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Exchange Rates and Politics

I like to keep things basic.  Also, I prefer focusing on the plausible and ignoring the merely possible.

Almost anything is possible; clever theoreticians and interest-groups with something to gain are forever pointing out possibilities.  For example, it is possible that foreign-government manipulation of exchange rates will generate net harm to the American economy, and that intervention by Uncle Sam will make things better.  Possible, but implausible.

First, currency values and exchange rates are determined by a variety of complex facts and expectations.  It’s implausible to suppose that the Bank of Japan, the Fed, or any other central bank has the ability to control with precision the value of any currency – and even more implausible to suppose that it can do so without creating problems for itself on other fronts.  As is well known, a central bank in a country free of special controls to keep trade “in balance” cannot manipulate its currency’s exchange rate without sacrificing its (the central-bank’s) ability to conduct independent monetary policy.

Second, it’s implausible to suppose that the only reason for buying dollars is that foreign central banks want to artificially raise the dollar’s value to promote exports.  Banks plausibly want to hold dollars because the dollar remains a strong reserve currency.  It’s safe and liquid.

This implausibility is deepened by the recognition that devaluation of the home currency is an unnecessarily indirect means of promoting exports.  A foreign government intent on promoting exports could subsidize exports directly, or slash taxes on their production, rather than hold its monetary policy hostage to the pursuit of export promotion.

But let’s suppose, for the sake of argument, that a foreign central bank is indeed intent on promoting exports by artificially propping up the value of the dollar against its home currency — that is, by using its citizens’ resources to enhance artificially the purchasing power of Americans.  How does it do so?  Obviously, it buys up dollars.

But accumulating dollars is costly.  The bank must get the resources to buy these dollars from somewhere.  It can create more of its own home currency to use to buy dollars.  Or it can get these resources by raising taxes.  Either way – through inflation or a heavier tax burden – the efficiency of that economy suffers.  Some firms and industries that would otherwise have become vibrant – perhaps even vibrant exporters – now never grow or thrive.

Milton Friedman emphasized that there is no such thing as a free lunch.  Well, nor is there such thing as a free subsidy.

Most implausible of all, of course, is the notion that politicians and bureaucrats can be trusted to read and act upon international economic data objectively and non-politically.

Who really believes that government officials, given the power to restrict trade if they determine that currency values are “inappropriate,” will exercise this power wisely?  Who really believes that the determination, in practice, of whether or not a particular exchange rate is appropriate will not be overwhelmingly influenced by interest-group pressures?  Who really believes that something other and nobler than rank protectionism is behind this agitation for “protecting” Americans from “undervalued” foreign currencies?

I certainly believe no such thing.

The safest course for America (as for any other country) is for its government to eliminate its own trade barriers regardless of what other governments are doing.  If – if – other governments are indeed taxing their citizens in order to benefit powerful exporting interests in their countries, that’s a problem overwhelmingly for the citizens of those countries.  If those citizens cannot solve those problems, Uncle Sam is not to be trusted to do so.  Indeed, Uncle Sam can be trusted only to use real or perceived mercantilist policies pursued by other governments as an excuse to pursue its own mercantilist policies — as an excuse to plunder the many for the benefit of the politically connected few.


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