An End to Currency Manipulation
THE U.S. DOLLAR last week appeared mercifully to end its
plunge. World markets cheered, and the immediate financial
crisis in the U.S. abated. But this week the dollar is retesting
all-time lows versus the euro and yen, and commodity
prices, capital flows, and trade remain vulnerable to its
movements. Inflation in dollar-linked China is rising fast,
and an over-strong yen could thwart Japan’s recent recovery
after its painful 1990s deflation. In the U.S., currency swings
are destabilizing the economy and fueling anti-trade popu-
lism. After a decade of wild instability, it’s time to rethink
global currency markets and monetary policies.
How did we get here? After the global inflation of the
1970s, the currency interventions of the late 1980s helped
push the value of the yen ever higher, and Japan slid into a
long deflation. With Fed Chairman Alan Greenspan’s high
real interest rates, the dollar-linked world then stumbled into
its own deflation in the late 1990s.
As the dollar strengthened dramatically in the late ’90s, it
exerted enormous pressure on all dollar debtors, rumbling
through Asia in 1997-98, then on to Russia, Turkey, and
Argentina. The world’s capital fled these crashed economies
and the new euro area and poured into the U.S. Foreign re-
serve accumulation slowed or even sank. Capital shunned
hard tangible assets like oil and gold, and profits at old-
economy companies shriveled. U.S. farmers and manufac-
turers suffered. Money went into soft abstract assets like
Microsoft, Cisco, and Silicon Valley dot-coms. U.S. stock
markets rose to half the world’s equity wealth.
But eventually the strong dollar overwhelmed the U.S.
economy, too, where longer contracts and debt structures,
more services and less manufacturing, and profitless dot-
coms could save America from the effects of deflation only
for so long. Dollar debtors in the U.S. finally succumbed to
squeezed profit margins and very tight credit, with corporate
defaults hitting records in 2001 and again in 2002. After
9/11, everything changed, as the Fed turned up the dollar
spigots and liquefied the world economy with 1% interest
rates.
The last five years were thus a mirror image of the late
’90s. With negative real interest rates in the U.S, the dollar
weakened substantially. Capital poured into Asia, and
Europe revived. Money flowed away from soft intellectual
ventures and into dollar-sensitive hard assets. Oil, gold, and
all other commodities skyrocketed, as did the equity of old-
economy industrial companies. Dollar-linked real estate
soared. Foreign dollar reserves boomed. The world share of
equity wealth rose toward 70% as the U.S. share shrank
by BRET SWANSON | March 26, 2008 | FAR EASTERN ECONOMIC REVIEW
toward 30%. In 2003, despite the U.S. technology crash, 13
of the 20 richest people in the world were Americans. To-
day, according to Forbes, that number has dropped to four.
Rising global wealth is a welcome trend and is driven in
large part by greater freedom and thus productivity and
growth in booming Asia. But it is also driven by the weak
dollar, which shifts money to the oil-rich Middle East and
Russia, and by stronger global currencies, which attract in-
vestment to Europe and Asia. Just as the U.S. could not for-
ever sustain a stronger dollar, however, no country can pros-
per for long with a currency that is excessively weak or
strong.
Since 1994, China’s peg to the dollar was a key to its
growth and the long but relatively smooth modernization of
its financial system. Although it endured falling prices from
the strong dollar of the late ’90s, it valiantly held its dollar
link and avoided the fate of its Asian neighbors. Overall, the
dollar peg has been a very good deal for both China and the
U.S. It created a seamless trading partnership that brought
the nations together economically and politically. But many
wonder what U.S. politicians are thinking when they charge
China with “currency manipulation.” With the dollar swing-
ing wildly from super-strength to destructive depreciation
inside of 10 years, the Chinese might ask, “Who’s the real
manipulator?”
For all the benefits of the dollar-yuan peg, the dollar’s
recent depreciation is simply too much for some. Inflation of
6% in China has been matched by rising prices of around 7%
in Indonesia, Singapore and Saudi Arabia, and 15% in Viet-
nam. Kuwait abandoned its dollar peg, and other Middle
Eastern nations are considering it, too. China, which long
resisted Washington’s badgering, now sees yuan apprecia-
tion as a necessary tool to fight inflation.
China is in the crucial process of more fully opening its
capital account and, hopefully, making its currency converti-
ble. Ideally, dollar-yuan stability would allow China to more
rapidly modernize and open up. But when the dollar itself is
unsteady, China must constantly adjust to ward off hot
money inflows and dollar-induced inflation. Domestic ten-
sions rise and important reforms are delayed.
Although currency swings of 30%, 40%, or 50% seem
arbitrary and harmful to many, most economists believe in
hyperflexible exchange rates. Eminent scholars like Martin
Feldstein and John Taylor believe a weaker, more “competi-
tive” dollar helps attenuate the U.S. trade deficit with Asia.
Never mind the conceptual argument. (Many of us think the
trade deficit means a beneficent capital surplus; the trade
gap, in other words, reflects our prosperity gap.) But does
the weak dollar theory even work in practice? In fact, as the
dollar weakened these last half-dozen years, the U.S. trade
deficit didn’t shrink, it boomed, mostly because of surging
imports of weak-dollar high-cost petroleum.
Inflation, capital outflows, huge asset price swings, mod-
ern-day bank runs, psychological impacts on investors and
entrepreneurs—these effects of the weak dollar cannot be
modeled in mechanical fashion. This is why the value of
money is not like any other product, whose value is set in the
marketplace. The value of money in a floating rate environ-
ment where fine-tuning central banks print money cannot be
“set by the market.” This is an illusion. Money is not a prod-
uct or commodity. Money is an abstract concept—a measur-
ing rod, a standard of value, a unit of account that must re-
main constant over time. Only then can workers and busi-
nesses, entrepreneurs and investors engage in meaningful
trade, risk new money in forward-looking ventures, and lend
and borrow money on reasonable terms. Movement in the
value of money is not a helpful “adjustment” but harmful
noise that impairs the transmission of all-important informa-
tion. How can one determine the price of a house, or a com-
plex mortgage security, for example, when the value of
money itself is under suspicion?
To achieve a dynamic and growing economy, you need
an utterly undynamic, stone-cold unit of money. It is the
information-rich creative spikes of entrepreneurship and
profit—or economic entropy—that comprise all economic
growth. A high-entropy message requires a low-entropy
carrier.
The great events of the globe increasingly are governed
by the movements of world currencies. We need a return to
currency stability. But that requires a return to dollar stabil-
ity. And the dollar is the responsibility of the Federal Re-
serve.
Mr. Swanson is a senior fellow and director of the Center for
Global Innovation at The Progress & Freedom Foundation.