Summers: How America Must Handle the Falling Dollar

Larry Summers on the falling dollar:

How America must handle the falling dollar, by Lawrence Summers, Commentary, Financial Times: ...The dollar’s decline may provoke anxiety but it should not be a surprise... There is nothing very new about a decline in currency of a country running a large current account deficit and whose economy is softening. But in important respects the situation of the dollar is almost without precedent.

The vast majority of the US current account deficit is now being funded by central banks accumulating reserves as they seek to avoid appreciation of their home currencies. While the US dollar is usually viewed as a floating rate currency, substantial and critical parts of the world economy operate with currencies pegged to dollar parities or at least managed with them in mind. ... Some means of engagement must be found with those who have yolked their currencies and so their financial policies to that of the US.

The US has responded in an ad hoc way by carrying on a “strategic dialogue” with China – by far the largest economy with an exchange rate linked to the dollar – backed by congressional threats ... and references to communiqués from the Group of Seven leading industrial nations. In reality the dialogue is anything but strategic. Like so much of American international policy in recent years, it seems to confuse the firm statement of legitimate desire with the serious conduct of diplomacy.

Think of the questions Chinese policymakers must ask themselves. What is the highest US priority – global financial stability or market access for well-connected US firms? Can the US take yes for an answer or is it a certainty that a new president will insist in 18 months on a new set of economic diplomacy accomplishments with China? In which areas, if any, is the US prepared to adjust its policies in response to global interests? Given that the Chinese authorities have presided over nearly double digit annual growth for a generation, do US officials who make assertions about what is in China’s interest have the experience and knowledge of China that should cause their views to be taken seriously? Why is China being singled out? How could China – even if it wished to – act in ways that the US prefers without appearing to yield to international pressure?

Maintaining global financial stability and the role of the dollar requires a more strategic approach – a task that, given the political calendar, is likely to fall to the next US administration.

The G7 process has lost its focus on exchange rate issues ... [and] is something of an anachronism in the current international context. It needs to be radically reinvented, starting with a change in its composition. ... Two principles stand out.

First, any new approach must be premised on the desirability of a strong, integrated global economy that benefits the citizens of all countries, not on the idea that economists or politicians can calculate “fair” exchange rates. The right and potentially effective case for adjustments in the current alignment of exchange rates relies on their unsustainability and the distortions they induce in macroeconomic policies, not on ideas of fairness to workers.

Second, multilateralism is better politics and economics than unilateralism but it must not become an excuse for inertia. Any new group should be as large as necessary and no larger, should meet with some frequency and should include central bankers. It should be analytically informed but everyone should know that key decisions will ultimately be taken by senior officials in the national interest, not by international organisations.

The stakes are high. Well-managed finance cannot on its own make a country stable and prosperous, let alone the world. But history tells us that poorly managed finance foments instability and economic insecurity.

See also: Is the Yuan Really Appreciating?, by pgl

Comments

[Peter Schaeffer]

“Think of the questions Chinese policymakers must ask themselves. What is the highest US priority – global financial stability or market access for well-connected US firms?”

I think this is a subtle hint that putting Goldman Sachs in charge of our China policy might not be best choice. Note that both Clinton and Bush made this mistake.

For a good article on the subject, see “Are US trade politics really driven by the profits US banks hope to earn in China?” over at http://www.rgemonitor.com/blog/setser/150535.

“Given that the Chinese authorities have presided over nearly double digit annual growth for a generation, do US officials who make assertions about what is in China’s interest have the experience and knowledge of China that should cause their views to be taken seriously?”

Obviously not, which is why our discussions with the Chinese should focus on our economic interests, not theirs.

“Why is China being singled out?”

Because China is our second largest trading “partner” and other Asian countries won’t allow their currencies to appreciate until the RMB peg is broken.

The word “partner” is in quotes because we don’t really “trade” with China. They sell us goods and we sell them debt. Check out the BEA stats. The import/export ratio is around 5:1.

[F. Frederson]

The fall of the dollar obviously needs to be "handled" in some way on the international stage, but beyond reforming the G7 he doesn't seem to be proposing much. And he totally glosses over the causes: reckless fiscal policy, irresponsible Fed policy, and overconsumption by the population at large. Perhaps it was a coded message for the Illuminati and I'm just not privy to it, but it seems like a waste of column-inches to me.

