MNI EXCLUSIVE: USD Intervention Tools Toothless- Ex-Officials

By Evan Ryser

     WASHINGTON (MNI) - Former U.S. Treasury officials doubt the effectiveness

of the tools available to combat Chinese currency depreciation should President

Donald Trump intervene in markets by selling dollars.

     Mark Sobel and Fred Bergsten told MNI the Treasury Department's Exchange

Stabilization Fund (ESF), which could be deployed to intervene in markets, is

quite limited.

     "I don't think it would be very impactful at all. One issue is how much

could they do," said Sobel, who oversaw the ESF from 2000 to early 2015 and is

now U.S. chairman of the OMFIF think tank.

     Fred Bergsten, a former Treasury official in charge of currency

interventions under several presidents and now a founding director of the

Peterson Institute for International Economics, agreed currency intervention

against China would likely be feeble.

     "Jawboning is about all that they would have," he said. "It is not clear

that jawboning would work. He has tried it intermittently and he could try it

more systemically," he said, referring to Trump.  

     Curbing the U.S. budget deficit would be "the most fundamental thing to do"

besides pressuring the Federal Reserve to cut interest rates a lot more,

Bergsten said. Smaller deficits can slow growth and inflation, reducing global

demand for U.S. dollars.

     Trump tweeted on Thursday that he is not "thrilled with our very strong

dollar" and blamed the Fed for "keeping the dollar high." In late July he said

he could act to weaken the dollar "in two seconds" if he wanted. Larry Kudlow,

Trump's top economic adviser, and Treasury Secretary Steve Mnuchin have

dismissed suggestions Trump is pushing officials to weaken the dollar. 

     Trump has often said China uses a weak currency to run up large trade

surpluses against the U.S. Chinese officials allowed the yuan to depreciate to

the weakest since 2008 in the last week as Trump threatened to impose new

tariffs. 

     The ESF has been used in currency interventions in 1995, 1998, 2000, and

2011. The effects of currency intervention would be determined, among other

things, by its size and whether it is coordinated with allies. Another issue is

whether the Fed would run counter to tradition and allow a so called

unsterilized intervention-- declining to sell assets from its balance sheet that

would blunt the impact on domestic monetary policy.

     --Drop in the Bucket

     Today the ESF holds a total of $95 billion. Of that, $51 billion is in the

form of IMF Special Drawing Rights (SDRs), $21 billion in foreign currencies and

$23 billion in U.S. Treasury securities. By comparison China has more than $3

trillion in foreign exchange reserves.

     "It would be seen as a drop in the bucket," Sobel said. "It might just

increase global financial market instability and, as you see all the time as you

see a risk-off environment, money tends to flow to the United States. It might

even be counterproductive."

     In the past America acted in concert with allies when intervening in

currency markets.

     "If the U.S. was going it alone against a big country, particularly against

the markets, you need probably a lot more than doubling the ESF, you probably

need to expand it many fold from where it is now," Bergsten said. 

     "I don't think this would have any support anywhere in the world," Sobel

said. He added that China's major trading partners would not go against China.

"They are not going to bite the hand that feeds them." 

     --Sterilized or Unsterilized Under Debate

     A further question is not only whether the Fed would join the Treasury, but

also whether it would sterilize any currency intervention by selling some of its

securities holdings to offset monetary effects. 

     The New York Fed is the official agent for the Treasury and has

traditionally matched funds and shouldered intervention amounts equally with

sterilization even when the Fed has reservations about the purported goals. 

     But in the post-crisis operation framework where the Fed is slowing down

efforts to shrink the size of its balance sheet, the Fed could break precedent

and allow an unsterilized intervention. That is in part due to the decline this

year in excess reserves at depository institutions but also because intervention

this time could have little impact on short-term interest rates. 

     Asked whether the Fed would partner with Treasury, Sobel said "My gut

impression from having dealt with them for years and years is that they would

want no part, absolutely no part in this."

     "Economists feel that sterilized intervention is not particularly

effective, but that unsterilized intervention in so far that it reflects a

change in the underlying monetary policy can be more effective," Sobel said.

     The effectiveness of Fed coordination and sterilization, nevertheless,

remains an open question.

     "Even sterilized intervention can be effective. Certainly most governments

think that. U.S. intervention has always been sterilized and most intervention

by other countries including China when it was doing it massively 10 years ago

was sterilized," Bergsten said. "I think sterilized intervention demonstrably

works but there is a big debate about that."

--MNI Washington Bureau; +1 202 371 2121; email: evan.ryser@marketnews.com

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