Yves here. I’m a fan of Tim’s work on the Fed beat, and consider this post on the implications of the announcement tonight of Japan’s intervention to lower the value of the yen to be particularly important.
By Tim Duy, the Director of Undergraduate Studies of the Department of Economics at the University of Oregon and the Director of the Oregon Economic Forum, who writes at Tim Duy’s Fed Watch
At the beginning of August, I wrote:
Now, suppose Japanese officials believe that intervention is required regardless of the G-20. Presumably, they will give US Treasury Secretary Timothy Geithner a phone call to at least keep him in the loop, if not to receive his implicit consent. One wonders if Geithner will recognize what he would be consenting to: Japanese intervention, if it occurs, means that Chinese authorities managed to get Japan to acquire their Dollar reserves for them. Instead of buying Dollars, China buys Yen, which in turn induce Japan to buy Dollars. This maintains the artificial capital flows to the US while allowing China to escape accusations of being a “currency manipulator.”
Since then, Japan’s currency challenge only intensified, culminating in last week’s almost comical complaint from Japanese policymakers:
Japan’s government said it will seek discussions with China over the nation’s record purchases of Japanese bonds as an appreciating yen threatens to undermine an economic recovery.
Japan is closely watching the transactions and will seek to maintain close contact with Chinese authorities on the issue, Vice Finance Minister Naoki Minezaki told lawmakers in Tokyo. Finance Minister Yoshihiko Noda suggested at the same hearing that it’s inappropriate for China to buy Japan’s bonds without a reciprocal ability for Japanese to invest in China’s market.
Did policymakers recognize the irony of their situation? It is not exactly a secret that Japan has made frequents excursions into the currency markets. But apparently they feel that intervention should be limited to Dollar purchases. Surely another Asian nation wouldn’t play the same game on them?
Alas, the Chinese did – under pressure to “loosen” the renminbi – and pushed the Japanese into intervening last night to tame the surging Yen. In effect, the Chinese managed to get the Japanese to do their Dollar buying for them. Honestly, I have a hard time faulting the Japanese. They are facing a serious deflation problem, and pumping Yen into the system is an appropriate response (all though, they might simply sterilize the intervention, which would be, in my opinion, a policy error).
What must be going through the head of US Treasury Secretary Timothy Geithner at this point? After all, as far as global imbalances are concerned, if he can’t stop central banks from intervening in the Dollar, he really isn’t going to be making much progress on reversing the deteriorating US trade deficit . And before anyone gets too excited about the most recent trade numbers, note the trend remains intact. Moreover, CR is tracking the LA ports data, and it looks ugly). Geithner is now out and about trying to jawbone Chinese officials. From his interview with the Wall Street Journal:
WSJ: Are you satisfied with China’s progress on the yuan?
Geithner: Of course not. China took the very important step in June of signaling that they’re going to let the exchange rate start to reflect market forces. But they’ve done very, very little, they’ve let it move very, very little in the interim. It’s very important to us, and I think it’s important to China, I think they recognize this, that you need to let it move up over a sustained period of time.
So, Geithner finally realizes the extent of the Chinese nonevent. Recall the press fanfare that accompanied the initial Chinese currency announcement – journalists falling all over themselves to speak brightly of China’s economic maturation. How many of those stories were sourced by Treasury officials crowing about the breakthrough that allowed them to avoid labeling China a currency manipulator? And where does this leave Geithner? Either complicit in trumping up the most minor of policy adjustments, or completely sucker punched by his Chinese counterparts. Honestly, I don’t know which is worse.
What it all boils down to is this: There apparently is no motivation for global central banks to stop directing capital inflows at the US in an effort to support mercantilist objectives. If it isn’t China, it will be some other economy. And equally apparent, there is no motivation among US policymakers to address such government directed capital flows. Which will leave politicians falling back on ultimately harmful trade barriers. The absolute inability of US policymakers to seriously address a global financial architecture where a rule of the game is “when in doubt, by Dollars” will ultimately have serious consequences via disruptive adjustment when the system can no longer be maintained, via either external or internal forces.