Defining Currency Manipulation for Scott Sumner

A little over a week ago, Scott Sumner wrote a post complaining that I had not yet given him a definition of currency manipulation. That complaint was a little bit surprising to me, because I have been writing about currency manipulation off and on for almost five years already on this blog (here’s my first, my second, and a more recent one). Now, in all modesty, I think some of those posts were pretty good and explained the concept of currency manipulation fairly clearly, so I’m not sure why Scott keeps insisting on the need for a definition. I am more than happy to accommodate him, but before doing so, I want to respond to some comments that he made in his post.

Scott began by quoting at length from my most recent post in which I responded to his criticism of my contention that China has in the past — but probably not the more recent past — engaged in currency manipulation. My basic argument – buttressed by an extended quotation from the world’s greatest living international-trade theorist, Max Corden — was that although nominal exchange rates are determined by monetary-policy choices, such as exchange-rate pegs or targets or nominal quantities of money, while real exchange rates are determined by real forces of resource endowments, technology, and consumer preferences, it is possible for monetary policy — either deliberately or inadvertently — to affect real exchange rates. This did not seem like a controversial argument to make, but Scott isn’t buying it.

Scott examines the following passage from my quotation of Corden:

A nominal devaluation will devalue the real exchange rate if there is some rigidity or sluggishness either in the prices of non-tradables or in nominal wages. The nominal devaluation will then raise the prices of tradables relative to wage costs and to labour-intensive non-tradables. Thus it protects tradables.

And he finds it wanting.

I can’t figure out what that means. Taken literally it seems to imply that a nominal depreciation that is associated with a real depreciation is a form of protectionism. But that’s obviously nonsense. So what is he claiming? We know the nominal exchange rate doesn’t matter; only the real rate matters. But currency manipulation can’t be just a depreciation in the real exchange rate, as real exchange rates move around for all sorts of reasons. If a revolution broke out in Indonesia tomorrow, I don’t doubt that the real value [of] their currency would plummet. But no one would accuse Indonesia of currency manipulation.

There is I think some confusion in the way Scott interprets what Corden said. Corden says that if monetary policy is used to depreciate the real exchange rate, then it may be that the monetary policy had a protectionist intent. Scott’s response is that there are many reasons why a real exchange rate could depreciate, and most of them have nothing to do with any protectionist intent. If there is a revolution in Indonesia, the Indonesian real exchange rate will depreciate. Scott asks whether Indonesian revolutionaries are currency manipulators. My answer is: not unless there is a plausible argument that the revolution was intended to cause the real exchange rate to depreciate, and that the a revolution is a moderately efficient way of benefitting those Indonesians who would gain from a depreciated exchange rate. I think it would be hard to make even a remotely plausible argument that starting a revolution would be a good way for Indonesian industrialists to capture the rents from their revolutionary protectionist strategy. But if Scott wants to make such an argument, I am willing to hear him out.

Scott considers another example.

How about a decline in the real exchange rate caused by government policy? Maybe, but I don’t recall anyone accusing the Norwegians of currency manipulation when they set up a sovereign wealth fund for their oil riches. That’s a government policy that encourages national saving and hence boosts the current account. Nor was Australia accused of currency manipulation when they did tax reform in the late 1990s.

OK, fair enough. There are government policies that can affect the real exchange rate. Is every government policy that reduces the real exchange rate protectionist? No. The reduction of the real exchange rate may be a by-product, an incidental consequence, of a policy adopted for reasons that have nothing to do with protectionism. The world is a complicated place to live in.

Then referring to a passage of mine in which I made a similar point, Scott comments.

The term ‘motive’ seems to play a role in the passage above:

If the motive for the real devaluation was to protect tradables, then the current account surplus will be only a by-product, leading to more accumulation of foreign exchange reserves than the country’s monetary authority really wanted. Alternatively, if the motive for the real devaluation was to build up the foreign-exchange reserves – or to stop their decline – then the protection of tradables will be the by-product.

Scott doesn’t like talking about “motives.”

