Is Intervention Suggestion for Real?

Yesterday's Financial Times carried an op-ed type of piece that acknowledged there was no alternative now to the dollar as the main reserve currency and numeraire. While this is consistent with our own analysis, we take exception at the idea that "the chances for coordinated intervention among developed economies to support the dollar are higher now than any time in the past 10 years." We see no evidence for such a claim. Intervention is best conceptualized as an escalation ladder. Coordinated intervention is near the top. The major developed countries have barely stepped on to the ladder at all.

We have seen several major countries express concern about their currencies strength as the impact on their economic recoveries. Yet since officials made such comments their currencies, like the Canadian dollar and euro, have pulled back.

The issue is not the dollar's weakness. Over the past year, the euro has fallen 11.2% against the dollar. The Canadian dollar is 12.3% weaker. The British pound is 18.2% lower.

To the (limited) extent that intervention is truly being contemplated, it is not to stop the dollar from falling, it is more a case that some countries want a weaker currency for domestic purposes. With key rates near-zero and traditional monetary policy tools largely exhausted, exchange rates are an even more important transmission mechanism.

The kind of intervention the FT op-ed piece spoke of would be coordinated intervention to support the dollar, perhaps like the coordinated intervention to support the euro back in 2000. However, like the kind of intervention often seen or rumored in Asia, where countries intervene on the individual bilateral exchange rates, since the particular problem is not really dollar weakness, than the intervention operation might not be focused on dollar-euro, but diluted by various bilateral operations.

The experience of the Swiss National Bank over the past few months seems to largely recapitulate the Japanese experience from earlier this decade. Unilateral intervention in the foreign exchange market not backed up by other policy adjustments does not have a high probability of success.

The G8 are likely to reiterate the need to avoid protectionism, even though many countries have enacted such measures. At the same time, the foreign exchange market is unlikely to get much more than a passing reference. Protectionism can take many forms and beggar-thy-neighbor currency policies are among them. The U.S. stands out as one of the few countries that have not expressed concern about the strength of its currency and yet some, like the author of the op-ed piece still suggest the weakness of the dollar is very salient problem.

Of all the challenges policy makers and investors face, the so-called dollar weakness does not seem a particularly pressing one.