Time for US to restore a strong dollar

A prominent People’s Bank of China official has made headlines by arguing Beijing should guide the yuan higher. His reasoning? To tame the effects of surging global commodity prices.

Lyu Jinzhong, the PBOC’s director of research and statistics, has the right idea – expressed in a China Finance article – as markets everywhere quake over intensifying inflation pressures. But though he has the right idea, he has the wrong country.

Much good globally might come from the US Treasury Department and the Federal Reserve re-establishing the strong dollar policy. It is one that served the globe well for 23 years until Donald Trump came along and acted more like a leader in Buenos Aries than Washington.

For a president of one of the most developed economies, Trump had a patently developing-nation view of exchange rates. On the campaign trail in 2016, candidate Trump rarely missed a chance to complain that an “undervalued” yuan is “killing” American living standards. He also complained about yen and euro rates he felt were too low.

In January 2018, one year into his regime, Trump’s Treasury chief, Steven Mnuchin, announced a formal end to the strong dollar imperative in place since 1995. Soon after, Trump hired Jerome Powell to helm the Fed and push US monetary policy into uncharted territory.

The dollar’s volatility since then has had three effects on global markets.

One, it raised the specter of the White House actively debasing the linchpin currency of the global financial system. Two, it made farcical the Treasury’s annual “currency manipulator” labels – it’s hard to slam Beijing, Hanoi or Seoul for doing exactly what Washington does. Three, it helped fan the flames of today’s inflation pressures.

China tolerating a stronger yuan

Periods of dollar softness — say, in the mid-to-late 1970s — tend to be associated with rising global inflation. And 2020 arguably followed this same weaker-dollar-higher-prices pattern.

In this context, Lyu’s heart is in the right place, at least economically speaking.

China’s producer price index surged 6.8% in April year-on-year, the fastest in three-and-a-half years. Consumer prices rose just 0.9%. As David P Goldman wrote in an Asia Times analysis, China is indeed tolerating a rising yuan to curb imported inflation. It’s also trimming debt and taking macro-prudential steps to tame prices.

But the real inflation problem in the second half of 2021 may be in President Joe Biden’s economy. The vaccination surge he’s engineered since January set the stage for a dramatic economic recovery. Not the 8% growth the International Monetary Fund (IMF) expects from China – but plenty strong enough to boost consumer prices.

A stronger dollar might help on two levels.

First, it would keep what is still the largest economy from overheating. The hotter the US gets, the more likely the Fed will either taper or even hike interest rates. That will have devastating implications for economies everywhere – Asia particularly, given the centrality of exports.

Second, it would increase American purchasing power. The more the two biggest economies share their growth around the globe, the more synchronized the post-Covid recovery will be.

Calming nerves

Restoring the strong dollar policy also would calm nerves about the health of US Treasury securities. The highest US inflation in April since 2009 shook global markets. For all the hysteria, though, US 10-year yields – now 1.6% – are markedly lower than in January, when they were pushing 3%.

Yet markets still fear a spike in US rates. Asian central banks are by far the biggest holders of US government debt. The top-10 holders are exposed to the tune of more than $3.5 trillion. Calming those collective nerves could give governments greater confidence to reform their economies.

So far, newish Treasury Secretary Janet Yellen has been non-committal, observes economist Megan Greene at the Harvard Kennedy School. Even so, Yellen has said the exchange rate should be “market-determined.” That, Greene says, “eases the risk the administration might work to weaken the dollar to help boost exports.”

Yellen was a Fed governor back in 1995, when then-Treasury secretary Robert Rubin established the rising-dollar framework. Two years later, she was named White House chief economist. That was the same era when strong demand from US consumers helped Asia recover from the region’s 1997-98 crisis.

At the time, the US played an “oasis of prosperity” role as global demand cratered.

That was then-Fed chairman Alan Greenspan’s 1998 description of America’s locomotive role amid the Asian crisis. That “oasis” propped up the globe at a moment when strong demand was most needed.

Hence, hopes America’s post-Covid recovery has global legs.

A bipolar recovery, please

“The US economy is poised for a breakout year, as massive fiscal stimulus, loose monetary policies and pent-up demand translate into rapid GDP growth,” says Cornell University’s Eswar Prasad, the author of Gaining Currency: The Rise of the Renminbi.

Prasad argues that “renewed consumer and business confidence has led to generally strong consumption and investment growth, and financial markets have continued to perform well.” What’s more, he says, “the US and China are shaping up to be the main drivers of global growth in 2021.”

In both economies, Prasad says, “household consumption and business investment have surged” and so have “measures of private-sector confidence.” More broadly, rising Chinese and US demand is helping industrial production rebound around the globe, as evidenced by rising commodity prices and increased trade.

“Nonetheless, the US, China, India, Indonesia and South Korea will probably be the only major economies to exceed pre-pandemic GDP levels by the end of this year,” Prasad says. “In most other regions, the 2020 recession will most likely leave longer-lasting scars on both GDP and employment.”

All the more reason to nurture rising demand in the two biggest economies. In fact, China’s economy alone is playing something approximating the economic “oasis” role today.

It expanded 2.3% last year, leading the pack among major economies out of the pandemic. It’s telegraphing 6% growth this year, though many economists expect over 8%. The US and China recovering in sync, just as parts of Europe are showing signs of economic life, could be just the thing.

Plaza Accord redux?

But some balance is needed on exchange rates – perhaps even something formal.

Guangdong University economist Will Hickey is hardly alone in making the case that “major economies should pursue currency agreements to stabilize the US dollar.”

This can work both ways, of course. At times, excessive dollar strength can enrage lawmakers in Washington and trigger Trumpian calls for protectionist measures. At others, an undervalued US currency can fuel just as much geopolitical angst as inflation.

The game is finding an acceptable exchange-rate range.

In 1985, the deal reached by France, Germany, Japan, the UK and the US at the Plaza Hotel in New York was to depreciate the dollar. At the time, multilateral action was required to realign exchange rates and global trade dynamics.

In the 2020-2021 Covid-19 era, Hickey argues, “a new Plaza Accord is necessary, even more so than in 1985, to soothe market volatility.”

Hickey highlights the ways in which the monetary landscape has changed since.

For one thing, global capital markets are considerably deeper than in 1985, but also infinitely more complex and electronically integrated. For another, unilateralism is now the dominant ethos – a breakdown that Trump actively accelerated. Finally, the China of today is more of a dollar-backed economy than President Xi Jinping’s team like to admit.

Put these changes together and a substantially weaker dollar exchange rate would be a non-starter for the Group of Seven nations, circa 2021. A higher one would offer much greater benefits.

In January, Jake Sullivan, Biden’s national security advisor, told the Wall Street Journal that the Plaza Accord is a worthy template for Beijing-Washington relations.

It’s time to turn talk into action. Only this time, to see that a stronger dollar could be just the thing to heal the wounds of recent years.