The Fed and Exchange Rates

When you have a hammer, so the saying goes, everything looks like a nail. The Federal Reserve, under Jerome Powell, has been acting like it has only one tool in its toolbox, the hammer of monetary policy. This particular hammer can pound down and pry up interest rates. Powell has been moderately successful with this hammer. Last year he overreacted to a warming economy, sharply constraining monetary growth to a level far below what would be appropriate for his inflation targets. This year he has swung the other way, rapidly increasing the money supply to compensate for the problems caused by his initial overreaction. His target has been a 2% inflation rate, and his hammer is the right tool for that nail.

But interest rates don’t only affect inflation, they also affect exchange rates. The interest rate that Powell is setting is pushing the dollar upward in foreign exchange markets, and the high exchange rate is counteracting President Trump’s efforts to balance U.S. trade. Powell doesn’t seem to realize that the Fed also has a screwdriver that he can use to target the exchange rate.

Fed Chairman Alan Greenspan faced a similarly high dollar in 1997. But instead of giving the “Asian Tigers” loans by buying some of their assets, he let their currencies collapse. He then stimulated the U.S. economy so that increased U.S. imports from the world would stimulate the world economy. As a result of this policy and other similar policies, the U.S. lost millions of manufacturing jobs.

Especially galling was Greenspan’s failure to help South Korea. Due to the falling won, many South Korean businesses that had borrowed money in dollar-denominated loans couldn’t make their loan payments, so they and the banks that had loaned them the money were facing bankruptcy. In his memoirs, Greenspan noted that the Federal Reserve had been in touch with the South Korean central bank, but had not offered it a single loan. He wrote:

So when Charlie Siegman, one of our top international economists, phoned a Korean central banker on Thanksgiving weekend and asked, “Why don’t you release more of your reserves?” the banker answered, “We don’t have any.” What they’d published as reserves had already been spoken for. (p. 189)

Fed Chairman Ben Bernanke faced a similarly high dollar in late 2008. The dollar was spiking upwards in foreign exchange markets due to the international liquidity crunch following the Lehman Brothers collapse. Instead of making Greenspan’s mistake, Bernanke loaned money to friendly central banks by buying their currency (currency swaps). It worked!

However, Bernanke appeared to forget his screwdriver in early 2011 (Quantitative Easing 2) when he used his hammer to target the dollar’s exchange rate because “Currency undervaluation by [trade] surplus countries is inhibiting needed international adjustment and creating spillover effects that would not exist if exchange rates better reflected market fundamentals.” But his attempt to target exchange rates had to be abandoned when it drove inflation up from 1.63% for the 12 months ending in January to 3.87% for the 12 months ending in September.

In short, the U.S. is approaching a situation similar to 1997 and 2008. Once again the dollar is rising in foreign exchange markets as the international economic picture deteriorates. Once again the Fed needs to act. Powell needs to learn from Greenspan’s 1997 mistake and Bernanke’s 2008 success. He should lend dollars abroad by buying foreign assets. Such loans would drive down the dollar’s exchange rate, stabilize foreign currencies, help foreign businesses pay interest on dollar denominated loans, and also help foreigners purchase U.S. exports.

And there is another reason why the Fed should act now. Buying low and selling high is the ideal strategy for making money in any market. Powell should establish a U.S. sovereign wealth fund which would purchase foreign stocks when foreign currencies are low and the dollar is strong. After those currencies rise back to normal levels, those investments will pay a higher return in terms of dollars. Other countries already have sovereign wealth funds which they use to buy U.S. stocks, and foreign central banks have already bought trillions of dollars worth of U.S. assets. Turnabout is fair play!

The Fed has multiple tools available. Powell should continue to use the hammer of monetary policy to target inflation, but he should use the screwdriver of foreign asset purchases to target the dollar’s exchange rate. By doing both, he could stabilize the world economy while sustaining the longest expansion in U.S. economic history.

The Richmans co-authored the 2014 book Balanced Trade published by Lexington Books, and the 2008 book Trading Away Our Future published by Ideal Taxes Association.