As an economist, references to “motives” make me very uncomfortable. Let’s take the example of China. Did China’s government try to reduce the real value of the yuan because they saw what happened during the 1997 SE Asia crisis, and wanted a big war chest in case they faced a balance of payments crisis? Or did they do the weak yuan policy to shift resources from domestic industries to tradable goods industries? I have absolutely no idea, nor do I see why it matters. Surely if a concept of currency manipulation has any coherent meaning, it cannot depend on the motive of the policymakers in a particular country? We aren’t mind readers. This is especially true if we are to believe that currency manipulation hurts other countries, as its proponent seem to suggest. How will it be identified?

Scott is mixing up a lot of different issues here, so let me try to sort them out. There are indeed two plausible explanations for China’s vast accumulation of foreign-exchange reserves in the 1990s and in the 20 aughts. One is a precautionary build-up of foreign-exchange reserves to be available in the event of a financial crisis; the other is exchange-rate protection, aka currency manipulation. It’s true; we can’t read the minds of the policy makers, but we can make reasonable assessments of the relative plausibility of either hypothesis, based on the size of the accumulation, the policy steps that were taken to implement and facilitate the accumulation, the public pronouncements of relevant officials, and, if we had access to them, the internal documents upon which policy-makers relied in reaching their decisions. Now obviously, the Chinese government is not about to share their internal documents with me or any outside investigator, but that is a choice made by the Chinese, not some inherent deficiency in the evidence upon which a diligent researcher could potentially rely in making a determination about the motivation for Chinese policy decisions. As an economic historian of considerable accomplishment, Scott is well aware of the kind of evidence that is relevant to evaluating the motives of policy makers, so I can’t help but suspect that Scott is playfully engaging in a bit of rhetorical obfuscation here.

In the spirit of Bastiat, consider the following analogy. Suppose that for years we had been buying bananas from Colombia for 10 cents a pound. American consumers got to eat lots of cheap tasty fruit, which don’t grow well in non-tropical countries. Then in 2018, Trump sends a team of investigators down to Colombia, and finds out that we’ve been scammed. It’s actually not a warm country, indeed quite cool due to its high elevation. The Colombian government had spent millions building giant greenhouses to grow bananas. We’ve been tricked into buying all these cheap bananas from Colombia, which artificially created a “competitive advantage” in the banana industry through subsidies.

Here’s my question: Why does it matter why the Colombian bananas were cheap? If we benefited from buying the bananas at 10 cents a pound, why would we care if the price reflected true competitive advantage or government subsidy? Does the US benefit from buying 10-cent bananas, or not?

Once again, there’s some tactical diversion taking place. The question at hand is whether a protectionist policy could, in principle, be implemented through monetary policy. The answer is clearly yes. But Scott is now inviting us to consider a different question: Do protectionist policies adopted by one country adversely affect people in other countries. The answer is: it depends. Since there are no bananas grown in the US, export subsidies by the Colombian government to their banana growers would not harm any Americans. However, if there were US banana growers who had invested in banana trees and other banana-growing assets, there would be Americans harmed by the Colombian subsidies. It is possible that the gains to American banana consumers might outweigh the losses to American banana growers, but then there would have to be some comparison of the relative gains and losses.

Now Scott comes back to his demand for a definition.

But that’s not all. Even if you convinced me that we should worry about interventionist policies in our trading partners, I’d still want a definition of currency manipulation. There are a billion ways that a foreign government could influence a real exchange rate. Which ones are “manipulation”? It’s meaningless to talk about China depreciating its currency, without explaining HOW. A currency is just a price, and reasoning from a currency change (real or nominal) is simply reasoning from a price change. Which specific actions constitute currency manipulation? I don’t want motives, I need verifiable actions. And [why] does this concept have to involve a current account surplus? Australia’s been running CA deficits for as long as I can remember. Suppose the Aussie government did enough “currency manipulation” to reduce their trend CA deficit from 4% of GDP to 2% of GDP. But it was still a deficit. Would that be “manipulation”. Why or why not?

OK, here it is: currency manipulation occurs when a government/monetary authority sets a particular nominal exchange-rate target which, it believes, will, at current domestic prices, give its export- and import-competing industries a competitive advantage over their foreign competitors, thereby generating a current account surplus. In addition, to prevent the influx of foreign cash associated with current account surplus from raising domestic non-tradable prices and undermining the competitive advantage of the protected tradable-goods sector, the government/monetary authority either restricts the amount of base money created or, more likely, increases reserve requirements imposed on the banking system to create a persistent excess demand for money, thereby ensuring a continuing current account surplus and accumulation of foreign exchange reserves and preserving the protected position of the tradable-goods sector.