The truth - collectively America is going to have to tighten its belt substantially when it emerges from its long national nightmare in January of 2009 - might have been a useful thing to hear from someone of Summers' stature.

[donna]

Oh, sure it's all China's fault. Not that we're overspending or anything.

Idiot.

[James Killus]

Hmm, my immediate reaction to the question was "drop it like a hot potato and hedge some bets with Euros and such."

I assume that the current Wile E. Coyote markets are being propped up to give the "right people" time to unwind their dollar positions and prepare for the fall. Or is the right word "crash?"

[dissent]

First, any new approach must be premised on the desirability of a strong, integrated global economy that benefits the citizens of all countries, not on the idea that economists or politicians can calculate “fair” exchange rates.

The right and potentially effective case for adjustments in the current alignment of exchange rates relies on their unsustainability and the distortions they induce in macroeconomic policies, not on ideas of fairness to workers.

Whatever does this mean? What is the argument for which this is a counter-argument? He seems to be saying that a case for dollar deval, yuan reval must not include 'fairness to workers'. Whose workers? Ours? China's? Is this a reference to the millions of American manufacturing jobs lost? Or to the low Chinese wages & benefits? Or what?? This is mush.

And this:It should be analytically informed but everyone should know that key decisions will ultimately be taken by senior officials in the national interest, not by international organisations.

Is this a reference to the WTO? Is this proposing a change in the relation of 'national interest' to international trade agreements? Or what???

This is too obscure to be useful.

[Robert Edele]

One thing that worries me is the rising price of imports. As a nation we are very dependant on imports for many low elasticity products such as oil and low-end consumer products. As the dollar slumps, imports will not drop much but the cost will rise rapidly.

Even worse, these products are disproportionately consumed by lower income people, who have already been suffering from stagnant or even falling real wages.

[gordon]

Dissent is right about the article's obscurity. I might hazard a guess that Summers is suggesting something like the 1987 Louvre Accord (which tried to reverse the Plaza Accord) but with an expanded group of nations involved - notably the inclusion of China. Presumably the aim would be to unwind China's huge US Dollar holdings in an orderly way. There appear to be no indications of mechanism in the article. Looking at history for clues, we might notice that the US' part of the Louvre Accord was to reduce the Govt. deficit and reduce the growth of money supply. Japan's part was to try to stimulate domestic demand. Is this what Summers is fishing for, with China substituted for Japan?

[Lafayette]

Article: The right and potentially effective case for adjustments in the current alignment of exchange rates relies on their unsustainability and the distortions they induce in macroeconomic policies, not on ideas of fairness to workers.

This is academic drivel. An adjustment is something that you make to an automobile engine -- not global exchange rates.

Pray tell, just how does Summers think that adjustments are going to happen? We've been pushing the Chinese to "adjust" more rapidly and they continue on their merry way at a snails pace (about half a percent per year). They are not members of the G8 and therefore no direct pressure can be made to adjust unilaterally -- just jawboning, which doesn't seem to be working.

The dollar is at an all-time low against the major currencies, exports are booming and, as far as the US is concerned, that's just fine. (The only concern is imported oil, so smaller cars with longer mileage are on the planning boards.) But, that won't be enough to boost overall economic activity and redress the dollar.

Any revaluations (not adjustments) to exchange rates would require longer-term trends in not only trade patterns but financial flows. And, why should that happen, for as long as the US & Europe are both hooked on cheap Chinese goods?

If there are any adjustments to be made it is in the way we consume. Let's look at the Japanese example for clues. (The Chinese are virtually repeating in almost every way the Japanese recovery after WW2.)
* First find fiscal ways to privilege production onshore, meaning the quicker amortization of any high-productivity mechanism employed in manufacturing. (Coupled with a government sponsored prize for Best Innovation.)
* Higher taxation at both the middle and high-end, the revenues employed on infrastructure development ... meaning prompting families to make their major investments in improving their existence ecologically. Tax rebates (meaning exclusion from the tax increase) for those who use new alternative-energy sources.
* Tax rebates for investments in production that go to selected states who have a traditional history of supplying the US with either energy or manufacturing components. This means effectively Latin America. (It will have a twofold beneficial effect: (1) enhanced economic activity in Latin America will help slow immigration from there, and (2) these are bona fide clients for American produce.)
* Tax capital that is not returned to labor (but goes to investors) thereby enhancing general disposable income. Introduce tax rebates for companies that undertake to pay skills enhancement of their workforce through schooling.

