Time for a Bit of Currency Manipulation?

The Day of the Triffin

On August 9 1971 the French government sent a warship to New York City with the instructions to repatriate its gold deposits from the New York Federal Reserve. Other countries also demanded the redemption of their dollars for gold. There were fears that the US might not actually have enough gold to meet its international commitment to redeem dollars. One week later President Nixon announced that dollars could no longer be converted to gold or other assets and a ten per cent tariff was levied on imports in order to protect US firms. This effectively brought the Gold Standard to an end and swept away the Bretton Woods system, ushering in the system we (kind of) have today.

Donald Trump is often compared to Richard Nixon due to their characters (which I think is unfair on Nixon), but there is a clear parallel between their actions on the economy and their motivations behind it. This is because rather than a tariff war, what is going on in the world right now is actually a currency war.

The Bretton Woods System and the role of the Dollar as the world’s reserve currency was seen by the French as an ‘exorbitant privilege’ for the US. However, Nixon was frustrated that it was only the US which had to maintain the Gold Standard. We see the same thing with Trump today. While the Gold Standard has gone and we now live in a world of floating exchange rates, the US Dollar is still the world’s reserve currency and so demand for dollars increases its value.

This is a problem for Trump as he sees it as making US exports less competitive and has frequently accused China of manipulating the Yuan in order to boost its own exports at the expense of the US. He has also expressed his frustration with other East Asian nations for also keeping the value of their currencies artificially low.

If (and it’s a big if) there is any method in Trump’s actions over the past few weeks it is that he wants to weaken the US Dollar. Although he really loves tariffs, the incredibly high ones on countries other than China might turn out to just be a bit of a sideshow. I think it is likely that we will see Trump use the tariffs as a bargaining chip with the rest of the world to not necessarily remove their own trade barriers but rather to strengthen their own currencies in order to boost US exports.

Trump has already said that he wants to reshape the global trading system so that it works for the US. As an aside, this is ridiculous given that the US pretty much just does what it wants when it comes to trade. As such, I can see ushering in a new world order where other countries are forced to keep the value of their currencies artificially high.

At the same time Trump wants to keep the Dollar as the world’s reserve currency and so we find ourselves facing the Triffin Paradox. Given that countries need large Dollar reserves in order to conduct international trade then demand is always going to be high and so will its value. As such, the country will inevitably run a trade deficit. Keynes foresaw this at Bretton Woods and proposed a global currency for trade called the Bancor which he felt would help to deal with this but his idea was shot down by the Americans.

So, what should be done?

Countries obviously shouldn’t bow down to threats from larger ones. Thankfully most countries have not retaliated by raising their own tariffs. This is the right response. Let US firms and households feel the pain without subjecting your own economies to it. However, the rest of the world can’t just simply get pushed around and so they should assure Trump that while they won’t be increasing their own tariffs, they will instead do what he fears by lowering the value of their own currencies and strengthening the Dollar. While I don’t think they should actually engage in currency manipulation in practice (although China is probably doing it), it might be seen as a credible threat.

What of the status of the US Dollar as the world’s reserve currency? There really is no viable alternative. The fantasists in the BRICS countries might dream of developing a new currency in order to topple the Dollar’s hegemony, but they really don’t have the clout. As for the Yuan, China would be very reluctant because it wants to keep a tight control on it. As for Keynes’ Bancor, it is a nice idea but even he admitted that it was complex and utopian. There are obviously Special Drawing Rights at the IMF which function like the Bancor, but the level of bureaucracy that the Bancor would involve and the impact on national sovereignty mean that Keynes was right about it being utopian.

Instead, the world needs to start taking currency manipulation and unfair trade practices seriously. In many ways Trump is right to point out the abuses by China and part of his ‘plan’ seems to be to unite the rest of the world against China.

The UK, the EU, and East Asian countries need to work with Trump to reinvigorate the WTO which has been largely useless. It needs real power where unfair trade practices are dealt with severely including countries being suspended or expelled. There should be a new round at the WTO where countries promise to significantly reduce their tariff and non-tariff barriers. Ideally there would be zero tariffs across the board but any move towards liberalisation should be welcomed.

We also need a similar body to actually enforce rules against currency manipulation - call it something like the World Currency Organisation where nations can sue each other and the rules are rigorously enforced. None of this will work without US buy-in and so is unlikely to happen and, while perhaps not as utopian as Keynes, it is very optimistic. However, it is surely preferable to the mess we’re currently living through.

Thanks as ever for reading. I’m planning on writing every week again (thankfully there is a lot to write about). Enjoy the sunshine!