How to Negotiate Peace With Honor in Currency Wars
Brazil’s president, Dilma Rousseff, and her finance minister, Guido Mantega, are attacking the U.S. Federal Reserve for embarking on a third round of quantitative easing. By aggressively buying bonds, the Fed aims to push interest rates lower, and that will nudge the dollar down as well.
This will hurt Brazil and other developing-country exporters, Mantega says, and what’s more, it’s meant to. To him, the U.S. has declared “currency war.”
Mantega’s complaints about what used to be called “beggar thy neighbor” exchange-rate policy are partly justified, even though his attack on the Fed is misguided. Many countries are manipulating their currencies to put trading partners at a disadvantage. It is a collectively self-defeating practice that everybody has an interest in curbing.
Brazil has particular reason to worry. Its economy is struggling. Capital lured by Brazil’s relatively high interest rates (the government’s three-month bonds yield more than 7 percent) has kept its currency too strong, and that has been a brake on output and employment.
You can see why Mantega might think QE3 would make this problem worse. Yet his attack on the Fed is wrong. If the bond-buying plan works, Brazil will benefit. And whether it works or not, QE3 sure isn’t currency war.
The Fed’s primary goal is not to manipulate the dollar but to expand demand at home. It hopes to do this mainly by lowering interest rates and convincing investors that rates will stay low for a good while. This should encourage consumers to spend and companies to hire and invest. If these things happen, U.S. imports will rise and exporters such as Brazil can expect to benefit.
Granted, the Fed wouldn’t mind some dollar depreciation, but that isn’t its main purpose. U.S. exports are small relative to the rest of the economy. QE won’t help much unless it boosts domestic demand. If it succeeds, it will help Brazil -- and if it doesn’t help Brazil, it probably won’t succeed.
Although Mantega is wrong about QE3, his wider concern about currency manipulation is right. Indeed, it is an issue over which Brazil and the U.S. should make common cause.
Let’s be a bit more precise about who is a currency manipulator. The charge is best limited to countries that stop their currencies from appreciating even though they have big current-account surpluses -- that is, countries that block the movement of currencies toward levels that would help balance global trade. That isn’t what the U.S. is doing with QE3. It is precisely what many other countries are doing, however, hurting the U.S. and Brazil alike.
If currency manipulation is defined this way, the leading offender is China. One measure is a country’s growth in foreign-exchange reserves: Manipulators hold their currencies down by using domestic money to buy foreign assets. Recently, and especially over the past year, China has eased this policy, but its foreign-exchange reserves still stand at a colossal $3.2 trillion.
By no means is China alone. Joseph Gagnon, a senior fellow at the Peterson Institute for International Economics, recently posted a list of 20 currency manipulators, ranked by foreign-exchange reserves. China tops the list, followed by Japan, Saudi Arabia, Russia, Taiwan, Korea, Hong Kong and Switzerland.
One response to currency manipulation is to resort to capital controls, as Brazil has done. The idea is to offset upward pressure on the currency by limiting inflows of capital, perhaps by taxing them. As we have explained, this is a defensible policy but one that is easy to get wrong. Carelessly executed, it hurts trading partners and can easily backfire. It has to be done cautiously and, because it is one more way to put other countries at a disadvantage, it needs to be supervised.
We favor adding currency oversight (and the sanctions that might go with it) to the duties of the World Trade Organization or the International Monetary Fund. This makes excellent sense because currency manipulation can add to trade-policy friction and vice versa, in a cycle of mutually assured disadvantage.
Currency manipulation already violates WTO and IMF rules, but there is no enforcement. This should change. Meanwhile, Mantega and other finance ministers need to be more careful about whom they accuse of waging currency war. The U.S. isn’t among them.
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