Commentary on Political Economy

Thursday, 3 September 2020



A Currency War Is the Last Thing the World Needs

The ECB’s chief economist made a rare verbal intervention that stemmed the dollar’s drop. Policy makers need to tread carefully in FX.

Stronger but weaker.
Stronger but weaker. Photographer: Bloomberg/Bloomberg

“It's our currency, but it’s your problem,” John Connally, Richard Nixon’s treasury secretary, told the world in 1971. Four decades later, the dollar’s weakness threatens to incite a full-blown currency war that could distract policy makers from their key task of mending the post-pandemic global economy.

The U.S. currency has been on a downward trend for several months. The Federal Reserve’s recent shift to an even more dovish stance — saying that it will allow inflation and the labor market to run hotter for longer than previously — looks set to exacerbate the dollar’s decline.

“Had the changes to monetary policy goals and strategy we made in the new statement been in place several years ago, it is likely that accommodation would have been withdrawn later, and the gains would have been greater,” Fed Governor Lael Brainard said in a speech this week. In other words, the U.S. central bank will delay tapping the interest-rate brake for longer in future.

The strategy adaptation, announced last week by Fed Chairman Jerome Powell after a yearlong review, will embolden traders who were already speculating on dollar weakness and have raised their bets on the euro to record levels.

Euro Bulls

Bullish bets on the euro in the futures market are at a record

Source: Commodity Futures Trading Commission via Bloomberg

The euro’s steady ascent against the currencies of its main trading partners is clearly starting to make the European Central Bank a bit nervous, prompting its chief economist, Philip Lane, to make a rare and limited verbal intervention earlier this week.

“The euro-dollar rate does matter,” Lane said on Tuesday. “If there are forces moving the euro-dollar rate around, that feeds into our global and European forecasts and that in turn does feed into our monetary policy setting.”

Trading Places

The euro has risen against the currencies of its main trading partners as well as versus the dollar in the past year

Source: Bloomberg

Lane’s gentle attempt to jawbone the euro lower suggests that the ECB is uncomfortable with a value for the common currency of more than $1.20, the level it briefly breached for the first time in two years before his comments drove it down — and bang in line with its average value since it was introduced in 1999.

The ECB’s pain is easy to name. The stronger the euro, the greater the disinflationary effects as foreign goods cost less. Imported deflation, often from China, has been a persistent factor in keeping inflation subdued in many developed economies.

The guardian of monetary stability in the euro bloc has very few options left to meet its inflation target, as it already has deeply negative interest rates and a vast quantitative easing program. The euro area is now technically in actual deflation, after headline consumer prices declined by an annual -0.2% in August. There are several mitigating factors that perhaps exaggerate this dip, but more worrying for policy makers is the substantial drop in core inflation to just 0.4%.

Deflation Trap

Core euro area inflation has dropped sharply this year to a record low

Source: Bloomberg

The data risk making a mockery of the ECB’s own policy review, which is expected to make the seismic shift in dropping the current “below but close to 2%” inflation target in favor of an explicit 2%.

Diverging inflation expectations between the U.S. and Europe go a long way to explaining the 6% rise in the value of the common currency against the greenback this year. The euro five-year forward inflation swap index at 1.22% is nearly a full percentage point below its dollar equivalent at 2.14%.

Greater Expectations

Forward inflation pricing is running at a faster pace in the U.S. than in the euro region

Source: Bloomberg

For its part, the Fed is effectively conducting a policy of benign neglect in the currency market, having provided almost limitless access to dollar liquidity for central banks around the world during the pandemic. For the benefit of its own economy, and for much of the developing world, the U.S. central bank is in no rush to reverse that.

That leaves the ECB fighting a battle to keep a lid on its own currency against a wall of indifference. Moreover, history suggests that central banks are relatively powerless to change the market value of their currencies.

Japan spent almost $80 billion between January 1999 and April 2000 in a failed effort to stop its currency appreciating against the dollar. During that period, the yen strengthened to as high as 101.46 per dollar from a low of almost 125 yen. The advance only halted once traders began to question Japan’s economy, and didn’t reverse until evidence of a slowdown become irrefutable.

And it’s 20 years since the ECB intervened unilaterally in the currency market. Back in November 2000, it was trying to resuscitate the euro, which had dropped to a low of 82.30 U.S. cents a few weeks prior to three solo efforts at market manipulation. By the end of the year, the currency had crawled to about 94 cents, but only because traders became less enamored of the prospects for the U.S. economy.

