Global Currency Wars – In The Trenches

Donald Trump spent a good bit of time tweeting about monetary policy and currencies this week ahead of the September Fed meeting and in response to the ECB’s renewed stimulus push.

Among other things, Trump called the Fed “boneheads”, demanded negative rates and accused the ECB of “trying, and succeeding, in depreciating the Euro against the VERY strong Dollar, hurting US exports”.

The president’s musings on FX and rates are now a daily occurrence, which leaves market participants in a state of constant suspense with regard to prospect of outright, active FX intervention by Steve Mnuchin, something which almost surely would not work.

Read more: Here Are At Least A Half-Dozen Ways A Currency War Could Go Wrong For The US

One of the most important things to understand about this debate vis-à-vis China is that the administration never tells the public the whole story, where that means explaining how hard Beijing tries to alleviate depreciation pressure during periods when it becomes particularly acute. August of 2018 and this August are both textbook examples.

We spent a ton of time documenting the PBoC’s efforts in that regard last month. Day after day, the central bank leaned into the counter-cyclical factor to set the daily reference rate stronger than expected in a bid to maintain stability after sending a message to Trump on August 6 by letting the currency breach the psychologically important 7 handle.

Read more: China’s Black Swan Yuan Fixes Are The Market’s New Plunge Protection

“Had it not been for the PBoC’s de facto intervention in curtailing [the] daily reference rate, CNY would have surpassed 7.30”, UBS wrote late last month, adding that Beijing was setting the fix stronger versus consensus estimates by an average of 195 pips.

(UBS)

All of the above serves as the backdrop for the latest edition of Goldman’s “Top Of Mind” series, which finds the bank expounding at length on the “currency wars”, and the prospect of US intervention to bring down the dollar.

“Exchange rates do matter for trade, and the US’ non-oil trade balance has deteriorated sharply since the Dollar began to climb in 2014, so it’s no surprise that Trump’s laser focus on the US trade deficit would end up targeting Dollar strength–and that currency would become another front in the US-China trade war”, the bank’s Allison Nathan writes, adding that “whether the US should, could, and would begin to proactively manage the Dollar, and whether these actions could lead to a global ‘currency war’ is Top of Mind”. Here’s a handy infographic documenting recent rhetoric from Trump and Mnuchin:

(Goldman)

As a reminder, the bank’s “Top Of Mind” notes are expansive takes on whatever the market topic du jour happens to be. They combine interviews with Goldman’s own employees and also with outside sources in an effort to provide a balanced and comprehensive assessment on whatever seems to be the most important question on market participants’ minds (hence “Top of Mind”). The above-mentioned Nathan conducts the interviews and collates the charts and analysis.

Below, find selected excerpts from the bank’s interview with Brad Setser, a Senior Fellow at the Council on Foreign Relations, who served as the Deputy Assistant Secretary for International Economic Analysis at the US Treasury, and Director for International Economics on the NEC and NSC. (Note: The interview is much, much longer than suggested by the excerpts – this is heavily abridged.)

Via Goldman (abridged)

Allison Nathan: Does China manipulate its currency today?

Brad Setser: No. I define manipulation as sustained purchases of FX to hold a currency down and maintain a large trade surplus. In my judgment, China no longer meets this definition. But it does manage its currency in several ways to keep the Yuan within a range that Chinese authorities are comfortable with.

Allison Nathan: Does the US decision to designate China a currency manipulator have any teeth?

Brad Setser: Designating China as a currency manipulator under the 1988 trade law literally has no teeth. The sanction is a negotiation, and the US and China are obviously already engaged in negotiations.

Allison Nathan: Is it in the US’ economic interest for China to stop managing its exchange rate?

Brad Setser: Currency is an important issue; the level of the Yuan against the Dollar matters for bilateral and global trade. I believe there is real reason to be concerned about the impact of sustained Dollar strength on the US manufacturing sector.

But the irony for the US is that right now–when the US has introduced significant tariffs on Chinese imports and the Chinese economy is relatively weak–the US actually needs China to continue managing its currency. That’s because–in contrast to the 2003-13 period when China was holding the Yuan down–China has, broadly speaking, been managing its currency to keep it stronger than otherwise would be the case, which is actually helping the US. Without China’s currency management we would have a weaker Yuan and, all else equal, a bigger US trade deficit. And the more tariffs the US puts on China, the more this will likely be the case.

Allison Nathan: How likely is it that the US intervenes in the FX market to counter Dollar strength?

Brad Setser: I currently don’t see US FX intervention as likely. It’s quite clear that the Trump Administration is willing to consider a broad range of policy tools to bring down the trade deficit, and intervention is one of them.

The challenge goes beyond a policy shift; institutionally, the US is not set up to intervene effectively in FX markets. The Treasury’s modest pool of foreign exchange reserves is too small to fund the substantial amount of intervention that would be required to meaningfully move the Dollar. The Fed could provide another source of firepower, but the Fed’s mandate is to target domestic conditions–not the exchange rate.

Allison Nathan: Could all of this lead to a currency war, assuming we’re not already in one?

Brad Setser: One definition of a “currency war” is a situation in which countries with relatively high interest rates are punished with strong currencies, which ultimately compels them to ease; in the end, everybody ends up easing and relative currency values don’t change much. Even though we’re seeing very low interest rates globally today, I don’t think that’s indicative of a currency war, but rather a reflection of weak growth and lots of global funds looking for yield. I think escalation into a more distinct and troubling kind of “currency war,” would require FX becoming a major part of the ongoing trade war.