The Buck Doesn’t Stop Here

Why Treasury Secretary Snow can’t prevent the dollar from falling, even if he wanted to.

Illustration by Mark Alan Stamaty

The dollar’s long slide has frustrated our trading partners, who are annoyed at having to compete against cheaper American products. So European finance ministers came to Boca Raton, Fla., last week for the G-7 meeting with hopes that the United States, in the person of Treasury Secretary John Snow, would act to strengthen the dollar against the euro and the yen.

The session ended, as all such sessions do, with a highly stylized joint communiqué and with canned statements by Snow and others on the importance of markets, the dangers of volatility, and the eternal vigilance of the world’s finance ministers.

What it didn’t end with was any American action. The United States is largely satisfied with the weak dollar and won’t do much to strengthen it. In response, currency traders have pushed the dollar still lower against the euro. The Europeans were dismayed, but it is hard to see how they could have expected another outcome. Even if Treasury Secretary Snow and the Bush administration decided they wanted to boost the sagging dollar unilaterally, it’s highly unlikely they could do so. “What tools does a treasury secretary have at his disposal?” asks David Backus, an economist at New York University’s Stern School of Business. “Pretty much none.”

In theory, the Treasury Department could strengthen the dollar by buying dollars and selling euros and yen. “But there’s just not evidence that this has much effect,” said Backus. “Unless you have enormous reserves it’s just not going to work.” In the mid-1990s, Mexico ran through tens of billions of dollars in reserves in a matter of months as part of a futile effort to preserve the value of the peso. Even if you have loads of cash, trying to prop up a currency might not be an effective strategy; daily trade volume is measured in the trillions.In January alone, Japan’s Central Bank spent a whopping $67 billion to support the dollar and weaken the yen—all to little effect.

And Secretary Snow has nothing like $67 billion to play with. The Exchange Stabilization Fund is a sort of kitty, created during the Great Depression, that the Treasury Department can use to intervene in exchange markets and assist foreign governments—largely without congressional oversight. It has about $38 billion. (But as this paper notes, not all its assets are in dollars.) The Federal Reserve Board can also buy and sell foreign currencies, but generally only does so in conjunction with Treasury. Neither Snow nor his predecessor, Paul O’Neill—who expressed well-publicized contempt for traders of financial assets—has shown any inclination to play the currency markets with the ESF. “As a matter of principle, the Bush administration seems less prone to getting involved with currency markets,” says David Gilmore of Foreign Exchange Analytics.

Snow could try to influence currency rates with rhetoric. By asserting that the administration supports a strong dollar, for example, the treasury secretary can suggest to traders that they would be well-advised to push the value of the dollar higher. Doing so might work if the government were really prepared to act in furtherance of this goal. But if the rhetoric is unaccompanied by action, no one listens. And currency traders have stopped paying attention to what the treasury secretaries say because they always say the same thing. They say the United States favors a strong dollar when the dollar is strong, and they say we favor a strong dollar when the dollar is weak. When uttered by Snow, a genial former railroad lobbyist who seems to have little influence on policy, the strong-dollar statement is effectively meaningless (especially since no one in the administration actually seems to want a strong dollar).

A third option for a treasury secretary would be a hybrid of direct financial intervention and jawboning. Clinton Treasury Secretary Robert Rubin, who had enormous influence on policy and decades of experience on Wall Street trading desks, mastered this subtle art. In his memoir, In an Uncertain World, Rubin recounts an episode in June 1998. The yen was at 141 to the dollar, the weakest the yen had been in eight years, and a bit too weak for the administration’s liking. Rubin told the Senate Finance Committee that intervention is “a temporary tool, not a fundamental solution.” Traders took the phrase as a sign that the administration wouldn’t intervene to support the yen. And so in the next few days the yen slipped further, to about 146 to the dollar. Then, without warning, the U.S. government bought $2 billion in yen. “Currency traders were caught by surprise and the exchange rate moved all the way back to 136 yen to the dollar,” Rubin recounted. He doesn’t say so, but Rubin played currency traders like a fiddle and engineered a short-term move in the dollar. This risky strategy requires a degree of sophistication about financial markets that this administration lacks.

Finally, the administration could try to lean on Federal Reserve Chairman Alan Greenspan to boost interest rates rapidly. That would certainly strengthen the dollar against the euro and other currencies. But the gambit wouldn’t work because Greenspan wouldn’t cooperate. In comparison with, say, the Bank of Japan, the U.S. central bank—the Federal Reserve—has greater independence. The Fed has worked in conjunction with the Treasury to support currencies. (The Federal Reserve Bank of New York acts as Treasury’s agent for intervening in the market, for example.) But the Fed has a mandate to ensure longtime price stability, not to abet industrial policy by calibrating exchange rates according to the whim of elected officials. Greenspan would surely rebuff any suggestion that he raise interest rates merely to support the currency. And it wouldn’t make sense in practice. A sharp increase in interest rates would sandbag the U.S. economy just in time for the election season.

Exchange rates today respond in large part to capital flows—not to the utterances of central bankers and finance ministers. And the vast structural forces affecting those flows—the comparative economic strength of the United States vs. the Eurozone, the insatiable desire by U.S. businesses and consumers for imports—are far beyond the reach of this, or any, administration.