Scott continues:

Should we care why a country has a big CA surplus? Suppose Switzerland has a big CA surplus due to high private saving rates, Singapore has a big CA surplus due to high public saving in common stocks, and China has a CA surplus due to high public saving in foreign exchange. What difference does it make? (And I haven’t even addressed Ricardian equivalence, which further clouds these distinctions.)

Whether we should care or not care about exchange-rate protection is a question no different from whether we should care about protection by tariffs or quotas. There is an argument for unilateral free trade, but most of the post-World-War II trend toward (somewhat) freer trade has been predicated on the idea of reciprocal reductions in trade barriers. If we believe in the reciprocal reduction of trade barriers, then it is not unreasonable to be concerned about trade barriers that are erected through currency manipulation as a substitute for the tarrifs, import quotas, and export subsidies prohibited under reciprocal trade agreements. If Scott is not interested in reciprocal trade agreements, that’s fine, but it is not unreasonable for those who are interested in reciprocal trade agreements to be concerned about covertly protectionist policies that are imposed as substitutes for tariffs, import quotas, and export subsidies.

We know that the only way that governments can affect the real exchange rate is by enacting policies that impact national saving or national investment. But almost all policies impact either national saving or national investment. So which of those count as manipulation? Is it merely policies that lead to the accumulation of foreign exchange? If so, then won’t you simply encourage countries to use some other technique for boosting national saving? An alternative policy that avoids having them be labeled currency manipulators?

In principle, there could be other policies aimed at increasing national savings that are protectionist in intent. One would have to look at each possible instance and evaluate it. At least that’s what would have to be done if one believes in reciprocal trade agreements.

There were some other points that Scott mentioned in his post that I will not address now, because the hour is late and I’m getting tired. Perhaps I’ll follow up with a short follow-up post in a day or so. Not promising though.

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15 Responses to “Defining Currency Manipulation for Scott Sumner”


  1. 1 Nick Rowe September 7, 2017 at 4:55 am

    David: Lovely reading the argument between you and Scott.

    We agree that a foreign government imposing import tariffs is bad. The question is whether “currency manipulation” can be defined in such a way that it is like an import tariff and is bad for the same reason. That is the trickier bit. A foreign government imposing a tariff on its imports (our exports) is taxing our people, which is bad for us. (Tax incidence depends on elasticities of course). A foreign government that accumulates foreign exchange reserves is, in effect, forcing us to borrow from them (if it holds our currency, then our central bank must print extra currency to prevent deflation and/or recession). I can imagine circumstances where maybe our country does not want to borrow from them. But being forced to borrow is very different from being taxed.

  2. 2 JKH September 7, 2017 at 8:38 am

    I’m sure Scott Sumner is saying a lot of interesting things – but I’m not clear how they directly negate your definition. They seem to question the usefulness of a definition altogether rather than reject your definition specifically.

    I have my own quibble with your definition for quite different reasons.

    I’ve scanned a few of your earlier posts on this subject, and it seems that the issue of “sterilization” is front and center. I believe you say that if – for example – a central bank sells securities in order to drain domestic money otherwise created by its own purchase of foreign exchange, this “sterilization” amounts to currency manipulation – because new domestic money is not allowed to work its way back into the system as a demand stimulant in the other direction. The policy is kept tight in order to sustain net export momentum. In the case of China, you expanded this sort of example to include the case of increased reserve requirements – as another way of impeding offsetting aggregate demand in the other direction. I think the more general idea is that the central bank has a range of options in its balance sheet management arsenal in order to get the desired effect of tightening (relative to the counterfactual). And I think it’s reasonable in this sense to interpret increased reserve requirements within a broader concept of “sterilization”.

    The observation I would make is that the central bank has no choice but to “sterilize” such FX inflows in any event. And because there is no choice, the criterion of sterilization cannot be the basis for the definition of currency manipulation.

