Currency intervention: how would the US do it, and would it work?

Washington’s FX policy has oscillated between heavy interventions and benign neglect

Eva Szalay in London


The Fed's recent dovish turn has made it easier for Donald Trump to push for interventions


The US dollar is near a multi-decade high, on a trade-weighted basis, and President Donald Trump is not happy about it. His increasingly blustery rhetoric, accusing other countries of manipulating their currencies lower to boost exports, could mean that the US Treasury Department intervenes in FX markets for the first time in years.

Since 1995, the US has stepped in three times — but on each occasion acted in concert with other big central banks to smooth excessive exchange rate fluctuations.

Could the US intervene on its own?

The short answer is yes.

America’s exchange-rate policy has oscillated from periods of large and frequent interventions to benign neglect under different administrations. In some cases, the view about exchange rates changed significantly under the same administration, flipping from viewing a strong dollar as a threat to making it an official policy — as in Bill Clinton’s two terms as president.

“What is remarkable about these fashions is how abruptly [policies] changed at times,” said Robin Winkler, a strategist at Deutsche Bank.

Following the breakdown in 1973 of the Bretton Woods exchange-rate system — in which the currencies of 44 countries were pegged to the value of the dollar, which, in turn, was pegged to the price of gold — big central banks regularly intervened to influence their currencies. In the US, President Richard Nixon had hoped that the end of the system would stabilise the dollar’s value but it did not, forcing the Treasury to step in frequently to buy dollars. Jimmy Carter’s administration also deployed significant resources to support the dollar in 1978 before interventionist policies briefly fell out of favour under Ronald Reagan.

The dollar appreciated more than 50 per cent under Reagan, with a 90 per cent rise against the Deutschemark in the five years to 1985. This led to a change of stance during Reagan’s second term, which ultimately led to the Plaza Accord of 1985, under which big central banks co-ordinated to weaken the greenback.

In the lead-up to the 1987 October stock market crash, the dollar gained ground again despite heavy intervention from the US. In late 1988 the currency saw another spurt, against the Japanese yen in particular, as the Federal Reserve raised interest rates. That led to the US intervening on an unprecedented scale in the first half of 1989, which caused clashes between the Treasury and the Fed’s rate-setting committee.

From that point, the Treasury “largely gave up on interventions, conceding that they had failed to have the desired impact”, said Mr Winkler.




How would intervention work this time?

Since 1934, the US Treasury has held responsibility for managing exchange rates, through the official vehicle for currency interventions — the Exchange Stabilisation Fund. The New York Fed acts as the official agent for the Treasury during interventions but the central bank also holds additional firepower to influence prices.

Historically, the Treasury and the Fed have acted together, shouldering intervention amounts equally, even when the central bank had reservations about the Treasury’s goals. If the Fed agreed to participate now, the administration’s war chest to buy other currencies would total about $200bn.

The Fed’s recent dovish turn has made it easier for Mr Trump to push for interventions, as the expected rate-cutting path aligns with the administration’s desire for a weaker dollar. But sensitivities around protecting the central bank’s independence will be more difficult to overcome and the Fed could resist calls to deploy its own firepower to help. If the Treasury decides to go it alone, the move could risk what Deutsche Bank calls an “institutional crisis”.

“Our interpretation is that the Fed would probably defer to the Treasury and go along even if it does not agree,” said Michael Cahill, an FX strategist at Goldman Sachs.




Does the US have broad support?

No, and without it, the results of an intervention could be mixed at best. While central banks have combined in the past to try to stabilise currencies — as in the aftermath of Japan’s biggest ever earthquake in 2011 — there is little evidence that peers such as the European Central Bank or the Bank of Japan would support the Treasury’s efforts.

Citigroup economists highlight that at the time of the Plaza Accord, every member of the G5 bloc was concerned about the strength of the dollar, but today only the US is complaining. “This is a one-sided Plaza at best,” said Citi.

That raises the prospect of tit-for-tat competitive devaluations. A unilateral US move “could harm severely the international monetary system”, said Mark Sobel, ex-Treasury official and US chairman of think-tank OMFIF.

Such a move would also make it hard for the Trump administration to label other countries as “manipulators”. Mr Cahill noted that the US would find it difficult to respond if China aggressively weakened the renminbi, for example.

And whatever shape intervention might take, intervening in the dollar may not be enough to offset factors that are pushing it higher. The US economy, for example, continues to outperform its peers. On that basis, Nomura strategist Craig Chan says the dollar could make gains in the second half — even if intervention causes some “short-term volatility and potentially a sharp fall”.


Who Will Win the Twenty-First Century?

