HomeBlogFinanceThe dollar that Washington doesn’t yet want to weaken

The dollar that Washington doesn’t yet want to weaken

Welcome to Trade Secrets. It’s one of those moments (that is, most of the time) when there’s not a lot of substantive trade policy as such going on but a lot that affects trade. Last week there was a big flurry of central bank decisions and fretting about exchange rates, which is the subject of the main piece today. Meanwhile, the trade ministers from the G20 met last week ahead of the big leaders’ summit in November, but the whole process still seems to be hobbled by geopolitical pose-striking. Charted waters looks at why in England it might not be so grim up north.

Plaza Accord, Schmaza Accord

Sharp increases in US interest rates and a soaring dollar are causing global alarm. As former Trade Secrets colleague Claire Jones writes, there’s an international backlash against the Federal Reserve.

Wait a second. Is it . . . could it be . . . are we heading for . . . do you want me to say the words . . . CURRENCY WAR? Well, you can see how the US authorities might come to share widespread worries over the dollar’s strength, but there doesn’t seem much sign of it yet.

The last big currency conflict was in the 2010s when US protests about an undervalued renminbi metastasised into a general moan that the US was itself deliberately weakening its exchange rate through quantitative easing. We’re currently seeing the inverse of that with tight US monetary policy and a strong dollar, a replay of the early 1980s that ended in the international Plaza Accord in 1985 to weaken the US currency.

Unlike the 2010s, inflation and hence importing price rises through depreciation is a big concern, with many countries feeling themselves forced to match the Fed’s increases. Even the Swiss National Bank, which has been intervening like crazy against the Swiss franc for years, building up epically huge reserves, is worried about having a weak currency. It’s like a firefighter turning to arson.

As Mohamed El-Erian, legendary markets guru and now president of Queens’ College, Cambridge, points out, the direction of the dollar’s travel makes total sense: it reflects higher US rates and growth. “The problem is the magnitude of the change. The most vulnerable economies in the developing world are having to run very tight monetary policy at a time when they are dealing with other things including the slowing global economy and energy security.” A string of debt defaults from lower-income countries that have borrowed in dollars is already under way.

In some cases other countries have made things worse. Turkey, apparently running monetary policy on a dare, is cutting interest rates during an inflationary shock with predictable effects on the Turkish lira. Japan intervened to support the yen last week, its first buying operation since 1998. But the intervention is leaning against its domestic monetary policy where Japan is holding down the yield curve, continuing to stimulate like it’s 2012. In the UK, the announcement of a big fiscal loosening last week pushed up interest rate expectations but hit sterling hard, the markets apparently concluding that the abysmal quality of UK policymaking more than offset higher yields.

But even concerns among less dysfunctional countries haven’t created a general realignment movement. Why? For one, the usual currency pugilists, China and the US itself, aren’t currently that bothered. China, its economy clobbered by the zero-Covid policy and falling global growth, will be helped by a weaker currency and has quietly let the renminbi slide, seeking only to control its descent.

The US, meanwhile, needs some anti-inflationary pressure and a strong dollar provides it. Plaza happened when internationally exposed American manufacturers and farmers complained loudly enough about competitiveness. We haven’t yet got near that stage.

Although President Joe Biden is obsessed with manufacturing, he has focused on domestic industrial policy based on public spending aimed largely at serving the American market. The use of domestic procurement provisions, such as the contentious tax breaks for electric vehicles, protect US manufacturers from international competition through subsidies rather than currency depreciation. Obviously this doesn’t help US exporters in third markets, but for the moment this doesn’t seem to be a big concern.

Biden has also kept most of Donald Trump’s tariffs against China in place. To the extent that trade protectionism and weakening the currency are substitutes for each other, so far he’s gone for the former.

How and when does the US become concerned and some Plaza-type action start to be a real possibility? If US unemployment rises sharply and American industry and labour unions focus again on currencies, the underlying calculus will start to shift. El-Erian reckons the most likely immediate triggers will be a political issue or a “financial accident” — some kind of markets crisis.

But it’s likely to take a while. The Fed isn’t indifferent to suffering elsewhere, but it’s not its job to set monetary policy for foreign countries. Not until the US domestic pressures start to move will Washington become ready to act. This episode of dollar neglect most likely has a while to run yet.

As well as this newsletter, I write a Trade Secrets column for FT.com every Wednesday. Click here to read the latest, and visit ft.com/trade-secrets to see all my columns and previous newsletters too.

Charted waters

With the pound tanking against the dollar, interest rates escalating, high inflation and concern about recession, is there good news for the UK economy? Well, there is if you are in the north of England.

This region is the only part of the UK that has attracted increased amounts of foreign direct investment, rising by almost three-quarters, according to data from fDi Markets, part of the Financial Times group, the Office for National Statistics and the Department for International Trade, my colleague Jennifer Williams reports.

The figures were praised by the Northern Powerhouse Partnership, a lobby group created in the middle of the past decade to lift the north’s economic significance, whose economists include former Treasury minister Lord Jim O’Neill. But it also fell to O’Neill to give a reality check to the figures.

The FDI rise represented the only “notable success” to have emerged from the Northern Powerhouse push to boost the region’s economy, he noted. (Jonathan Moules)

The stalling of the EU-Mercosur trade deal has weakened Europe’s influence in Latin America.

Inside Vietnam’s attempts to climb the international value chain.

IMF bailouts have hit a record high as rate rises push lower-income countries’ borrowing costs.

The Trade Talks podcast looks at the Biden administration’s new approach to Indo-Pacific trade.

Trade Secrets is edited by Jonathan Moules

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