    The reason why the CB has no choice is quite simple. Any CB that wishes to run a non-zero interest rate policy must employ such “sterilization” in the broadest way. In this broader interpretation, I would include within the range of “sterilization” techniques, not only increased reserve requirements as you have done, but the payment of interest on excess reserves, as now occurs under QE.

    The central bank cannot issue non-interest bearing bank excess reserves – to an inordinate excess – without causing the effective trading rate for the policy standard to plummet to zero. That is why the Fed must pay IOR.

    One can interpret the central bank balance sheet management process as including a set of techniques that enables it to minimize non-interest bearing excess bank reserves in order to manage a non-zero policy rate. Expanding this concept further, the whole operation is an effective sterilization machine – in order to control the level of non-interest bearing excess reserves and thereby control the trading level for the target policy interest rate. This was the standard operation of the pre-2008 Fed, which ran minimal non-interest bearing excess reserves, while the QE era Fed controls things by paying a floor interest rate on excess reserves, thereby avoiding the potential problem by eliminating non-interest bearing excess reserves altogether. Again, these kinds of things are necessary in order for the central bank to have an effective policy target for a non-zero interest rate.

    As far as central bank currency is concerned, the quantity issued is subject to endogenous demand. Therefore, it is a non-item for purposes of this discussion. The central bank always responds to the demand for currency by issuing currency. It has no discrete operational steps available that would correspond to a concept of “sterilizing” such issuance. If an exporter wanted currency in exchange for selling his foreign exchange to the central bank, he would end up getting it – and the central bank would have no choice in the matter. So that cannot be a logical part of any “sterilization” discussion, and cannot be interpreted as evidence that sterilization is not taking place. That leaves excess bank reserves, as I just discussed.

  3. 3 David Glasner September 7, 2017 at 8:42 am

    Nick, Many thanks. I would not compare currency manipulation to an import tariff. The better comparison is with an export subsidy, which also violates reciprocal trade agreements. My point in all my posts about currency manipulation has not been to argue that it should be banned, but to clarify the concept so that the term is properly limited to the relatively small number of cases in which it actually fits the policy that the term is being used to describe. I would also point out that Earl Thompson in his book with Charles Hickson, Ideology and the Evolution of Vital Institutions discussed what he called the hyper-savings, undervalued-currency, export-led growth policies of Japan and West Germany after WWII as a covert payment to the US for the military security provided by the US forces stationed on their soil and the US nuclear umbrella.

  4. 4 David Glasner September 7, 2017 at 8:57 am

    JKH, I seem to recall that this point has come up before in our discussions about central bank policy, perhaps with respect to currency manipulation. If I understand your argument, it is irrelevant what interest rate policy the monetary authority follows and what reserve-requirement ratios the monetary authority imposes on the banking system. Whatever those policies and settings are, the requirement of the monetary authority to provide the level of reserves demanded by the banking system will lead to exactly the same outcome. I am sorry if I am misinterpreting you, but that doesn’t seem to make any sense to me. And if I have misinterpreted you, please clarify for me what your argument is.

  5. 5 JKH September 7, 2017 at 9:21 am

    David,

    If I understand your argument, an absence of sterilization would be reflected as an increase in some quantity of non-interest bearing excess bank reserves as initially created by CB FX purchases.

    Sterilization would drain those excess non-interest bearing bank reserves. The CB has a range of techniques for doing that, including but not limited to: sale of assets, conversion of excess reserves to required reserves, or conversion of non-interest bearing excess reserves to interest bearing excess reserves.

    Two points:

    1. All of these techniques drain non-interest bearing excess bank reserves otherwise created by FX intervention. They all “sterilize” that initial effect in some way.

    2. The central bank has no choice but to employ such sterilization techniques if it wants to control a non-zero policy interest rate level. So presence or absence of sterilization can’t be a criterion for presence or absence of currency manipulation. Sterilization is always present and so currency manipulation thus defined would always be present.