For years, Europeans were lulled into thinking that the peace and prosperity of the immediate post-Cold War period would be self-sustaining. But, two decades into the twenty-first century, it is clear that the Old Continent miscalculated and now must catch up to the digital revolution.

Joschka Fischer

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BERLIN – The first two decades of the twenty-first century are beginning to cast a long shadow over the Western world. We have come a long way since the turn of the century, when people everywhere, but particularly in Europe, indulgently embraced the “end of history.”

According to that illusory notion, the West’s victory in the Cold War – the last of the three great wars of the twentieth century – had given rise to a global order for which there could be no alternatives. Thenceforth, it was thought, world history would march steadily toward the universalization of Western-style democracy and the market economy. The new century would merely be a continuation of the previous one, with a triumphant West extending its dominion.

The world is wiser now. The web of alliances and institutions that sustained the West’s dominance is proving to be a product of the twentieth century, its future now in doubt. The global order is undergoing a fundamental change, as its center of gravity shifts from the North Atlantic to the Pacific and East Asia. China is on the threshold – economically, technologically, and politically – of becoming a world power and the sole challenger of the incumbent hegemon, the United States.

At the same time, the US is growing tired of its global leadership role. It began to step back under former President Barack Obama; but under Donald Trump, it has accelerated its withdrawal in a chaotic and dangerous manner. America’s abdication of leadership poses a threat to the very existence of the transatlantic West, which rests on a foundation of shared values and political institutions. In the absence of any reasonable alternatives, the structure is crumbling.

Russia, meanwhile, is confronting the future by looking to its twentieth-century past. Like the Soviet Union, it is placing its bets entirely on nuclear weapons. Yet in the twenty-first century, power will be determined not by one’s nuclear arsenal, but by a wider spectrum of technological capabilities based on digitization.

Those who aren’t at the forefront of artificial intelligence (AI) and Big Data will inexorably become dependent on, and ultimately controlled by, other powers. Data and technological sovereignty, not nuclear warheads, will determine the global distribution of power and wealth in this century. And in open societies, the same factors will also decide the future of democracy.

As for Europe, the Old Continent entered the new century in anything but optimal form. Living under the cozy post-historical illusion of everlasting peace, the European Union failed to complete the project of integration (though it did manage to expand eastward). The implicit withdrawal of the US security guarantee under Trump has struck Europe like a bolt from the blue.

The same could be said for the digital revolution. The first phase of digitization – consumer-facing platforms – has been led almost entirely by the US and China. There are no competitive European platform firms to speak of, nor are there any European cloud-computing companies capable of keeping up with the behemoths in Silicon Valley and China.

The most important issue facing the new European Commission, then, is Europe’s lack of digital sovereignty. Europe’s command of AI, Big Data, and related technologies will determine its overall competitiveness in the twenty-first century. But Europeans must decide who will own the data needed to achieve digital sovereignty, and what conditions should govern its collection and use.

These questions will determine the fate of democracy in Europe, and whether the Old Continent’s future will be one of prosperity or decline. As such, they must be decided at the European level, not by individual nation-states. Equally important, these questions must be answered now. Europe needs to get the digital ball rolling – or be run over by it.

In the years ahead, automotive design and manufacturing, mechanical engineering, medicine, defense, energy, and private households will all be disrupted by digital technologies. The data generated from these sectors will largely be processed through the cloud, which means that control of the cloud will be vital to countries’ long-term economic and strategic fortunes.

To safeguard its digital sovereignty, Europe will need to make massive investments in cloud-computing capacity and the other physical resources underpinning the digital revolution. Europe has been far too slow and indecisive in this respect. Its challenge now is to catch up to the US and China, lest it be left behind permanently.

Europeans should not harbor any illusions that the private sector will take care of things on its own. Europe’s competitive disadvantage calls for a fundamental change in strategy at the highest level. The EU institutions will have to lead on setting regulations and, together with the member states, on providing the necessary financing. But securing Europe’s digital sovereignty will require a much broader effort, involving businesses, researchers, and politicians.

Following the recent 50th anniversary of the first Moon landing, there has been much media discussion about a potential manned flight to Mars. For Europe, though, space travel can wait.

The top priority must be to establish and safeguard digital sovereignty, and to do whatever is necessary to arrest its own decline and protect democracy. For better or worse, the twenty-first century is well underway.

Joschka Fischer was German Foreign Minister and Vice Chancellor from 1998-2005, a term marked by Germany's strong support for NATO's intervention in Kosovo in 1999, followed by its opposition to the war in Iraq. Fischer entered electoral politics after participating in the anti-establishment protests of the 1960s and 1970s, and played a key role in founding Germany's Green Party, which he led for almost two decades.

