A Short Note On Currency Manipulation

With charges of “currency manipulation” getting media attention again, it’s important to understand that the benefits of currency manipulation — if they exist at all — are wildly overstated.

There are lots of reasons why people are wrong to hyperventilate about currency values, and I’ll have a longer note when I get some time, but here are two things to keep in mind:

(1) Managing your currency to achieve a lower value relative to the dollar isn’t cost-free — in fact, for most countries, it’s expensive.

The mechanics of managed currency operations works like this: a country buys up the U.S. dollars in its economy, paying for them with its newly printed domestic currency. It then takes those dollars and buys dollar-denominated assets — overwhelmingly, U.S. Treasury securities. But the government now has a problem: by printing its local currency to buy up U.S. dollars, it dumped a lot of new money into the economy. So, to prevent causing domestic inflation, the country then “sterilizes” its currency intervention by selling domestic securities to its citizens, “mopping up” all that excess money it injected.

How is that expensive? The country now holds very low yielding U.S. Treasury securities, but is obligated to pay higher yielding domestic securities. The spread between what the country earns and what it’s now obligated to pay is a fiscal cost. That’s money that could be used to build roads or bridges or schools, social safety nets for its citizens, or other productivity-enhancing investments. And by increasing the supply of local securities that need to be sold, the country also elevates local interest rates above where they otherwise would have been. In other words, in an effort to help export-oriented sectors, you end up hurting interest rate-sensitive sectors.

(2) It’s true that keeping your currency artificially low can temporarily lower the price of your exports. Unfortunately, it’s symmetrically true that it also artificially increases the price of your imports.

An artificially low currency weakens the purchasing power of a country’s citizens. Understood this way, it literally makes a country’s own citizens poorer in the aggregate — even if it might make some politicians and well-connected firms happy. Worse, an artificially low currency also means that a country’s firms — including exporting firms — also pay higher prices for the components they import. The benefit nets out. In a world of increasing globally sourced manufacturing, manipulating currencies to capture trade advantages becomes increasingly silly.

There are some circumstances where it makes sense for a country to manage its currency — think of a small economy like Singapore that imports most of what it consumes, so changes in exchange rates have a bigger impact on inflation than changes in interest rates. Or developing economies that have shallow capital markets where a few chunky trades can produce large exchange rate swings. But there are real trade-offs, and they’re not cheap.

The hyper focus on currencies distracts from real issues that impact our trade relationships — like market access, intellectual property protection, and other non-tariff barriers.

Prosperity is not derived from artificially weakening your currency. If the U.S. did it, we’d be worse off, not better off. So I’m not sure why people think other countries are better off when they do it.