These measures could (not surely) change our trade patterns and alleviate the dollar. They certainly would make America more productive if Americans saw tangibly that they were benefiting personally (in terms of income) by enhanced productivity.

Maybe we would even see Joe Blow from Kokomo on the front cover of BusinessWeek as business Hero of the Year? Instead of Bill Gates?

LS: It should be analytically informed but everyone should know that key decisions will ultimately be taken by senior officials in the national interest, not by international organisations.

OK, Larry, what key decisions are going to help make exchange rates more fair? (Whatever that means, since you failed to define it.) "Fairness to workers" is not something that Central Bankers have close to their hearts.

They are tasked to containing inflation. Basta.

What Larry is suggesting is to micromanage world commerce such that it is globally integrated in such a way as to be fair to all workers. If this were possible, whoever achieved that bit of magic should be given the Nobel Prize for Economics consecutively for the next ten years.

It aint gonna happin. So, let's bite off objectives that we can both chew and digest, as those suggested above. We need to get our own house in order before we tackle the world.

[foo]

"yolked their currency"??

Will they end up with egg on their faces?

[paine]

this is a most signifigant column

much to decypher here

scoffs like this one that larry s skips ovewr
the real falling dollar causes
ie

" reckless fiscal policy,
irresponsible Fed policy,
and
overconsumption by the population at large "

i think miss the point

larry is applying here for
forex realignment czar
in the st hillary admin

who's views is he looking to sponsor ???

why of course the dembo side of wall street

who's views is he trying to pre empt????

the insurgent populist groundlings
now riding in the second class cars
of the donkey express to total power

[lonesome moderate]

We've been pushing the Chinese to "adjust" more rapidly and they continue on their merry way at a snails pace (about half a percent per year).

Actually, it's been just under 5% a year against the dollar since they officially ended the peg in July 2005. Of course, the Yuan has actually lost value against the Euro and many other currencies since then.

Just today, the Chinese Central Bank "signalled" that they will let the Yuan appreciate somewhat faster in the coming year, although they apparently didn't say how much faster. According to Marketwatch the market is expecting a 7.3% appreciation over the coming year.

I'm not an economist, but to me a 7% a year sounds like an awful lot. Like it or not, we have a current relationship with China (and Japan) that is predicated on their sending us lots of stuff and us sending them pieces of paper that are supposed to serve as a "storehouse of value". Obviously we are going to have to end this, but it's going to have to be fairly slow if we don't want to wind up in recession.

[paine]

killius your a keen fellow

but this :

"... is the right word "crash?"
is not worthy of you even as a joke

the imperial dollar

CAN NOT CRASH

any one i submit who doesn't instantaeously understand this
needs to "get with the system"

decline yes but
as majestically as it can
drops will be jagged of course
but no crash

even if the big boys decide the pegs must go
they won't be popped
the rmb will spiral up
like the yen of yore
over many years a pair of decades even
up its going relentlessly
and in stages with pauses of course along the way
even a stray reversal or four perhaps
but
up up up

the rupee is where eyes need to focus next

like it has against the euro

[paine]

laff:
your scolding of summers
was fun to read...on several levels

[Lafayette]

LM: .... to me a 7% a year sounds like an awful lot.

When salary rates in manufacturing / engineering are at one tenth of what they are in the US or Europe, just what difference do you think a devaluation of 7 or 77 or 107% is going to make?

Méi shén (that's "nothing" in Chinese).

[paine]

lets say the rmb is undervalued by 100 percent
against the dollar

at 7 percent
real relative appreciation
(ie adjusting nominal appreciation by relative inflation rates )

it would take about ten years
to level
the forex imbalance

not really too long all things considered

[Lafayette]

paine: ... lets say the rmb is undervalued by 100 percent against the dollar

You say it, because it suits your calculation. I wouldn't.

In fact, it undervalued by far far more. Say thirty years of waiting?

That makes for a lot of patience ...