Going to the Moon and Going to India

By George Friedman

 

Last weekend marked the 50th anniversary of the Apollo 11 mission, the first manned space flight to the moon. In endless articles, observers are asking why no attempts have been made to land men on the moon since the Apollo program.

In considering this, I think it’s useful to examine the U.S. and other space programs against a prior, comparable period of exploration – the European journey to the Western Hemisphere. The similarities and differences between the two will help us understand the issues behind that question.
 
The Race to India
The initial European explorations five centuries ago had similarities to the U.S. and Soviet space programs of the 1960s. First, both were extremely expensive and carefully planned. The two countries most competitive in these explorations, Portugal and Spain, spent a substantial proportion of their national budgets on the expeditions. The Portuguese trained captains and navigators and built ships that could sustain a crew for extended periods of time and survive dangerous conditions. They carried out a systematic program of exploration, with each voyage pushing farther south along the African coast in search of a passage to India. Meanwhile, Christopher Columbus had approached several countries, including France and England, soliciting funding for his own expeditions, but he was repeatedly turned down because of the program’s cost and improbability of success. Only Spain was willing to fund his journey, contributing both state funds and private investment.

Second, both programs were undertaken for reasons of national security and prestige. The Portuguese and Spaniards were bent on finding a route to India, the source of critical products for Europe. The traditional route from India to Europe had been disrupted by the Ottoman conquest of Turkey and the accompanying increases in tariffs. This shifted the economic process in Europe, and any nation that found another path to India would prosper enormously from the trade, with the added benefit of weakening the Ottomans.

Portugal’s program introduced new naval technologies and explored uncharted waters. It was Portugal that finally found the southern tip of Africa, navigating around it and through the Indian Ocean to India itself, landing in 1498. This frightened the Spaniards. They feared that Portugal would threaten them in Iberia and become the dominant power in Europe. The Spanish had only just expelled the last Muslim enclave in Spain in 1492, and the cost had crippled the national budget. But if Spain simply allowed Portugal to control the new route to India, Portugal would eventually control the oceans, and Portuguese power and prestige would dwarf Spain’s.

That’s why they were prepared to invest in Columbus’ risky voyage. The Portuguese navy dominated the southern route, and they had to find a different one. Columbus’ proposal to sail westward into unknown waters was risky. But it was the only practical chance for Spain to compete in the race to India. When Columbus reached what he thought was India, he found very little of value there.

In that sense, his voyages were a failure, and he returned to Spain to great criticism. But the Spanish doubled down, permitting additional journeys that also yielded little economic benefit, prompting Spain to suspend further explorations. The Portuguese, whose route to India had economic value and lent them national power, continued their voyages. The Spaniards slipped behind.

But in due course, with further exploration that was far less risky than Columbus’, the Spanish discovered the Incas in the Andes and the Aztecs in Mexico, both wealthy with gold and silver. The Spaniards conquered them (with disease as well as guns), took their wealth, and defeated Portugal in the race to wealth and power.

The Race to the Moon

The U.S. and Soviet space programs, like the European expeditions, were rooted in political and strategic considerations. Toward strategic ends, each country created and launched spy satellites to monitor the other’s military preparations. It was therefore critical that large sums be devoted to low Earth orbit spy satellites. Toward political ends, each sought prestige. The U.S. and the Soviet Union were making ideological claims concerning the effectiveness of their social and political systems, using demonstrations of technology to persuade other nations to come into their camps. The initial Soviet manned flights brought them political influence. Later, the moon landing lent that influence to the U.S. But there was a fundamental difference between the value of that influence and the cost of the space programs.

Manned flights did not persist, but space as a realm of military power did. And over time, the military power of space yielded economic benefits, from increased communication capabilities to GPS. Still, the economic benefits of manned missions to the moon simply did not compare to those that eventually accrued to Spain and Portugal.

Without clear economic value, Spain put a hold on exploration. Columbus’ journey yielded substantial scientific knowledge, but it could not support the cost of further exploration. Expeditions had to be justified by more immediate benefits. The same can be seen in the hiatus on U.S. manned moon missions. Having achieved its political and military ends, the U.S. continued the scientific dimension with limited unmanned explorations. Further manned trips to the moon were not economically viable.

That is changing now. As I argued in my recent piece on command of the seas, space is now the key to military power. And that means that space is now a potential battleground. Control of space will depend on strategic depth. If space is the key to military dominance, then nations will move beyond extremely vulnerable satellites – a few key satellites for GPS and communications control may not survive a major conflict.

