An intervention in favor of intervention
BUT NOT A PREDICTION
An opinion piece in the Financial Times by Satyajit Das recently argued that exchange rates have become a much less fraught issue because of a variety of factors. He cites onshoring of foreign investment in the US that began in the 1980s, internal transfer pricing in USD within multinationals, the virtually universal pricing of commodities in dollars, increased local currency issuance by emerging markets, etc.
Within 24 hours, there were rumors that Bank of Japan intervention (or at least some aggressive phone calls to dealing desks) had been behind a sudden, and brief, appreciation of the yen just below the psychological 150 level in USDJPY. I would be remiss if I did not supply at least one dad joke here, albeit one I’ve already made before— “BoJ checking rates, Endakation only.” The Japanese government has for some time made it clear that it is unhappy with yen weakness, so some kind of shot across the bows might not be a huge surprise, but it might also not do that much by itself.
As longtime followers know (10 years on Twitter yesterday), I have long believed that a) multilateral FX intervention is a good thing and should be more frequent and b) it can be effective at least at arresting trends if not turning them. See here , e.g.
What follows is just an attempt at description, and perhaps prescription, but certainly not prediction. Still, I think that as a result of a few negative feedback loops in play across different markets, there may be a case for multilateral intervention right now. I don’t think it’s especially crucial from the point of view of the macroeconomy, but it probably wouldn’t hurt to get some potentially destabilizing dynamics out of the way early.
It might be useful to classify the circumstances have led to the handful of instances of multilateral intervention that we have seen since 1995 (when it became much rarer under the Rubin treasury). These instances come down to joint intervention to sell USDJPY in 1998, to buy EURUSD in 2000, and to buy USDJPY in 2011 (after Fukushima). I believe it is possible to classify the worries that led to such US behavior in three categories—a) Exchange rate developments threatening the ability to conduct cyclically appropriate monetary policy in one or more countries b) Market developments in one country spilling over into in other countries, with a consequent threat to broader global financial stability and c) Exchange rate developments threatening an exacerbation of trade conflict.
Now here’s what I see happening that may fit some of those criteria.
USDJPY near a psychologically important nominal level (150) with Japan’s REER at all time lows. Now since China clearly has its own host of cyclical difficulties, it’s not clear that USDJPY has been a major driver of USDCNY, which is itself at levels (7.30) where the authorities are mounting a defense. Nevertheless, a turn weaker in the USD against JPY would probably give CNY a welcome respite as well. And for all that the US-China relations are already on the rocks, they are unlikely to get better if there is a worry about a huge surge in Chinese exports to the US (and especially) to the EU, which doesn’t have tariffs in place. Of course, this worry about the transmission belt from JPY to CNY (then still pegged at 8.28 in 1998) was what led to the USDJPY intervention in 1998, just about one week after Rubin signaled o a hands-off policy on currencies.
What makes this time different (and more interesting and possibly dangerous) is less what’s happening in exchange rates and more what’s happening with global bond yields. There are 2 widespread (and interlinked) narratives in markets that could lead to damaging spillovers. The first is that the easiest way for Japan to strengthen the yen is for the BoJ to allow JGB yields to rise. But this then leads to the second narrative—rising JGB yields would raise yields around the world, with potentially problematic implications for debt dynamics and systemic stability, particularly in the Eurozone periphery.
Meanwhile, (as I have been wont to go on for at least 8 years) there has also been a big structural shift in the US balance of payments since the shale revolution. Shale has led the USD to act like a commodity currency, i.e., one that appreciates when the price of oil rises. This is in stark distinction to the behavior of the USD in the 2000s and in the 1970s (see related random move observation below) when high oil prices led to USD weakness. I believe that was because overseas holders of the USD looked at the combination of large petroleum deficits and a core-inflation targeting Fed and dumped the dollar because it was a poor store of value against an international USD-denominated currency basket that had a lot of energy in it.
But the flip side to this good news for the USD is weakness in JPY and EUR against a backdrop of persistent global supply shocks. This in turn increases pressures from imported inflation in those areas, leading both to real income shocks and to pressures for higher rates (at different places in the curve in Japan vs. in the Eurozone). This means that unusually, particularly when compared to what has been happening since the early 2000s, exchange rate weakness EVEN IN ADVANCED ECONOMIES might be leading to an effective tightening rather than a loosening of financial conditions. And this could be a problem for global growth.
Meanwhile, the structure of US inflation right now (higher in services than in goods markets) does not suggest to me that an effort to stop further USD appreciation would significantly undermine the Fed’s efforts against inflation.
And, of course, as a card-carrying globalist (or unhinged pro-globalization polemicist as it says in my Twitter bio), I’m always on board with any attempts at greater international cooperation and coordination. And as I’ve said before on numerous occasions (including in the pieces I linked to above), I’m much more enthusiastic about the globalization of goods and services than I have been about the globalization of portfolio flows, where some periodic multilateral leaning against the wind could be much more useful. Indeed, whenever I think about joint intervention in foreign exchange markets, I cannot help but channel Neil Simon and exclaim, Plaza??? Sweet!!!
I should note here that one of the reasons I think this could work this time around is that the traditional concern about reserve adequacy might not hold, particularly in the case of Japan. What matters is not BoJ reserves but the size of the immense Japanese private sector holdings outside that country. And those holders of overseas assets have been through several episodes of getting caught out by a sudden, unexpected strengthening of JPY (Endaka, hence the joke above) as in 1998 and 2008. And any hint that official preferences on both sides of the Pacific are against further Yen weakness could sway those investors.
Random movie observation
So I watched 3 Days of the Condor yesterday on Prime (again for the first time in more than 40 years). It really doesn’t stand up that well on a second viewing—the intrigue doesn’t work, the romantic relationship is pretty appalling, and as a record of the paranoia of the age, The Conversation is vastly superior. And The President’s Analyst (1967) is both hysterical and paranoid from a pre-Watergate era so it’s really wonderful. But there are good period shots of NYC in the 1970s, a plot point having to do with the US oil deficit, and most importantly, this is probably the first movie that led me to realize that there’s an actual job where you can do nothing but read books and newspapers about other countries. But I guess the robots will be doing that now.