  6. 6 David Glasner September 7, 2017 at 9:54 am

    JKH, I find “sterilization” to be an unuseful concept. The term is widespread in the literature and it’s usually associated with the notion that an influx of FX reserves into a central bank should generate a monetary expansion that is some multiple of the increase in FX reserves. So sterlilization is very closely related to the money-multiplier view that we both agree is not the right way to think about what determines the quantity of money held by the public. Although I did refer to sterlilization in my first few posts on currency manipulation, I don’t think you will find any subsequent mentions of that term. I am not sure if that resolves the issue that you raised, but if you can restate your objection to what I have written without reference to sterilization, maybe we can get to the substantive issues.

  7. 7 Nick Rowe September 7, 2017 at 11:47 am

    David: “The better comparison is with an export subsidy, which also violates reciprocal trade agreements.”

    Hmm. It does sound a bit closer to an export subsidy.

    Would I be right in guessing that somewhere at the back of your mind, when you think about currency manipulation, is the Bank of France in the 1930’s?

  8. 8 David Glasner September 7, 2017 at 11:57 am

    Nick, Yes you would. 1928-33 to be exact

  9. 9 JKH September 7, 2017 at 12:04 pm

    David,

    I used it because you used it in those posts (which I’ve been reviewing recently). I might not have used it otherwise. In fact I constructed my comment around that term, only because of that. I am aware that it is a questionable term, which is why I included it in quotation marks.

    I don’t need to use it. It turns out it is a distraction for both of us.

    Here goes again, with some duplication because I think what I have written does not require major change in substance. Maybe it will be easier without the annoyance of the term no longer uttered.

    I believe you say that if – for example – a central bank sells securities in order to drain domestic money otherwise created by its own purchase of foreign exchange, this withdrawal of money amounts to an event of currency manipulation – because new domestic money is not allowed to work its way back into the system as a demand stimulant in the other direction. The policy is kept tight in order to sustain net export momentum. In the case of China, you expanded this sort of example to include the case of increased reserve requirements – as another way of increasing the demand for money, thereby impeding an expansion of domestic demand. I think the more general idea is that the central bank has a range of options in its balance sheet management arsenal in order to get the desired effect of tightening (relative to the counterfactual of leaving the money created by FX purchases in its pure form). And I think it’s reasonable in this sense to interpret increased reserve requirements within the broad range of actions that a central bank might undertake to avoid a monetary expansion in the home currency, which is what I understand to fall under your concept of currency manipulation in conjunction with a fixed FX rate and FX reserve accumulation.

    The observation I would make is that the central bank has no choice but to undertake such actions with respect to FX inflows in any event. And because there is no choice, this act of leaning against the wind by somehow withdrawing (or transforming) money otherwise created by central bank purchases of foreign exchange cannot be the basis for the definition of currency manipulation. There is no choice in the matter.

    The reason why the CB has no choice is quite simple. Any CB that wishes to run a non-zero interest rate policy must employ such techniques in the context of FX inflows to its own balance sheet. In this broader interpretation, I would include within that range of techniques, not only increased reserve requirements as you have done, but the payment of interest on excess reserves, as now occurs under QE. That said, I think there may be a gradation of monetary effects across such alternative actions.

    Something like that has to be done, because the central bank cannot issue non-interest bearing bank excess reserves – to an inordinate excess in effect – without causing the effective trading rate for the policy standard to plummet to zero. That is why the Fed must pay IOR.

    One can interpret the central bank balance sheet management process as including a set of techniques that enables it to minimize non-interest bearing excess bank reserves in order to manage a non-zero policy rate as required. Expanding this concept further, the whole operation of the central bank balance sheet serves to control the level of non-interest bearing excess reserves and thereby control the trading level for the target policy interest rate. This was the standard operation of the pre-2008 Fed, which ran minimal non-interest bearing excess reserves, while the QE era Fed controls things by paying a floor interest rate on excess reserves, thereby avoiding the potential problem by eliminating non-interest bearing excess reserves altogether. Again, these kinds of things are necessary in order for the central bank to have an effective policy target for a non-zero interest rate.

    As far as central bank currency is concerned, the quantity issued is subject to endogenous demand. Therefore, it is a non-issue for purposes of this discussion. The central bank always responds to the demand for currency by issuing currency. It has no operational steps available that would correspond to a withdrawal of currency similar to what is available through open market operations at the level of banks reserves. If an exporter wanted currency in exchange for selling his foreign exchange to the central bank, he would end up getting it – and the central bank would have no choice in the matter. So that cannot be a logical part of any discussion about how currency manipulation may or may not be present. That leaves excess bank reserves, as I just discussed.

