Paul O'Neill, a Treasury secretary under George W Bush, ran into controversy on his first overseas trip when he had the temerity to question the often celebrated, and sometimes bemoaned, strong-dollar policy. O'Neill inherited the mantra from the Clinton years and regarded it as little more than rhetoric. That doctrine won accolades at home, but was considered unhelpful abroad, especially in Asia.
What the US really had, O'Neill argued, was a strong-economy policy. If growth was robust, relative to others, that would be reflected in the value of the greenback. If it waned, then the dollar would decline. People should just chill. That advice is as good today in Tokyo, Seoul, Jakarta and New Delhi as it was a few decades ago. Contemporary Treasury officials don't talk — and aren't pestered — as much about foreign-exchange policy as their predecessors. But the strong dollar sure exists in practice, and it reflects a surprisingly resilient American economy. Nations on the receiving end in 2024 have no great choices, but aren't totally powerless.
The rally this year wasn't supposed to happen. Many forecasters predicted a pullback, premised on indications from the Federal Reserve that inflation was retreating sufficiently, and the economy cooling enough, to warrant some reduction in interest rates. Now, Fed officials are having doubts. After some very encouraging declines in the pace of price increases, progress has been disappointing recently. The job market remains muscular, retail sales are doing well, and manufacturing is reviving. Chair Jerome Powell signaled Tuesday that borrowing costs will need to remain high for longer. This is a setback for the Fed, but a boon for the dollar.
The shift is reverberating through Asia. The Indian rupee fell to a record low Tuesday. Indonesia waded into the market to back the rupiah and South Korea issued a rare warning about pushing the won too low. Japan has been trying to cushion the yen's fall by foreshadowing steps; a weaker yen pushes up the cost of energy imports, Japan is a big consumer. Despite a historic rate increase last month by the Bank of Japan, which was supposed to turn around the currency, it slumped to a fresh 34-year low. Japan has refrained from its maximum, direct threats of intervention. The government may yet get there, but the prudence is wise. The last thing you want is to directly fight the dollar when it is on a rampage. Best to pick your moment.
When I was responsible for Bloomberg's currency news from 2003 to 2006, intervention from Japan was common. It had been standard practice for decades to massage fluctuations in the yen, mainly preventing it from strengthening too far. Regardless of specifics, I would often hear the cry of “intervention never works” because the underlying trajectory of a particular currency usually wasn't reset. But broad assessments of success or failure can brush over important nuance. Often the goal isn't to turn around the fortunes of a currency on a long-term basis. Officials may be aiming to manage a decline or appreciation, rather than prevent it. They may also be seeking to inject a bit of two-way drama, to make sure traders don't think the action is all one way. Such an approach can be useful in buying time.
And there are instances when state action has roughly marked a turning point. Support for the euro from Group of Seven nations, especially the US, helped the battered single currency find a bottom in late 2000. In mid-1998, when the yen tumbled amid mounting losses at Japanese banks, then US Treasury Secretary Robert Rubin joined Tokyo in buying. That assisted in turning the tide. America wanted something in return for its contribution, though. Then deputy secretary Larry Summers was dispatched to Japan to urge authorities to undertake reforms.
What we are seeing today doesn't amount to a crisis and circumstances are nowhere close to mirroring those of 1997-1999 in Asia. Exchange rates are far more flexible, which can amount to short-term discomfort but avoid long-term meltdown. And nobody wants to burn through reserves in an effort to defend artificially high valuations. That's likely to mean some war talk, a touch of intervention, and perhaps some regulatory steps to make short sellers think twice. It might even be necessary to hike interest rates, perhaps outside of scheduled policy meetings. That can really get attention. Indonesia, always sensitive about the rupiah, might resort to that remedy, though not so much that it smothers the economy.
Chatib Basri, a former Indonesian finance minister, described in an interview last year how tough it is to get the balance right when the dollar is formidable. “Every time the currency depreciates, we have this trauma because of the experience of 1998,” he told me. “You need to use monetary policy, but not as a single instrument. If you raise rates too high, you are going to crush the economy. You need some degree of capital mobility. Let the exchange rate move with the market, but introduce some intervention...some prudential steps and some capital flow management.”
Other than that, have some patience. The pain won't last forever. Ideal or not, this is the reality of a world where one currency is truly first among equals. China's efforts to spruce up the yuan to challenge the dollar haven't panned out. The euro's promise fizzled. One thing Rubin and O'Neill did agree on was that, ultimately, markets tend to reflect economic performance. The dollar is über dominant, regardless of Treasury’s perspective.
Such was the outcry within the US to O'Neill's candor that he recanted, somewhat. He declared, not without sarcasm, that if he abandoned the strong dollar stance then he would hire a brass band at Yankee Stadium to be sure everyone heard it right. As far as Asia is concerned, there is never a trumpet around when you need it.
Credit: Bloomberg
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