—both use the euro.
I will end up showing that this US government initiative is every bit as absurd as John claims, but I will first try to explain the logic of the currency manipulation argument, before criticizing it on other grounds.
When I began investigating the issue of currency manipulation, I discovered that the concern isn’t actually about currencies at all. Rather what people object to is better described as saving manipulation. Policies that boost the current account by increasing domestic saving.
A recent book by Fred Bergsten and Joe Gagnon provides the best explanation of why some people worry about “currency manipulation”. Indeed it’s the only plausible interpretation that I’ve run across. In their explanation, it’s obvious that the actual concern is governmental attempts to artificially boost the current account surplus, almost always via policies that boost the national saving rate.
Actual currency manipulation, say by a new populist government in Latin America that devalues its currency, is not a source of concern. Because simple currency devaluation does not boost domestic saving, it does increase the current account. Instead, the gains from devaluation are offset by higher inflation, as predicted by Purchasing Power Parity.
The sort of currency manipulation that worries Bergsten and Gagnon is when countries artificially depreciate their real exchange rate by purchasing lots of foreign assets, or via fiscal austerity. Even countries such as Germany and Italy can do this sort of manipulation without impacting the nominal exchange rate at all. For instance, a Eurozone country can run a tight fiscal policy (currently more true in Germany than Italy.) Fiscal austerity can then depreciate a Eurozone country’s real exchange rate by reducing the domestic price level.
Despite the preceding, I end up in the same place as Cochrane. Let’s start with the question of why the government doesn’t honestly tell us exactly what it is objecting to. Why not label Germany and Italy “saving manipulators”, if that is what we actually object to?
I suspect the reason is political. If our government says, “those devious Germans are manipulating their currencies”, then it sounds bad to most Americans. If we say, “those devious Germans are running balanced budgets”, it doesn’t sound bad at all. Most Americans already believe that Germans are sensible people, and if we tell them that Germany balances their budget then Americans will look even more enviously on the highly disciplined German economic system.
It’s true that academic economists now tend to worry about the “paradox of thrift”, and the associated idea that more saving will depress aggregate demand. But most people still believe that balanced budgets are prudent. While I usually agree with the professors over the man on the street on macro issues, fiscal policy is one area where I go with popular prejudice. I don’t believe that we are hurt by German saving, as any negative effects on aggregate demand are offset by US monetary stimulus. Indeed more saving is often good, as it boosts investment without reducing aggregate demand.
Here’s my general rule of international relations. If you have a quirky theory that most people do not accept, you are free to implement that theory in your own country. But you are not free to force the entire world to adhere to your quirky theory. Thus America should be free to tear up our nuclear agreement with Iran, but it is not free to force all other countries to follow our lead in a policy rejected by most experts in America and in our allies. Similarly, the US government is free to run trillion dollar deficits if it believes that the theories of John Maynard Keynes are applicable to an economy where the Fed targets inflation at 2% (they aren’t), but it’s not free to force other countries to adhere to Keynesian theory. I think most Americans understand this, which is why the Treasury hides a policy directed at saving manipulation under the extremely misleading label of “currency manipulation.”
In fact, the US government policy is far worse than what one might infer from the previous discussion. The Treasury Department’s accusations of currency manipulation are based in part on the level of bilateral trade deficits, a concept almost universally regarded by economists (including Bergsten and Gagnon) as being utterly meaningless. It’s hard to overstate the craziness of implementing US policy that is aimed at harming other countries and that is based on the economic equivalent of astrology. Here’s Cochrane:
I called this post “institutionalized nonsense.” Yes, every president brings to his (or, someday, her) Administration some nutty ideas, some campaign rhetoric that does not correspond to cause-and-effect reality. Sensible cabinet secretaries and career staff must indulge the rhetoric.
But by this document the Treasury is institutionalizing nuttiness — setting up rules and procedures that monitor bilateral goods “deflcits,” and waste our Nation’s vanishing prestige haranguing countries about their “macroeconomic policies” that produce such undefined and ill-measured ephemera. Why listen to us on, say Iran sanctions or Tiananmen square if we are going to indulge in this sort of nuttiness?
Meanwhile, the administration continues to badger the Fed to lower interest rates in order to… well, to manipulate our currency!
PS. I’ll present my paper on saving manipulation at the upcoming WEA meeting in San Francisco.
PPS. Don Boudreaux and Tim Worstall are just as skeptical.
READER COMMENTS
Kevin Erdmann
Jun 9 2019 at 3:47pm
It would be interesting to see you walk through (1) how QE plays out in this way and (2) how it would change if the fed bought foreign securities through QE.
Scott Sumner
Jun 9 2019 at 4:57pm
Kevin, Bergsten and Gagnon say that QE is not currency manipulation if domestic assets are purchased, but is (or at least might well be) if foreign assets are purchased. They base this on some empirical studies that suggest the purchase of foreign assets will boost domestic saving, as foreign assets are not perfect substitutes for domestic assets.
stoneybatter
Jun 10 2019 at 9:37am
In defense of Treasury, this is not a policy that they are choosing to institutionalize. Congress passed the Trade Facilitation and Trade Enforcement Act in 2015 which requires Treasury to use the following three criteria in its obligatory report to Congress:
(I) a significant bilateral trade surplus with
the United States;
(II) a material current account surplus; and
(III) engaged in persistent one-sided intervention in the foreign exchange market.
https://www.congress.gov/114/plaws/publ125/PLAW-114publ125.pdf
Scott Sumner
Jun 10 2019 at 12:39pm
stoneybatter, Yes, I should have made that clearer. Another point I could have made is that Congress gave the President a lot of discretion in enforcing trade policies. Obviously President Trump has chosen to exercise that discretion with greater aggressiveness.
dede
Jun 11 2019 at 2:31am
I started to read the Treasury Report.
Apart from the nonsense on currency manipulations accusations directed at any country having a trade surplus with the US (the basic idea behind the scene is that if these countries can sell more to the US, it is because their currency is cheap, so the currency MUST be manipulated – reason why they do not need economists’ arguments to the contrary), what strikes me is that this seems like mere rhetoric in order to start Central Planning at a global level :
– “Japan should […] create a more sustainable path for long-term growth, and help reduce Japan’s public debt burden”
– “Korea […] should continue to limit currency intervention”
– “Germany should take meaningful policy steps to unleash domestic investment and consumption”
– “Italy […] needs to undertake fundamental structural reforms to raise long-term growth – consistent with reducing high unemployment and public debt”
– “Ireland […]” – That’s an exception : the author of the report might be of Irish decent because he does not give any policy advice for Ireland
– “Singapore […] should undertake reforms that will lower its high saving rate and boost low domestic consumption”
-“Malaysia […]should […] by encouraging high-quality and transparent investment and ensuring sufficient social spending”
-“Vietnam […] should reduce its intervention and allow for movements in the exchange rate that reflect economic fundamentals”
-“India has been removed from the Monitoring List”
-“Switzerland has been removed from the Monitoring List” but still “should also adjust macroeconomic policies”
Thanks Uncle Sam for all your advices but could you leave us alone and deal with your own business?
Travis Allison
Jun 11 2019 at 2:18pm
Is there a typo in the following line?
“Because simple currency devaluation does not boost domestic saving, it does increase the current account. ”
Should it be “…it does *not* increase the current account. ” ?
Travis Allison
Jun 11 2019 at 3:09pm
Scott, how do PPP and real exchange rates interact? You said that the impact of currency devaluation would be offset by PPP. You also said that a country could save more and then have a lower real exchange rates, and presumably that lower real exchange rate is not offset by PPP. Why the difference?
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