When you have a hammer, so the saying goes, everything looks like a nail. The Federal Reserve, under Jerome Powell, has been acting like it has only one tool in its toolbox, the hammer of monetary policy. This particular hammer can pound down and pry up interest rates. Powell has been moderately successful with this hammer. Last year he overreacted to a warming economy, sharply constraining monetary growth to a level far below what would be appropriate for his inflation targets. This year he has swung the other way, rapidly increasing the money supply to compensate for the problems caused by his initial overreaction. His target has been a 2% inflation rate, and his hammer is the right tool for that nail.

But interest rates don’t only affect inflation, they also affect exchange rates. The interest rate that Powell is setting is pushing the dollar upward in foreign exchange markets, and the high exchange rate is counteracting President Trump’s efforts to balance U.S. trade. Powell doesn’t seem to realize that the Fed also has a screwdriver that he can use to target the exchange rate.

Fed Chairman Alan Greenspan faced a similarly high dollar in 1997. But instead of giving the “Asian Tigers” loans by buying some of their assets, he let their currencies collapse. He then stimulated the U.S. economy so that increased U.S. imports from the world would stimulate the world economy. As a result of this policy and other similar policies, the U.S. lost millions of manufacturing jobs.

Especially galling was Greenspan’s failure to help South Korea. Due to the falling won, many South Korean businesses that had borrowed money in dollar-denominated loans couldn’t make their loan payments, so they and the banks that had loaned them the money were facing bankruptcy. In his memoirs, Greenspan noted that the Federal Reserve had been in touch with the South Korean central bank, but had not offered it a single loan. He wrote:

So when Charlie Siegman, one of our top international economists, phoned a Korean central banker on Thanksgiving weekend and asked, “Why don’t you release more of your reserves?” the banker answered, “We don’t have any.” What they’d published as reserves had already been spoken for. (p. 189)

Fed Chairman Ben Bernanke faced a similarly high dollar in late 2008. The dollar was spiking upwards in foreign exchange markets due to the international liquidity crunch following the Lehman Brothers collapse. Instead of making Greenspan’s mistake, Bernanke loaned money to friendly central banks by buying their currency (currency swaps). It worked!

However, Bernanke appeared to forget his screwdriver in early 2011 (Quantitative Easing 2) when he used his hammer to target the dollar’s exchange rate because “Currency undervaluation by [trade] surplus countries is inhibiting needed international adjustment and creating spillover effects that would not exist if exchange rates better reflected market fundamentals.” But his attempt to target exchange rates had to be abandoned when it drove inflation up from 1.63% for the 12 months ending in January to 3.87% for the 12 months ending in September.

In short, the U.S. is approaching a situation similar to 1997 and 2008. Once again the dollar is rising in foreign exchange markets as the international economic picture deteriorates. Once again the Fed needs to act. Powell needs to learn from Greenspan’s 1997 mistake and Bernanke’s 2008 success. He should lend dollars abroad by buying foreign assets. Such loans would drive down the dollar’s exchange rate, stabilize foreign currencies, help foreign businesses pay interest on dollar denominated loans, and also help foreigners purchase U.S. exports.

And there is another reason why the Fed should act now. Buying low and selling high is the ideal strategy for making money in any market. Powell should establish a U.S. sovereign wealth fund which would purchase foreign stocks when foreign currencies are low and the dollar is strong. After those currencies rise back to normal levels, those investments will pay a higher return in terms of dollars. Other countries already have sovereign wealth funds which they use to buy U.S. stocks, and foreign central banks have already bought trillions of dollars worth of U.S. assets. Turnabout is fair play!

The Fed has multiple tools available. Powell should continue to use the hammer of monetary policy to target inflation, but he should use the screwdriver of foreign asset purchases to target the dollar’s exchange rate. By doing both, he could stabilize the world economy while sustaining the longest expansion in U.S. economic history.

The Richmans co-authored the 2014 book Balanced Trade published by Lexington Books, and the 2008 book Trading Away Our Future published by Ideal Taxes Association.