With the Fed still perceived as having more monetary policy ammunition available than its peers, the dollar still looks like a one-way downward bet, albeit in an increasingly crowded trade. Unless that outlook changes, the ECB will have to endure further euro gains — and resist the urge to go on the offensive, verbally or otherwise, or risk inflaming cross-border economic tensions at a time when the global outlook is perilously fragile.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the authors of this story:
Mark Gilbert at
Marcus Ashworth at

The man in the arena or, in this case, the lab.
The man in the arena or, in this case, the lab. Photographer: Yuri Gripas/Abaca Press/Bloomberg

The U.S. Centers for Disease Control has just told states to prepare for a possible vaccine as early as November, putting the issue of vaccine approval front and center. So consider this column an open letter to scientists, researchers and other experts in public health. I have some news for you: In the debate over how quickly the Food and Drug Administration should approve a vaccine for Covid-19, and over concern about premature approval, you are losing to President Donald Trump.

Right now your arguments are simply not good enough. To be clear, I am inclined to agree with you, as I am not myself flying around the world, trying to get the “early vaccines” from Russia and China. Yet the all-important question of the optimal speed of vaccine approval deserves far more attention. The Federal Reserve puts hundreds of economists on the task of figuring out the best monetary policy. There should be an equal number of you in the field of public health studying vaccine policy.

One of your weaker arguments is that Trump’s push is disturbing because it is making the FDA “too political.” First, American responses to crises, such as Sept. 11 or the Great Recession, have always been political. Second, and more to the point, there is a strong case that the FDA should take politics into account more, not less.  

The FDA has been too risk-averse in the very recent past, for instance in its reluctance to approve additional Covid-19 testing. Economists have generally concluded that the FDA is too risk-averse in the long term as well, considering all relevant trade-offs. What kind of fix might there be for those problems, if not a “political” one? Of course the initial risk-aversion was itself the result of a political calculation, namely the desire to avoid blame from the public and from Congress.

An interdisciplinary group of experts has promoted the idea of so-called human challenge trials to get vaccines tested more quickly and accelerate the fight against Covid-19. The FDA did not endorse this idea, despite its value, partly (and certainly) for political reasons.

In sum: The American people will not buy the claim that the current FDA is above politics. Nor should they.

As a public-health expert, you are also missing the broader context behind the current vaccine debate. In the early months of the pandemic, as late as April, it was common to hear that there might not be a vaccine for at least four years, and many were not sure if it would be possible at all. It is now likely (though not certain) that there will be a pretty good vaccine within a year.

That is a wonderful development, and it speaks well of your intelligence and hard work. Still, given that recent history, is it crazy for the American people to wonder if the process could be accelerated further? After all, the Chinese have a vaccine right now (albeit probably an inferior one), and they have been known to complete complicated infrastructure projects with a speed not previously thought possible.

Some of you cite the World Health Organization’s recommendation that “successful vaccines should show an estimated risk reduction of at least one-half.” Again, that might well be correct, but has the WHO proven so reliable so far, for instance on mask-wearing? Can you be so sure that a general WHO estimate is correct for what is a unique pandemic?

It’s not just about wanting to speed things up. One might argue that, due to the unprecedentedly high number of vaccines currently under consideration, the optimal threshold should be higher, not lower, for fear that the world will be left with a suboptimal choice.

Many of you in public health also argue that the speedy approval of a vaccine would damage your credibility and the cause of public health more generally. That may well be truebut there is a utilitarian argument for risking that credibility in an effort to get a vaccine more quickly. At any rate, it is entirely possible that the credibility of public-health authorities will decline anyway — even, or especially, if there is a slower vaccine approval process.

Too often I have seen one of you cite a single factor on one side of the approval equation, then invoke your authority or some previously existing institutional standard to suggest that this factor is decisive. In a Trumpian world, where credentials and authority no longer settle a debate — on public health or other matters — this kind of argument is not sufficient.

My plea is that such arguments and others be accompanied by concrete numbers, if only rough back-of-the-envelope estimates, and that all of the factors be considered together. Those numbers should incorporate the human, economic and public-health costs of allowing the current situation to continue for months. The result could be a useful public debate about the optimal speed of vaccine approval.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

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