Global: The Pitfalls of Rhetorical Currency Policies
by Stephen Roach (from Beijing)
Oct 31, 2003
I was eagerly awaiting a return visit to Japan’s Ministry of Finance. It was a timely opportunity to peer inside the power structure of Japanese foreign exchange policy. Quickly it became apparent to me that these plans were in disarray. It was October 29 and the yen had just strengthened through the ¥108 threshold versus the dollar. You would have though the sky had fallen. The MOF’s brain trust had scrambled into full-scale FX alert. It gave me considerable pause as I returned to a full schedule of meetings in Tokyo on this two-week tour in Asia.
In Japan, currency fluctuations have a special aura in defining the national psyche. There are digital real-time yen clocks everywhere you go in Tokyo -- even in the hallowed halls of the MOF. The value of the yen is critical in shaping the tone of how official Japan feels about the state of its economy and financial markets. The yen also drives the mind-set of Corporate Japan, and it shapes the all-important debate over reforms. I would go so far as to maintain, that in Japan, there is a clear trade-off between the yen and reforms -- the weaker the currency, the less pressure the nation feels to embark in the heavy lifting such efforts require. Conversely, the stronger the currency, the greater the sense of urgency. I remember full well the discernible sense of panic in the air during my travels to Japan in the spring of 1995, when the yen was surging toward the ¥80 threshold versus the dollar. In retrospect, the urgency for reform was at its peak at that very point in time. The 45% depreciation of the yen that followed over the ensuing three and a half years had the counterproductive result of alleviating the near-term pain but diminishing the immediate urgency for reform. Unfortunately, the record speaks for itself -- the Japanese never really lifted a finger on reforms over the 1995-98 interval. Had the pressure of a strong yen remained in place, the outcome might have been very different.
A day later and halfway around the world in Washington, US Treasury Secretary John Snow was once again asked to explain America’s so-called “strong dollar” policy to the US Congress and world financial markets. This time it was in the context of the Treasury’s eagerly awaited “Report to Congress on International Economic and Foreign Exchange Rate Policies.” The world scrutinized Secretary Snow’s remarks for the smoking gun of a new adjective, a different punctuation mark, a shift in body language. Meanwhile, experts in the US Senate have somehow determined that the Chinese renminbi is 27.5% undervalued; legislation (S 1586) co-sponsored by Senators Charles Schumer (D-NY) and Lindsey Graham (R-SC) seeks to impose huge countervailing tariffs on Chinese imports if the RMB is not revalued upward by at least that magnitude. I believe it is ludicrous to think that politicians and policy makers believe in the rhetorical approach to setting relative prices in the world’s deepest and most liquid financial markets. Nor should they have much faith in the “science” of determining a currency’s so-called fair value. (As an aside, I should note that US Senate staffers have told me how they arrived at their estimate of a 27.5% undervaluation of the RMB; they took the arithmetic average of the extremes of 15% and 40% as provided to them by a panel of “experts.”) In my opinion, it’s high time that responsible officials take the initiative in attempting to wean financial markets from relying on words over substance in understanding the means by which the world’s most important prices are set.
America doesn’t need a strong dollar policy any more than Japan needs a weak yen policy, in my view. Nor should a poor but rapidly changing Chinese economy be put in the box of having to endorse a revaluation of its currency, when in fact its overall trade position is in rough balance with the world as a whole -- a US$9 billion trade surplus over the first nine months of 2003. What America needs, if I may be so presumptuous -- and in fact what the Japans, Chinas, and Europes of the world need, instead, are strong growth policies. Let me be a bit more specific: What the world really needs are commitments to productivity-led growth -- and the market-based reforms that will foster such an outcome. Under such regimes, strong currencies would be a natural outgrowth of fundamentally sound growth. The dollar will take care of itself -- as will the yen, the euro, and yes, even the RMB. To be sure, in the currency realm, we live in the zero-sum construct of relative prices. There will always be currencies that look strong on a relative basis and those that, by default, appear weak. But if the world’s collective focus is on growth, those occasions will be transitory fluctuations rather than fundamental misalignments that scream out for painful resolution.
Ironically, that was the real message of the recent G-7 meeting in Dubai -- an Agenda for Growth that got lost in the shuffle of the three or four words of the communiqué that were changed with respect to currency policy. I’ll be the first to admit that I was just as guilty as anyone else in looking to subtle shifts in language as a guide to what the G-7 was attempting to accomplish at the time (see my first impressions in the Forum on September 22, “Breakthrough”). Yes, the dollar’s recent downtrend has broadened out in the ensuing six weeks, with the adjustment spreading from the euro to the yen axis. But that’s more of a tactical detail, in my view. What the G-7 was attempting to convey is that growth should be the main focus -- and that the burden of global growth must now be shared by the world as a whole rather than carried almost exclusively by the United States, as has been the case since 1995. To the extent that the road to a renewal of economic growth rests on a foundation of sustained productivity enhancement, market-based reforms become an essential ingredient of the global growth equation. Primary focus on the rhetoric of currency policies deflects attention from this critical objective.
It’s not hard to understand why politicians and policy officials would rather turn their attention elsewhere. The structural reforms required to sustain productivity-led growth are often the toughest medicine for any economy to take. That’s because they usually entail a reworking of social contracts between governments, businesses, and workers. As such, structural reforms can threaten deeply entrenched conventions of job and income security -- threats that have enormous social and political implications. In light of these severe consequences, there is a natural inclination to avoid reforms. Yet in the end there is no other choice. It takes courage and vision to look through the short-term pain and see the long-term gain. In my view, it also takes pressure -- pressure that leaves an economy and its leadership with no option other than reform. To the extent that a strong currency achieves such an outcome, that is a good thing.
But that doesn’t mean a nation should frame its policies around a specific currency target. In fact, I believe that it is now time for America to abandon its strong dollar policy. If America stays the course of productivity-led growth, I can assure you the dollar will be strong enough. So will the yen, the euro, and the RMB -- provided, of course, that Japan, Europe, and China also focus on the imperatives of productivity-led growth. We are deluding ourselves in thinking that we know what the exact price point of any currency should be. Currency strength is too important to be left to the whims of politicians. A shared focus on the imperatives of balanced global growth will hand over that price-setting mechanism to the markets -- precisely where it belongs. |
