Some Senators Want to Conscript the Fed in a Currency War

As the world obsessed over Wednesday’s interest rate cut, a certain politician who lives in a large white house decided to interpret it through the lens of currency wars and made some tweets about how it didn’t go far enough to compete with other major exporters’ currencies. Naturally this attracted many headlines, which we mostly shrugged at, seeing as how managing the currency isn’t in the Fed’s mandate. But some plucky senators introduced a bipartisan bill on Wednesday that would seek to change just that by giving the Fed a third mandate: balancing the current account within five years. The logic: Too much foreign investment made the dollar too high, hurting exporters, so the Fed must tax said foreign investment to make it drop while adjusting interest rates as needed to further discourage capital. In our view, this ignores basic economics. Forcing the Fed to fight currency wars is a solution in search of a problem, making us thankful Congress is likely too gridlocked for this bill to go anywhere.

Economic data have repeatedly disproven the theory that weak currencies boost exports, making them magical economic mojo. If currency wars were actually worth fighting and winning—whatever that even means—then Japan would have had the world’s strongest economy from 2013 on thanks to the BoJ’s stalwart effort to weaken the yen. Instead, Japanese exporters chose to keep production and prices steady and live off the easy profits from currency conversion. Hence, the weak yen didn’t stimulate Japanese output much. It was an accounting gimmick. Meanwhile, it also made imports more expensive, which wasn’t so great for a nation that imports most of its energy (e.g., oil and natural gas).

Over on our shores, there is no visible relationship between the dollar’s value (versus a broad trade-weighted currency basket), imports and exports. Across the pond, UK exports didn’t skyrocket when the pound tanked after the Brexit vote three years ago. Even today, as the BoE warned a no-deal Brexit could send the pound to a 34-year low, no one cheered about a coming manufacturing renaissance. People intuitively know currency valuations are only a small input into decisions on where to locate factories. Labor costs, geography and local know-how generally matter a lot more, especially because they are more fixed than currencies, which are inherently volatile.

Beyond that, focusing on foreign investment completely misses the point. The reason America attracts a surplus of foreign investment is that our economy has evolved past mass production of natural resources and low-end goods. We focus mostly on services and high-end manufacturing, importing natural resources and low-end goods from countries that specialize in them. This is David Ricardo’s theory in real life—the way the capitalist world is supposed to work. Everyone has a specialty, and countries trade amongst each other to get the best of the best. With our higher-end economy comes higher-end, better-paying jobs and improved standards of living. (Not to mention the longer life expectancies associated with safer, office-based jobs.)

Anyway, economic evolution means we import a lot. We export a lot, too, but there are still a lot of barriers to service exports, so we have a trade deficit and, therefore, a current account deficit. Some use colorful euphemisms like “giant sucking sound” to describe this, as if we are trading all our jobs and money away. But that isn’t true, because the money we pay for those imports comes back as foreign investment. It is a simple accounting property. When your current account is negative, your capital account is positive. Sometimes that investment is in the form of offices, research centers and factories—that is the investment politicians like. Other times, it is in financial assets like stocks and bonds—that is the investment politicians think unnecessarily drives the dollar higher. But the alleged divide here is false. Investment is investment, and we would get it even if it were taxed, because we buy what other countries are selling.

We sort of wonder if politicians really would enjoy their policies being “successful.” Do they want imports of low-end goods and natural resources to crash? Do they want US companies to have a shortage of components? Do they want Target, Walmart and other import-peddling giants to go out of business? Do they want all the related retail job losses? Do they want shortages to drive prices higher? Do they want a bunch of robot-staffed factories in the middle of the country churning out widgets? Would any of this make voters happy?

Moreover, none of this would really affect the value of the dollar. It would still attract demand as the world’s most stable and liquid reserve asset. Money also has a way of flowing to the highest-yielding asset, and that asset has been the dollar for a few years now. To hold it down, you’d need capital controls, Treasury forex transactions and artificially low interest rates—and if that happens, we rather suspect markets would dislike it. They would see a formerly free capital market going back to the Dark Ages. Does anyone really think US monetary policy should match China’s?

Thankfully, gridlock probably renders this bill dead on arrival. If the Senate can’t even agree on who should be on the Fed’s board, we daresay they are highly unlikely to agree on massive changes to the Fed’s mandate. Previous bills to adjust the Fed’s mandate have gone nowhere in recent years, and Congress is just as gridlocked now as it was then. So we don’t expect this legislation to bother stocks much, if at all. But it is an object lesson—if an odd one—about the many blessings of gridlock.