The moon, then, becomes a strategic asset. Its military use is unclear at this point, but it is emerging. On the moon, it is possible to dig in and secure assets in ways that can’t be done in orbit. This means that a manned presence on the moon may well happen again, for the same reason that Spain continued its maritime exploration program: to build national power.

Still, the economic benefit of going to the moon is absent, and thus the cost of the military effort is not underwritten by economic gain, as was the case with the Iberian surge onto the oceans. This is the great weakness in a U.S. return to manned moon flights. I have written in the past that the value of space is unlimited solar power (which can be collected and returned to Earth as microwaves and then transferred into the electrical grid). Some argued that the platforms I envisioned would be vulnerable to attack, but that might be mitigated by lunar-based systems. Space-based solar power is much more efficient than Earth-based systems, which must deal with night and clouds. Beyond solar power, though, it is at present hard to imagine other economic uses of the moon.

One could say that space exploration is an end in itself. But except for limited efforts, this is empirically untrue. The Iberian exploration was driven by economics, military power and politics. The space exploration of the 1960s was driven by military power and political desire. The economic factor existed only where the technology developed could be spun off for commercial uses.

At present, commercial space companies are focused on supporting military and related efforts in space and on space tourism. The former would take place anyway, and the latter is a dubious indulgence. The commercial use of space remains the key for returning to the moon. And if my suggestion for space-based solar power is rejected, then some other must be found. Columbus did not come to America to build knowledge. He came for money, and Spain funded him for wealth and power.

Why Weak Corporate Earnings Don’t Signal a Weak Economy

Tepid results from multinationals don’t necessarily signal trouble at home

By Justin Lahart


The domestic economy is still solid, but the Federal Reserve’s beige book survey showed manufacturers continuing to worry about the uncertainty and costs associated with trade disputes. Photo: tim aeppel/Reuters
 

American companies are reporting second-quarter results, and the numbers so far have been nothing to write home about. Based on current estimates compiled by FactSet, earnings for companies in the S&P 500 will be down 1.9% from a year earlier. Actual results probably will be somewhat better given companies’ tendency to lower the bar and then clear it, but the final figures are unlikely to fit anyone’s definition of good.

It is tempting to hang earnings weakness on the domestic economy. Even though growth has moderated a bit, it is still solid. Macroeconomic Advisers estimates imply that final sales to domestic purchasers—a measure of underlying economic demand—was up 2.6% from a year earlier in the second quarter. That compares with a 2.9% gain in the second quarter of last year.



Outside the U.S., things aren’t looking so rosy, and that is a problem for many of the companies in the S&P 500, which conduct a substantial share of their business overseas. Paint maker PPG Industries ,for example, which generated more than half of its income outside the U.S. last year, highlighted weakness in the Chinese and European auto markets when it reported a 2.6% decline in second-quarter sales. The strength of the dollar compounds the problem: Industrial-equipment maker Dover said foreign exchange created a 2.6% headwind to sales.

Tariffs and trade tensions are another point of stress, particularly in the manufacturing sector.

The Federal Reserve’s beige book survey released Wednesday—a report of anecdotes drawn anonymously from business contacts around the country—showed manufacturers continuing to worry about the uncertainty and costs associated with the various trade disputes into which the U.S. has entered.

But trade counts as more of an issue for large public companies than for U.S. businesses at large. That isn’t just because of all the business they do overseas but also the kinds of companies they are. Some 190 of the 500 companies in the S&P 500—more than a third—are classified as manufacturers. Yet manufacturing jobs count for only 8% of U.S. employment.

Finally, companies are being confronted by rising labor costs and an inability to pass those costs on. It is part of why profit margins look to have slipped in the second quarter. But for most Americans, the combination of rising wage growth and low inflation probably counts as a good thing.

It is easy—and often makes sense—to view big U.S. companies as a barometer of the U.S. economy, but that is misleading at the moment. A measure of something isn’t the same as the thing itself.

The world economy

Markets are braced for a global downturn

The signals from bonds, currencies and commodities are increasingly alarming



LOOKING FOR meaning in financial markets is like looking for patterns in a violent sea. The information that emerges is the product of buying and selling by people, with all their contradictions. Prices reflect a mix of emotion, biases and cold-eyed calculation. Yet taken together markets express something about both the mood of investors and the temper of the times. The most commonly ascribed signal is complacency. Dangers are often ignored until too late. However, the dominant mood in markets today, as it has been for much of the past decade, is not complacency but anxiety. And it is deepening by the day.

It is most evident in the astounding appetite for the safest of assets: government bonds. In Germany, where figures this week showed that the economy is shrinking, interest rates are negative all the way from overnight deposits to 30-year bonds. Investors who buy and hold bonds to maturity will make a guaranteed cash loss.

