Is the Fed engaging in currency war?

By Felix Salmon
November 8, 2010
Sebastian Mallaby lost little time in declaring the move a "foreign policy misstep":

" data-share-img="" data-share="twitter,facebook,linkedin,reddit,google" data-share-count="true">

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.

It didn’t take long for veteran Fed watcher Greg Ip to push back, cheered from the sidelines by the WSJ’s David Wessel:

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.


We welcome comments that advance the story through relevant opinion, anecdotes, links and data. If you see a comment that you believe is irrelevant or inappropriate, you can flag it to our editors by using the report abuse links. Views expressed in the comments do not represent those of Reuters. For more information on our comment policy, see

Someone needs to explain to Sarah Paling that taking a class in high school in home economic doesn’t really prepare one for discussing macroeconomics. Geithner’s plan is brilliant!!! Either way the US wins.
After failing to get accommodations from the Chinese, Geithner is putting the Chinese in a no win situation. He is forcing the hand of every country to compromise or else. After failing to make any real progress, Geithner has adopted a more Israeli style of hardline negotiating! Geithner has masterfully created a situation where he will win on the currency conversion front or inflation or both; regardless of how well or how poorly Geithner does at persuading the G-20 to support his plan.
Currency conversion is not complicated. A strong dollar raises the value of Chinese US holdings, while a weaker dollar decreases the value of those same holdings. The fear of the Chinese walking away from the dollar completely is crazy… they own too many. Overtime the Chinese will decrease their holdings, but this was inevitable with or without Q2. Chinese revenue from sales in the US is on the decline and that decline is not going to be reversed anytime soon. Lower sales in the US means the Chinese simply have few dollars to buy US debt.
LET ME REPEAT… fighting the Federal Reserve and the currency traders would require massive purchases of the same dollars that they fear will go down in value!
Don’t feel sorry for China… China was and still is Fannie Mae’s largest bondholders, so China effectively got almost a half-trillion dollar bailout when the Fed stepped in and rescued Fannie Mae bondholders! China has exploited US policy thru fear and intimidation for far too long!
If the Foreign Central Banks try to fight the US Fed it will require them to buy mountains of dollars. It is not hard to imagine how pissed-off the Russians and Venezuela are about this prospect given their very vocal campaign to reduce their dollar holdings.
It is true that Japan, other Asian economy and developing countries will need to take some protective measures to limit capital inflows, but that seems to be a small price to pay to keep the US from falling into a Japan deflation or worse.
The doomsday scenario that Geithner fears is one where the US employment stumbles further and where the developing nation’s recovery pushes commodity prices to extreme levels. It would be terribly destabilizing!
Screw Germany. The German unemployment rate is half the US because of very shrewd maneuvering and favorable trade agreements. Russia hates anything that helps the US!
Hats off to Geithner!!!

Posted by Radioceleb99 | Report as abusive

Surely the structural causes of Germany’s trade surplus are largely out of German govt hands – or at least in the short-term – ie the old and aging population? I think the ECB can be criticised for many things, but as a currency manipulator not at all.

Posted by mjturner | Report as abusive


Some time back the Chinese currency was fixed at a constant price rate, now it is pegged against a basket of currencies and from what i have heard, one percentage of it is still fixed, from that prespective i don’t see harm in what the fed does.

Arvind Pereira

Posted by pereiraarvindin | Report as abusive