Is the Fed engaging in currency war?
After the Fed formally announced its new bout of quantitative easing, the CFR’s Sebastian Mallaby lost little time in declaring the move a “foreign policy misstep”:
Even before the Fed’s action this week, there was much loud talk of currency war. This now seems sure to intensify, and the United States has lost its moral authority to broker currency peace.
Mallaby concedes that “the Federal Reserve’s mandate does not require it to consider the foreign policy implications of its actions” — but that’s a bug, not a feature, from his point of view. Indeed, he says, QE “threatens to create a glut of liquidity reminiscent of the mid-2000s savings glut” which was diagnosed and criticized by none other than Ben Bernanke.
There are forms of QE that look more like currency manipulation: unsterilised foreign-exchange intervention, for example, such as the Swiss National Bank and Bank of Japan have both done (and even that is a nuanced case, a debate for another day). But that’s not what the Fed is doing. It is simply trying to do to long-term rates what it has already done with short-term rates…
If QE works as advertised, the decline in the exchange rate will eventually narrow the US trade deficit and reduce the US demand for global savings (though that will be offset as lower interest rates boost domestic investment and consumption). But that hardly turns it into a contributor to the supply of global savings, much less on anything like China’s scale.
Now Paul Krugman is weighing in:
The Pain Caucus — my term for those who have opposed every effort to break out of our economic trap — is going wild.
This time, much of the noise is coming from foreign governments, many of which are complaining vociferously that the Fed’s actions have weakened the dollar. All I can say about this line of criticism is that the hypocrisy is so thick you could cut it with a knife.
After all, you have China, which is engaged in currency manipulation on a scale unprecedented in world history — and hurting the rest of the world by doing so — attacking America for trying to put its own house in order. You have Germany, whose economy is kept afloat by a huge trade surplus, criticizing America for running trade deficits — then lashing out at a policy that might, by weakening the dollar, actually do something to reduce those deficits.
And in a very welcome development, an actual member of the FOMC, Kevin Warsh, has an op-ed in today’s WSJ in which he talks about the “nontrivial risks” of embarking on QE and mentions, among them, “an increasing tendency by policy makers to intervene in currency markets, administer unilateral measures, institute ad hoc capital controls, and resort to protectionist policies”.
Warsh says that the FOMC is able to adjust its policies if “these risks threaten to materialize”, which implies that the Fed is keeping at least one eye on the international consequences of its actions.
There’s actually not a lot of substantive disagreement between the two sides here. Both agree that QE is liable to weaken the dollar, just as rate cuts do; such things are an inescapable consequence of monetary policy and always have been. The debate is over the degree to which Fed actions are harming the dollar, and also the degree to which the Fed should care, in the face of 15 million unemployed American workers.
What’s very welcome here is that the debate is taking place at a high level, in public view, in blog posts and op-eds from journalists, think-tankers, and policymakers. People like Mallaby, Ip, Wessel, and Krugman are informed and engaged observers of the Fed’s actions and their national and international consequences, and the open web makes it easy to follow the discussion from one outlet to the next. These people are explaining and debating and informing the evolution of monetary policy, rather than simply observing and reporting — and the result is much more interesting and illuminating than a just-the-facts approach.