Central Bank Intervention a Losing Game for Taxpayers
THE Group of Seven (G7) finance ministers and central bank governors renewed their joint pledge to keep the United States dollar at a level consistent with ``longer-run economic fundamentals'' at their meeting in September. But this is a charade. Recent as well as prior evidence indicates governments cannot affect the equilibrium level of the dollar by what is known as ``sterilized'' intervention in the foreign exchange markets. (Sterilized intervention is the common practise by central banks of offsetting the impact on a nation's money supply of the purchase or sale of dollars by making counterbalancing moves in the domestic open market for government securities.)
Concerted intervention by the G7 attempted to prevent the 1989 dollar rise to no avail. In its latest quarterly report, the Federal Reserve Bank of New York indicated a total of nearly $12 billion intervention by the US. Undoubtedly other central bank intervention against the dollar was several times that amount.
Nor should the failure of coordinated intervention to depress the dollar have been a surprise. The total volume of trading can reach a half trillion dollars a day, whereas dollar intervention amounts to several billion over a period of several days or weeks. Central banks do not have sufficient buying power.
Furthermore, there is ample evidence from detailed statistical tests that such efforts will continue to be unsuccessful. At the 1982 Versailles Summit meeting, the US proposed that all the intervention by major central banks since the early 1970s be analyzed with the objective of determining its effects. Each of the G7 nations assigned top analysts to that task. They concluded after many months:
Sterilized intervention by central banks was unable to affect the equilibrium level of currencies.
On occasion, sterilized intervention did help restore order to disorderly markets.
On those occasions coordinated intervention among major central banks was more effective than going it alone.
To my knowledge, there has never been a major study that contradicts those conclusions. Coordinated intervention is also capable of promoting disorder in exchange and financial markets. It may even have had some responsibility for the Oct. 13 market flop. Although currency disorder may be welcome by traders as a profit opportunity, international trade and investment decisions are made more difficult.
Furthermore, currency intervention can result in additional governmental costs when the Fed and Treasury acquires foreign currencies and sterilizes the monetary effect by reducing holdings of US securities, as occurs when they are attempting to resist a dollar rise. Earnings of the Fed will almost certainly go down.
The Fed has been using dollars to buy Japanese yen and West German marks, which are then invested at a relatively low return. In July 1989, combined holdings of foreign currencies by the Fed and Treasury amounted to $39 billion. Since this large foreign currency position is not hedged, taxpayers are subjected to a large foreign exchange risk. If the dollar continues firm, losses will be incurred and the budget deficit will rise. Since benefits from sterilized intervention are missing, it is a losing game for taxpayers and should be investigated by responsible congressional committees.
Presumably G7 officials believed the dollar was too high because the US continues to run a sizable trade deficit. But the US trade deficit under present circumstances reflects the inherent strength of the American economy, not its weakness. The trade deficit is indirectly caused by the preference of foreigners to voluntarily invest in America. We have low tax rates, a stable democracy, and offer a highly competitive rate of return compared to most other nations. Foreigners must acquire dollars to invest in the US. Their demand keeps the dollar exchange rate at a level where imports exceed exports and the shortfall is financed by foreign savings.
Both Americans and foreigners gain from this. The stock of capital in the US is about $700 billion higher as a result of seven years of inflow. We are committed to paying dividends and interest to foreign investors; but the foreign-owned capital will generate the income to pay foreign owners. The payments will not reduce our living standards and American workers benefit from higher productivity and more jobs.
A change in the relative monetary policies of nations can affect the dollar exchange rate. The recent modest easing in our tight monetary policy, combined with tighter policies in Western Europe and Japan has recently weakened the dollar and contributed to the weakness in equity prices. The treasuries and central bankers of the developed world are well equipped to pursue policies designed to promote growth and price stability at home. They cannot and should not attempt to influence exchange rates through sterilized intervention and destabilizing public statements.