Thu, Oct 02, 2003 - Page 9 News List

Forex interventions have history of being costly and fruitless

By Christopher Lingle

The weakening of the US dollar accelerated after finance ministers from the G7 issued a communique calling for market-oriented international exchange rates. Soon afterward, the Japanese yen set a two-year high against the greenback. Of course, Japanese exporters are complaining bitterly that the rising value of the yen will cause their profits to erode. This has brought considerable political pressure to support government intervention in forex markets to avoid further advances in the value of the yen. In turn, officials in Tokyo have been jawboning the markets and implied that they will continue to weigh in to thwart foreign-exchange speculation and stem appreciation.

However, the doom-laden estimates offered do not consider the total impact of an appreciating yen. A focus only on the impact on exporters overlooks the fact that a strengthening currency benefits importers who buy more goods with fewer yen. And domestic producers are able to buy imported inputs for less. Meanwhile, many Japanese companies have offshore production facilities that will offset the impact of an appreciating yen on their ability to hold market share.

While a stronger currency may adversely affect some exports, this impact is mitigated through diversification of domestic production. Intervening in currency markets discourages producers from making decisions that will be in their long-term interest.

It turns out that these interventions cannot alter the inevitable gains in the yen against the dollar because of the inherent weakness in the US currency. Most market analysts and dealers expect the dollar to continue its downward path.

This is perhaps the most ruinous outcome of the irresponsible monetary policy pursued by the US Federal Reserve under Chairman Alan Greenspan. By forcing interest rates down artificially, it has caused such a massive flood of dollars into the system that no amount of intervention will be able to stem its decline on global currency markets.

While forex intervention is likely to be fruitless, it involves high costs and is a distraction from implementing other policies that could promote long-term growth. Indeed, currency intervention goes against the most basic notion of financial prudence. Basically, buying dollars that are certain to be less valuable with yen that are becoming more valuable is equivalent to a "buy high, sell low" activity.

While the net impact of market-induced changes in currency valuations is uncertain, there is also no way to know what the proper market rate of exchange is. And so, forex intervention is a highly speculative and Quixotic adventure that should be avoided.

In all events, currency values are less important as a determinant of long-run competitiveness than rising growth in productivity. Policy makers should be focusing on how to insure that the investment and regulatory climate is inviting for both domestic and foreign investors.

There are other and better tools at the disposal of policy makers in Tokyo if they wish to improve the capacity of their economy to grow. These include reducing the overall tax burden, reducing public-sector debt, cutting government spending and reducing waste or corruption.

On the microeconomic side, a rising yen will force out some inefficient firms that operate on small margins to eliminate some of the excess capacity that remains in the domestic manufacturing sector. Although it may be painful, the reduction of overcapacity and elimination of nonviable companies will improve the overall economic climate.

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