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A heretical view on the dollar Samuel Brittan The Financial Times 21/01/05 There is a conventional wisdom about the US dollar and world imbalances, which goes as follows. First, the dollar needs to fall further to reduce the US current account deficit from 5½-6 per cent of gross domestic product to at least 2½-3 per cent, and national authorities should intervene to make the fall orderly. Second, Asian countries, especially China, should stop stockpiling short-term dollar assets and revalue their currencies or float. Third, the US needs to raise domestic savings. This requires a drastic cut in the US budget deficit. Finally, as US fiscal retrenchment would have a contractionary effect on the world economy, the Federal Reserve needs to be cautious in its interest-raising policy. But above all, the eurozone countries and some of the Asian economies need to adopt more expansionary policies. Lip service is paid to increasing the flexibility of the eurozone labour markets. But in practice the pressure from the would-be international planners is nearly all on the demand side: in other words, for the European Central Bank to cut interest rates and for the stability and growth pact to be relaxed to permit larger government deficits. The whole package makes a kind of sense. The problem is that any one or two elements enacted on their own could be worse than muddling through. It would need a world political authority to enforce the whole package. But I doubt if even such an authority would have the knowledge to decide, for instance, how much currencies should move, or the degree of fiscal or monetary restriction required on one side of the Atlantic and expansion on the other. There is an illuminating account in the former UK finance minister Nigel Lawson's The View from No. 11 of the difficulties that arose in an earlier attempt to put a brake on the fall in the dollar in 1987. Despite accord in principle on necessary changes in international interest rate differentials, there was no agreement on "how any change in differentials should be shared between the countries whose interest rates needed to rise in relative terms and the country whose interest rate needed to fall". This helps to explain why the Plaza-Louvre experiment was so short-lived. The argument on currency intervention has also been complicated by a debate on its domestic monetary effects. If the ECB intervened on a large scale to cap the dollar it would need to issue euros, which could result in expansionary or inflationary pressure in the eurozone. A normal central bank might attempt to offset this effect by selling securities - "sterilisation" - although this might be difficult to reconcile with the ECB's mandate. The last attempt at international consensus on this was the Jurgensen Report for the Group of Seven in 1982, which suggested only unsterilised intervention would work. But surely, if the eurozone needs a stimulus, it would be simpler to implement it directly and allow the markets to determine the exchange rate consequences. The odds, however, are that the ECB would resist more than a token easing of policy; and European governments - fearful of their underlying structural budget deficits - would hesitate to increase them even further as part of a co-ordination exercise. I also find the argument about Asian revaluation to take the burden of adjustment away from Europe hard to follow. A currency cannot be revalued just by saying so. The government carrying it out would have to sell dollars to affect the supply and demand balance. But throwing dollar securities on to the international market risks a dollar rout. There are all sorts of reasons why a country like China might want to build up dollar reserves; and it is not for the rest of us to say "no". As the HSBC bank has just reminded us, a 10 per cent revaluation of the renminbi would only reduce the Fed's trade-weighted dollar exchange rate by 1 per cent, compared with the 20 per cent fall that has already taken place. Even if all other Asian currencies were to follow suit, the reduction would still only be 3.7 per cent, but with the risk of a speculative upheaval. We should confine our pressure on China to human rights issues. The bottom line is that a highly imperfect exercise in international macromanagement would increase the dangers of a slowdown or recession and stoke inflationary fears, which would inhibit curative policies. What then would I do? Stick to President George W. Bush's intention of gradually halving the US budget deficit, but no more than that. Meanwhile, the dollar should be left to its own devices unless there is such an overshoot in either direction that central banks are confident they can make a profit from intervention - an operation in which those responsible should be made to take a personal equity stake. But above all, stop the pressure to get east Asian countries to revalue.
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