Sunday, March 18, 2007

A Cry for Intervention

In the article linked above, AEI scholar Desmond Lachman bemoans the lack of government control over the currency market:

Even more troubling than today's growing payment imbalances is the fact that, the IMF notwithstanding, there appear to be no rules as to what countries might do with their exchange rates. Some countries seem free to fix their exchange rates at levels that are patently undervalued, while others seem free to actively manage their floating exchange rates in a manner that maintains for them an unfair international competitive edge. In this currency free for all, currencies are simply not moving in the direction that might offer hope that today's global payment imbalances might be attenuated anytime soon.

I think what Mr. Lachman is upset about actually is that currencies don't seem to want to move in a direction that he deems proper. How exactly he would change things is somewhat of a mystery however. In one paragraph, he blasts China for manipulating its currency:

China's central bank continues to intervene heavily in the foreign exchange market to prevent the Chinese currency from appreciating. It does so despite the fact that China's current account surplus has now widened to around 9 percent of its GDP and its international reserves have now surpassed the $1 trillion mark.

In the next he is upset with Japan for not intervening:

Yet despite the Bank of Japan's hands-off foreign exchange policy, the Japanese yen has depreciated by almost 20 percent over the past two years as the Bank of Japan hews to its low interest rate strategy. This has taken the yen to its most depreciated level in almost twenty years at a time when Japan's external current account surplus has remained in the vicinity of $150 billion.

No things are not going the way Mr. Lachman thinks they should:

In an ideal world, the United States dollar would depreciate most against the countries of those countries like China and Japan, which have the world's largest current surpluses. This would allow the U.S. to reduce its payments imbalance without putting undue pressure on economic regions like the European Union, which has an appropriate balance of payments position and which is not part of the U.S. balance of payments problem.

Incredibly, he misses the IMF on the world economic stage:

It is against this background that one has to regret the conspicuous silence on these matters by the International Monetary Fund.

Because you know the IMF has been so instrumental in guiding the world economy over the years.

The thrust of the article is that all these other countries need to do something with their currencies to correct the "global payment imbalances". But even Mr. Lachman acknowledges that this wouldn't fix the problem:

The correction of today's global payment imbalance problem will require a marked reduction in the United States external deficit. It is widely recognized, however, that currency movements alone will not correct the large U.S. balance of payments deficit even were those currency movements to be in the right direction. Rather the correction of the large U.S. payment imbalance would also require a major increase in U.S. household and government savings from their presently very low levels. This would be needed to make the room for the increased production of traded goods required to reduce the external deficit.

So the problem is one of our own creation but people like Mr. Lachman want other countries to provide the solution. If a paucity of US savings is the problem, maybe we should explore why that is the case and how to fix it rather than ask other countries to fix it for us. Maybe Mr. Lachman could also explain why it would be better if capital spending is accomplished with US savings rather than foreign savings. If the investments are made, what difference does it make where the savings originate? Finally, if we are in such a bad trade position, maybe Mr. Lachman could also explain why our exports are rising so rapidly:

I agree with Mr. Lachman that the US has some serious long term economic problems. We cannot continue to import the rest of the worlds savings indefinitely. We cannot continue to run large current account deficits indefinitely. If we continue down this path the likely result is a collapse of the dollar and all the problems that would entail. However, it seems to me that these problems are ones of US policy and can be corrected internally. Other countries policies may exacerbate the situation, but until we face the facts and start correcting our internal problems, what incentive do they have to change? Who are we to tell the Chinese to revalue their currency when the source of the problem is more likely our own inflationary monetary policy? Why would it be good for American consumers if foreign goods are more expensive?

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