In Switzerland negative yields extend all the way to 50-year bonds. Even in indebted and crisis-prone Italy, a ten-year bond gets you only 1.5%. In America, meanwhile, the curve is inverted—interest rates on ten-year bonds are lower than on three-month bills—a peculiar situation that is a harbinger of recession. Angst is evident elsewhere, too. The safe-haven dollar is up against many other currencies. Gold is at a six-year high. Copper prices, a proxy for industrial health, are down sharply. Despite Iran’s seizure of oil tankers in the Gulf, oil prices have sunk to $60 a barrel.

Plenty of people fear that these strange signals portend a global recession. The storm clouds are certainly gathering. This week China said that industrial production is growing at its most sluggish pace since 2002. America’s decade-long expansion is the oldest on record so, whatever economists say, a downturn feels overdue. With interest rates already so low, the capacity to fight one is depleted. Investors fear that the world is turning into Japan, with a torpid economy that struggles to vanquish deflation, and is hence prone to going backwards.

Yet a recession is so far a fear, not a reality. The world economy is still growing, albeit at a less healthy pace than in 2018. Its resilience rests on consumers, not least in America. Jobs are plentiful; wages are picking up; credit is still easy; and cheaper oil means there is more money to spend. What is more, there has been little sign of the heady exuberance that normally precedes a slump.

The boards of public companies and the shareholders they ostensibly serve have played it safe. Businesses in aggregate are net savers. Investors have favoured firms that generate cash without needing to splurge on fixed assets. You see this in the vastly contrasting fortunes of America’s high-flying stockmarket, dominated by capital-light internet and services firms that throw off profits, and Europe’s, groaning under banks and under carmakers with factories that eat up capital. And within Europe’s stockmarkets a defensive stock, such as Nestlé, is trading at a towering premium to an industrial one such as Daimler.

If there has been no boom and the world economy has not yet turned to bust, why then are markets so anxious? The best answer is that firms and markets are struggling to get to grips with uncertainty. This, not tariffs, is the greatest harm from the trade war between America and China. The boundaries of the dispute have stretched from imports of some industrial metals to broader categories of finished goods.

New fronts, including technology supply-chains and, this month, currencies, have opened up.

As Japan and South Korea let their historical differences spill over into trade, it is unclear who or what might be drawn in next. Because big investments are hard to reverse, firms are disinclined to press ahead with them.

A proxy measure from JPMorgan Chase suggests that global capital spending is now falling. Evidence that investment is being curtailed is reflected in surveys of plunging business sentiment, in stalling manufacturing output worldwide and in the stuttering performance of industry-led economies, not least Germany.

Central banks are anxious, too, and easing policy as a result. In July the Federal Reserve lowered interest rates for the first time in a decade as insurance against a downturn. It is likely to follow that with more cuts. Central banks in Brazil, India, New Zealand, Peru, the Philippines and Thailand have all reduced their benchmark interest rates since the Fed acted.

The European Central Bank is likely to resume its bond-buying programme.

Despite these efforts, anxiety could turn to alarm, and sluggish growth descend into recession.

Three warning signals are worth watching. First, the dollar, which is a barometer of risk appetite. The more investors reach for the safety of the greenback, the more they see danger ahead. Second come the trade negotiations between America and China. This week President Donald Trump unexpectedly delayed the tariffs announced on August 1st on some imports, raising hopes of a deal.

That ought to be in his interests, as a strong economy is critical to his prospects of re-election next year. But he may nevertheless be misjudging the odds of a downturn. Mr Trump may also find that China decides to drag its feet, in the hope of scuppering his chances of a second term and of getting a better deal (or one likelier to stick) with his Democratic successor.

The third thing to watch is corporate-bond yields in America. Financing costs remain remarkably low. But the spread—or extra yield—that investors require to hold risker corporate debt has begun to widen. If growing anxiety were to cause spreads to blow out, highly geared firms would find it costlier to roll over their debt. That could lead them to cut back on payrolls as well as investment in order to make their interest payments. The odds of a recession would then shorten.

When people look back, they will find plenty of inconsistencies in the configuration of today’s asset prices. The extreme anxiety in bond markets may come to look like a form of recklessness: how could markets square the rise in populism with a fear of deflation, for instance?

It is a strange thought that a sudden easing of today’s anxiety might lead to violent price changes—a surge in bond yields; a sideways crash in which high-priced defensive stocks slump and beaten-up cyclicals rally. Eventually there might even be too much exuberance. But just now, who worries about that?