Troubling Interventions

The most noteworthy commemoration of the second anniversary of Lehman Brothers’ collapse on September 15, 2008, was Japan’s unilateral currency intervention to depreciate the yen. That move marks a shift in the character of the global financial crisis, away from concern with banking problems and toward a focus on the world’s dysfunctional exchange-rate system – or, rather, its current lack of one. The Japanese intervention was immediately controversial. American politicians denounced it as predatory; Europeans saw it as a step on the road to competitive devaluations. And Switzerland’s central bank recently launched a costly and futile attempt to stop the Swiss franc’s rise against the euro – an effort that produced only large losses on the bank’s balance sheet. Japan’s new activism also was widely imitated. South Korea and then Brazil started similar action to drive down their currency. The 1980’s was the last time anyone tried this sort of intervention. At that time there was little agreement about its usefulness as a tool of international policy, and the G-7 summit at Versailles in 1982 was extraordinarily conflict-ridden and unproductive. Indeed, it was to be the first act in a long exercise of futile mega-diplomacy.Almost the only concrete outcome was the commissioning of a report by a group chaired by a senior French civil servant, Philippe Jurgensen, on whether intervention was an effective instrument against the volatility that seemed to be undermining trade relations. When the report eventually came out, it acknowledged that “excess” volatility had “adverse consequences” for individual economies, as well as for the smooth functioning of the international adjustment process. But the Jurgensen report was ambiguous about the effectiveness of intervention. It stated that interventions aimed at objectives inconsistent with economic fundamentals were futile and counter-productive. Americans read this as affirmation of their belief that all intervention was useless. Europeans, especially in France, drew the opposite conclusion that intervention could be useful if it were intended to get exchange rates right. But the report gave no guidance about how to judge whether exchange rates were appropriate or not. The high water mark of intervention came a few years later, between the Plaza meeting of finance ministers in September 1985 and the Louvre meeting in February 1987. The Plaza meeting produced an accord on concerted intervention to push down the value of the dollar, which all participants agreed was overvalued. The participants promised to use up to $18 billion over a six-week period. But, in fact, the depreciation of the dollar began well before the September 1985 meeting, and the meeting was limited in the sense that there was no discussion of monetary or interest-rate policy. By the time of the Louvre meeting, the dollar had fallen and the participants now discussed “target zones” or “reference ranges” around a central rate. There was apparent agreement on a new wave of coordinated interventions, but the agreed exchange rates did not hold. The Louvre agreement was not just ineffective. In retrospect, it was blamed for triggering a highly politicized debate about exchange rates, with every country trying to devise an approach that favored its own interests. The United States, in particular, put enormous pressure on Japan to take expansive policy measures to relieve the pressure on the international system. The resulting monetary expansion in the second half of the 1980’s fueled Japan’s massive asset-price bubble, the collapse of which seemed to lead directly to the country’s “lost decade” of stagnation. As debate about Japanese economic decline intensified, a consensus emerged in Japan that outside pressure had forced the country into adopting a dangerous and ultimately destructive course. The Japanese episode still echoes in modern debates. As the US pushes China to revalue the renminbi, American economists try to support the case for a stronger renminbi by looking at examples of surplus countries that adjusted by carrying out more expansionary policies. The most extraordinary contribution to this debate has come from the International Monetary Fund, whose April 2010 World Economic Outlook contains a chapter on how adjustment by surplus countries can be generally beneficial. The recommendation, which contains a long section trying to show that Japan’s 1987 and 1988 experience was not damaging, will be read in China simply as a statement that the US wants China to follow Japan in committing what amounts to economic hara-kiri. That is not a helpful message, given the current state of the world economy. A more sophisticated approach is required. After all, the real lesson of the 1980’s is that exerting massive pressure for exchange-rate adjustment and looser monetary and fiscal policy won’t work – especially since China now, like Japan then, is already running substantial budget deficits. As exchange markets became ever bigger during the past 20 years, most commentators assumed that central banks’ ability to influence exchange rates through intervention had shrunk radically. We are in danger of forgetting that vital lesson. The debate about China’s artificially pegged exchange rate has led Japanese Prime Minister Naoto Kan and French President Nicolas Sarkozy to begin to believe that they, too, might try shaping exchange rates. Indeed, Sarkozy has promised to make the search for a “better” exchange-rate system a key part of France’s agenda when it chairs the G-20 next year. But the problem is that the world’s central banks do not sing from the same hymnbook. The political obsession with a better exchange-rate regime amounts to an invitation to private markets to make large amounts of money by betting against those central banks that are pressed by politicians to take a particular view of the exchange rate. The bankers will laugh, while politicians wail and gnash their teeth. Harold James is Professor of History and International Affairs at Princeton University Copyright: Project Syndicate, 2010.