    In summary, if I understand your definition and argument, an absence of currency manipulation would involve an increase in some quantity of non-interest bearing excess bank reserves as initially created by CB FX purchases. Currency manipulation would involve draining or converting those excess non-interest bearing bank reserves. Yet the central bank has no choice but to employ such draining or converting techniques if it wants to control a non-zero policy interest rate level. Hence, such a choice can’t be the basis for a definition of the presence or absence of currency manipulation. Something must always be done that would fall under your definition of currency manipulation, as I understand it your definition.

  10. 10 Bob Murphy September 7, 2017 at 12:30 pm

    David,

    I endorse I think every single word of your post here. After reading Scott respond to David R. Henderson on his previous post, I think I have a better idea of where he’s coming from. So take the following for what it’s worth…

    WHAT I THINK SCOTT WAS TRYING TO SAY: “People keep accusing other governments–especially China–of ‘currency manipulation’ but when I ask them to be specific, they list criteria that would be consistent with all sorts of scenarios where we all agree there’s no manipulation going on. Ultimately it seems that to count as ‘manipulation’ we have to have these other criteria *plus* the intention of the foreign policymakers of boosting their own exports. But in general, I don’t see any of these foreign policymakers admitting that they are manipulating their currency, so that falls flat too. Can my critics give me a list of criteria to know when foreign officials are lying about their motives?”

    WHAT SCOTT ACTUALLY SAID: “We’re not mind readers. Any explanation of an economic phenomenon that relies on motives is dubious.”

  11. 11 David Glasner September 7, 2017 at 2:15 pm

    Bob, Thanks. Scott may think it’s impossible to read the minds of policy makers which is an empirical claim that could be either true or false. But even if he were right, that wouldn’t mean that a protectionist policy maker could not efficiently engage in currency manipulation; it would only mean that we couldn’t prove the protectionist policy maker was lying when he denied that he was engaging in currency manipulation.

  12. 12 Jerry Brown September 7, 2017 at 2:35 pm

    JKH, why must the central bank swap its domestic currency for the foreign currency earned by the exporter? If the central bank doesn’t do that won’t the exporter have to trade it on a foreign exchange market privately? And wouldn’t that tend to increase the value of the exporting nation’s currency, while decreasing the value of the importing nation’s currency?

    Are you saying that the exporter will sell it to a domestic bank in the exporter’s own country and then that bank will be short reserves, therefore the central bank will supply those reserves, so it works out to be the same thing?

  13. 13 JKH September 8, 2017 at 12:52 am

    Jerry,

    Here is the definition of currency manipulation that David provides as a core point of the post:

    “OK, here it is: currency manipulation occurs when a government/monetary authority sets a particular nominal exchange-rate target which, it believes, will, at current domestic prices, give its export- and import-competing industries a competitive advantage over their foreign competitors, thereby generating a current account surplus. In addition, to prevent the influx of foreign cash associated with current account surplus from raising domestic non-tradable prices and undermining the competitive advantage of the protected tradable-goods sector, the government/monetary authority either restricts the amount of base money created or, more likely, increases reserve requirements imposed on the banking system to create a persistent excess demand for money, thereby ensuring a continuing current account surplus and accumulation of foreign exchange reserves and preserving the protected position of the tradable-goods sector.”

    In my comments, I’m assuming that final point as a premise:

    “… to create a persistent excess demand for money, thereby ensuring a continuing current account surplus and accumulation of foreign exchange reserves and preserving the protected position of the tradable-goods sector.”

    I.e. I’m assuming the accumulation of foreign exchange reserves by the central bank through some sort of fixed exchange rate arrangement.

    My comments are aimed at addressing what then *must* happen in the management of the central bank balance sheet as a consequence of that assumed inflow of foreign exchange onto its balance sheet.

  14. 14 JKH September 8, 2017 at 2:58 am

    David,

    One more go at it.

