Is the dollar too strong? A recent Treasury report shows that it is. That’s bad for U.S. industry, U.S. workers, and U.S. farmers. It’s good for Chinese and German exporters, which are more competitive against U.S. goods than they should be. But this Treasury report, like previous reports, offers a lot of words and colorful graphs but recommends no action whatsoever.
“Since May 2021, the dollar strengthened against most major trading partners’ currencies, reflecting strong U.S. growth and rising interest rate differentials, as well as safe haven flows. The real broad dollar is 21.1% above its 20-year average as of end September 2022. In its most recent assessment, the IMF continued to judge the dollar to be overvalued on a real effective exchange rate basis,” stated the Treasury’s November 2022 report to Congress titled “Macroeconomic and Foreign Exchange Policies of Major Trading Partners of the United States.”
The real effective exchange rate is a weighted average of foreign exchange rates to the dollar, expressed in price-adjusted terms. Unlike the nominal exchange rate, it is designed to consider the effects of inflation on a country’s currency.
The dollar is America’s and the world’s most important price. The world uses it to sell Brazilian soybeans to China, or as an investment vehicle for European life insurance plans and Japanese global bond funds. Central banks in emerging markets buy dollars to shore up their own currency and keep foreign buyers of their sovereign debt confident that they can pay their bills. The demand for the dollar – both as a means to conduct global trade and as an investment – keeps it strong.
Because of those reasons above, the U.S. is always likely to have a strong currency. But after soaring by 10% in the year to September, the dollar is hugely overvalued.
An overvalued dollar makes it much more attractive for American capital to seek out returns abroad. An overvalued dollar means it is cheaper for countries in Latin America to import Chinese cars, then American-made ones. This discrepancy between the dollar and major world currencies has led to a trillion-dollar goods trade deficit and puts American producers at a disadvantage compared to everyone else. American products cost more on world markets. Foreign rivals can keep it that way by pumping money into American stocks and bonds. Whether this is intentional or not, Treasury does not know or does not say.
The twice-yearly Treasury report was initiated by Congress to monitor nations that intentionally manipulate their currency to the detriment of the US economy. While this report clearly states the US dollar is getting more overvalued and several small countries are holding their currencies down to deliberately benefit their trade balance, it advocates no action. CPA Chief Economist Jeff Ferry says the Treasury has once again missed an opportunity for action to boost the U.S. economy:
“The new report points out that global current account imbalances rose in 2022 to 2.1% of global GDP, around $2 trillion of imbalances, and the US current account deficit reached 4.1% of US GDP. This hollows out the US goods sector and causes global instability on a large scale. The report also points out that the Chinese renminbi declined by some 11% over the past year, and the Chinese government continues to refuse to provide information on how it manages its currency. The solution is for the US to take action to manage the dollar to a competitive level via the Market Access Charge, a policy tool that would make the US economy more competitive and ease the deflationary pressures of the strong dollar on many struggling poor economies.” — Jeff Ferry, Chief Economist for the Coalition for a Prosperous America
Inside the Treasury Report
Treasury’s annual report to Congress focuses on 20 countries and provides an assessment of how the dollar has performed against their currencies.
The dollar has strengthened considerably in the last year and the U.S. current account deficit has widened. These movements appear to be driven by stronger economic conditions and higher interest rates in the U.S. High interest rates mean that Treasury bonds pay more in interest to bond investors, attracting foreign investors from around the world, especially from the developed economies where interest payments are much less.
Treasury said that this year’s currency intervention by America’s leading trading partners “was in fact aimed to strengthen, not weaken, their currencies.”
How have they fared in their tasks?
The trade-weighted dollar appreciated over 10% through end-September, surpassing its highest level in two decades. The Japanese yen depreciated roughly 25% against the dollar over this period, largely due to the Bank of Japan’s low-interest rates. The euro gradually depreciated since March as the Ukraine war has raised concerns about economic activity. The euro was down 20% against the dollar by the end of September when the report was being written. The Great Britain pound saw an even stronger depreciation over this period following the British government’s announcement of tax cuts (since rescinded). Dollar appreciation has been largest against the advanced economies, but appreciation is broad-based. The Chinese renminbi depreciated almost 11% against the dollar this year as of September 30. Between mid-February 2020 and the end of September 2022, the dollar has gained at least 11% against advanced economy currencies and 8% against emerging market currencies. In some cases, the stronger dollar either erases or nearly cuts in half the Section 301 trade tariffs on China.
The economies covered in the Treasury report account for almost 80% of U.S. trade in goods and services.
In one of the required sections of the report, Treasury looks at the net purchases of foreign currency, conducted repeatedly, in at least 8 out of 12 months, and total at least 2% of an economy’s GDP. If a country meets that criteria, Treasury is tasked with alerting Congress that these partners have conducted a “persistent, one-sided intervention” on their currency which weakens it against the dollar. In this case, Switzerland and Singapore were singled out.
But, in total, seven economies—Singapore, China, Japan, Korea, Germany, Malaysia, and Taiwan—are part of Treasury’s Monitoring List. India, Mexico, Thailand, and Vietnam have been removed from the Monitoring List as of November.
Other than currency intervention, the two other criteria include “material current account surplus” and “significant bilateral trade surplus” with the U.S. Those trade partners also get called out.
Worth noting, Germany has met two of the three criteria in every Report since the April 2016 report, having a material current account surplus and a significant bilateral trade surplus with the United States. Germany is making the most noise in Europe at the moment regarding the electric vehicle tax credits in the Inflation Reduction Act, signed into law this year.
China and Switzerland have met all three criteria in this report – from the surplus side of things, to currency interventions.
Treasury did not say that any one country was a “currency manipulator”, however. This includes China. Treasury gave kudos to the People’s Bank of China for trying to control the descent of the renminbi against the dollar this year but said much of what they do at the PBoC remains a mystery.
Ironically, Treasury noted the bind a strong Swiss franc has on the economy there.
“The Swiss franc has also long been a safe haven currency that investors acquire during periods when global risk appetite recedes, or financial volatility accelerates, which can pose challenges for Swiss macroeconomic policymakers” the report stated. “In times of heightened regional and global risk, large safe haven inflows can put considerable appreciation pressure on the franc, and sustained appreciation can weigh on domestic inflation.”
Until September 2022, the Switzerland National Bank (SNB) maintained negative interest rates to limit franc appreciation and combat deflationary risks. Despite no yield whatsoever from holding a Swiss bond, investors wanted to hold the currency itself as a hedge against falling prices elsewhere – across the securities spectrum. “Foreign exchange intervention (has become) the remaining effective tool for the SNB to meet its inflation objectives,” Treasury said.
The final takeaway from the report: Janet Yellen’s Treasury said that the Biden Administration believes market determined exchange rates reflecting economic fundamentals is the appropriate arrangement for the dollar.