May 21, 2003

Gerard Baker Offers Kudos to John Snow

The Financial Times's Gerard Baker tries to give John Snow kudos for trying to educate the world's press and currency traders about the realities of exchange rate determination:

It is not just that the formal ending of the strong dollar policy had been prefigured by a succession of clumsy attempts at clarification by Mr Snow and Paul O'Neill, his policymaking Doppelgaenger. It is that the whole notion of a dollar policy is a piece of fiction that should have been abandoned years ago. Policymakers can set interest rates, tax rates and public spending levels. They can no more set the price of a nation's currency than they can set the price of an apple or a company's stock.... Before Mr Snow spoke, the dollar had been falling for two years - by more than 25 per cent against the euro, somewhat less against other currencies - because it was bound to.... And it will surely fall further. Mr Snow and his colleagues for once deserve some credit for belatedly simply trying to get out of its way.

Gerard Baker is largely right, but I see two problems with his analysis:

  1. You can fix the price of your currency--if you have the enthusiastic cooperation of your central bank and the government's budget masters. It's called a fixed exchange rate system. You can do it. You just don't want to: exchange-rate stability is not worth what you have to sacrifice to get it.
  2. This is not an argument a U.S. Treasury Secretary can win--given the mapping that foreign exchange traders believe holds between his statements and U.S. government policy--and it is a costly argument for a U.S. Treasury Secretary to try to make. This is one that you make your underlings wage with the press, on background.
Posted by DeLong at May 21, 2003 08:35 PM | TrackBack


Bad link, the piece is subscribers only which is a pity since the argument is important.

I don't agree with it at all. A dollar policy is possible, indeed this is what we have. The policy is being used to try and force Europe and Japan to mend their ways at gunpoint. (But since the analysis of the problem is wrong, forgive me if I beg to doubt the efficacy of the remedy). This is the real result of the Iraq war, no cooperation, no consensus, and we'll see what happens next. But the euro won't hold this value, ie this is NOT a reflection of a market valuation, but the result of expectations being 'steered'.

Movements of this violence in currency markets cannot be good for business. Why make a low return investment in a world of xcess capacity when you can turn 20% this year buying euro-bonds, and maybe another 20% next year buying US treasuries on the ride back up. In theory governments exist to prevent this type of thing, but I know, I am a lone voice here......

Posted by: Edward Hugh on May 21, 2003 10:12 PM

Mr. DeLong, I am a total layman, trying to be aware of the economic situation, particularly from a leftist political point of view. I read your postind every day, and thank you for your efforts.
My point regarding the dollar movements/status, and the Snow-job; Did not Snow say, very clearly, that Bush has not abandoned the "strong dollar" policy? Does this statement, in the glare of the reality postulated here ( value cannot be controlled), become a lie? At minimum, a conceptual untruth spoken on purpose?

Posted by: Richard W. Crews on May 21, 2003 10:36 PM

Is it worth a recap on breakdown in the early 1970s of the Bretton Woods system of pegged exchange rates to show how the system became unstable?

Posted by: Bob Briant on May 22, 2003 04:02 AM


Pardon me for jumping in, when you question was addressed to Brad. but....

The essence of the strong dollar policy, as far as real action goes, has long been to repeat the statement that "a strong dollar is in the interest of the United States." There was a brief period in which there was an exception to that limited effort - when the dollar's value had fallen to between 82 and 84 yen in mid-1995. At that time, Treasury Secretary Rubin instructed the Fed to buy dollars in joint action with the BoJ, with the result that the dollar made pretty continuous gains over the course of 3 years to around 145 yen. Since then, the Fed has been instructed to both buy and sell dollars against the yen, and for long stretches has not been instructed to do either (no intervention at all under Bush). Through it all, the Treasury Secretary and sometimes the White House has said repeated the "strong dollar" statement at fairly regular intervals. For years, that repetition has been the entire extent of the policy.

At least until Brad contradicts me.

Posted by: K Harris on May 22, 2003 05:57 AM

"You just don't want to: exchange-rate stability is not worth what you have to sacrifice to get it."

Ok, mister economic smarty pants, answer me this: since 1993, China has maintained a soft peg against the dollar, sacrificing what, exactly?

During the "Asian Flu", they were roundly praised for not devaluing. Since the Bush administration came into office, they've been regularly criticized for the peg (so far as I can tell, this means failing to help the U.S. devalue its way out of its balance-of-payments hole). The Japanese are now going on about "exporting depreciation".

And through it all, I've never seen anyone explain how the peg constitutes a sacrifice from the Chinese point of view.

Or, perhaps more to the point, how such a sacrifice outweighs the warm fuzzy stability that has kept the FDI pouring in.

Posted by: Michael Robinson on May 22, 2003 09:38 AM

The puzzle for me is what will the decline in value of the dollar against selective currencies spur our exports. Since China pegs its currency to the dollar and China is a large exporter to America and a competitor in exports to other countries, the effects of the deline in dollar value may be quite muted.

Suppose the dollar decline does not significantly spur exports. What do you think?

Posted by: anne on May 22, 2003 10:58 AM

The figure above shows that, while the U.S. dollar declined by almost 26% in nominal terms against the euro from its peak in February 2002, it fell only 17% against an index of major world currencies such as the euro, the yen, and the British pound (after adjusting for inflation). More importantly, the dollar actually increased slightly after adjusting for inflation compared to the currencies of other important U.S. trading partners, such as China. The main reason for this increase is that many of these countries fix the value of their currencies against the U.S. dollar, often keeping them artificially low to support exports to the United States.

This deliberate manipulation of the dollar's value has real implications for the U.S. economy. A declining dollar could ultimately lead to rising exports and falling imports, which would help to reduce the trade deficit, albeit with a lag of about 12 to 18 months. But the dollar has not declined against the currencies of countries that have had the largest increase in trade importance with the United States. While only 33% of U.S. trade was with countries not included in the index of major currencies in 1980, this number rose to 46% in 2002. Because a substantial share of trade is conducted with those countries whose currencies have declined against the dollar in recent months, the chance of increased exports and a reduced trade deficit is diminished.

Posted by: anne on May 22, 2003 11:40 AM

Remember, though the dollar was rising in value after 1993, China had enough of a cost advantage to hold and expand markets for exports. Now, with the dollar falling, watch Chinese grow even faster. Chinese imports tend to be concentrated around industrial products rather than consumer products.

Posted by: lise on May 22, 2003 11:51 AM
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