    Each of us has put forward our own version of a set of central bank balance sheet management techniques designed for use in conjunction with a current account surplus and the accumulation of foreign exchange reserves, such that the demand for money is increased relative to a presumed counterfactual. I have characterized the implicit, presumed counterfactual as the creation of new domestic money in the form of bank reserves, resulting from the purchase of FX by the central bank within the overall context of current account surplus and FX reserve accumulation. These techniques therefore cannot be an integral part of defining the meaning of currency manipulation, because they cannot be avoided in any case of any ongoing FX reserve accumulation. They are a direct constraint for reasons of interest rate management rather than FX policy per se.

    My point in effect is that this presumed counterfactual cannot exist as a central bank balance sheet management option. The central bank must employ the kinds of management techniques that both you and I have described in order to manage a policy target in the form of a non-zero interest rate. Thus, these balance sheet management techniques are employed for reasons other than any relationship they may have peripherally with a current account surplus or reserve accumulation.

    My impression is that you describe causality as flowing from these balance sheet management techniques (e.g. asset sales, increased reserve requirements) to an increased demand for money to a current surplus to an accumulation of foreign exchange reserves. And I am saying that cannot be a correct explanation of the causalities that are relevant to the issues of current account surplus, reserve accumulation, and currency manipulation.

    As a starting point, assume that there is already an accumulation of a stock of FX reserves on the central bank balance sheet as a result of an ongoing current account surplus under fixed exchange rates. Assume also that the central bank has been using balance sheet management policies such as described in the post and as I have described in my earlier comments to stop the creation of any new domestic money (money at least in the form of bank reserves as is implied by the descriptive context in the post), thereby reducing the money supply from what it would have been without those techniques, thereby increasing the demand for money, and thereby satisfying the conditions for the claim in the post that this will encourage the further continuation of the current account surplus and associated FX reserve accumulation.

    Now assume that the central bank pauses mid-course and considers two choices:

    The first choice is that the balance sheet management policy doesn’t change and that the central bank continues with techniques to stop the creation of new money (bank reserves) that otherwise would have occurred under the assumed continuing current account surplus and FX reserve accumulation.

    The second choice is that the central bank stops that policy of balance sheet management adjustment following the purchase of FX. Now the post specifies quite clearly that the purpose of the first policy is to stop money creation. So the counterfactual must logically comprise the case where money is created. This in context needs to assume the continuation of at least some additional FX reserve accumulation. Otherwise, the comparison is moot – because there is then no requirement to create new money in the context of the central bank policy choice we are examining, which is what to do about potential money creation resulting from FX purchases.

    There is the problem. Because I am saying that in the face of a decision to be made about the potential for new money creation in that FX accumulation context, the central bank has no choice but to choose to continue with the balance sheet management techniques noted in first choice above. As I described earlier, it must do this in order to control a non-zero policy interest rate.

    So in effect there is no real choice. In dealing with the question of potential domestic money creation (in the form of bank reserves) arising from FX accumulation, the central bank *must* adopt such balance sheet management techniques in order to prevent a material increase in the quantity of non-interest paying money, in order to avoid a drop in the overnight policy rate to an effective rate of zero). Once again: these techniques therefore cannot be an integral part of defining the meaning of currency manipulation, because they cannot be avoided in any case of any ongoing FX reserve accumulation. They are a direct constraint for reasons of interest rate management rather than FX policy per se.

  15. 15 Jerry Brown September 9, 2017 at 8:40 am

    Ok thanks JKH. I was confused as usual and thought you were arguing against the idea that currency manipulation could have a definition or exist. By assuming the accumulation of foreign exchange reserves by the central bank through some sort of fixed exchange rate arrangement, the manipulation has already been in effect and you are discussing how the central bank will have to deal with the effects of that policy. I think 🙂


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About Me

David Glasner
Washington, DC

I am an economist in the Washington DC area. My research and writing has been mostly on monetary economics and policy and the history of economics. In my book Free Banking and Monetary Reform, I argued for a non-Monetarist non-Keynesian approach to monetary policy, based on a theory of a competitive supply of money. Over the years, I have become increasingly impressed by the similarities between my approach and that of R. G. Hawtrey and hope to bring Hawtrey's unduly neglected contributions to the attention of a wider audience.

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