By Takeshi Kawanami from Washington
The Obama administration is growing increasingly vigilant toward the strong dollar. U.S. Secretary of Treasury Jack Lew has sent a warning to Japan by saying that “the finance ministers and central governors of the G-7 nations will reaffirm they will avoid competing over currency devaluation” at their financial ministerial meeting to be held in Sendai on May 20-21. To deal with the domestic economic slowdown, the presidential election, and congressional approval of the Trans-Pacific Partnership free trade pact, the U.S. has little choice but to stem the appreciation of the dollar.
“The devaluation of currency in one country sets off a chain reaction,” said Lew during his speech delivered on May 13. “Other countries would battle for a limited slice of the pie and that would not be good for the world.”
The brunt of his criticism is directed toward Japan. Finance Minister Aso has recently commented “We are ready to intervene (to top the yen from rising).” The U.S. has long cast a wary eye on China, but the country is going in the opposite direction and promoting the strong yuan out of fear of capital outflows. Now Washington is taking a hardline approach toward the host nation of the G7 meetings.
The yen rose against the dollar by nearly 15 yen at one point since the beginning of the year. Japan has been sending a warning to the foreign exchange market by hinting at yen-selling intervention, but Lew said in mid-April that “The market is orderly.” At the end of April, the Department of Treasury placed Japan and four other countries and regions on its “monitoring list” of foreign exchange practices to keep Japan’s market intervention in check. It is unusual for Japan and the U.S., which do not have major trade friction, to escalate tensions over currencies.
The Obama administration has kept quiet about Japan’s weak yen policy over the past three years. But it is changing course to prevent the dollar’s ascension, as it needs to deal with (1) the country’s steep economic slowdown, (2) the presidential election in November and (3) the congressional objection toward the approval of TPP.
The U.S. economy has stayed on a recovery path for nearly seven years, but it grew only 0.5% in real terms in the January-March quarter. A decline in exports and capital spending played a part, but the underlying cause is the dollar’s excessive gain against other currencies.
The dollar has risen in value over the past two years, and its effective exchange rate against other key currencies hit a new high in January for the first time in 13 years. The strong dollar has been gradually easing thanks to the Federal Reserve’s decision to put off an additional rate hike, but the currency remains strong. Its effective exchange rate is at an all-time high for the first time in nearly 10 years. The rift between Japan and the U.S. remains wide over their currency developments. While Japan views the yen as rapidly gaining momentum, the U.S. argues that the dollar remains strong.
The economy and the foreign exchange market will become a big factor in the presidential race. “If stock prices rise from the end of July until the end of October, the presidency goes to an incumbent or a candidate from the ruling party 80% of the time,” says Sam Stovall at S&P Capital IQ, who has analyzed the relationship between stock prices and the election.
But the idea of “President Trump” will become a reality if the strong dollar hurts growth and the currency market. The leading Republican candidate is criticizing Japan for manipulating currency markets. Japan’s yen-selling intervention at this time would stoke inward-looking public sentiments in the U.S. and give him a tailwind.
The U.S. foreign exchange policy is closely linked with the TPP, which President Obama wants to make his legacy. Anti-TPP sentiment lingers within Congress based on the view that “the trade pact will not be beneficial for the U.S. as Asian countries are devaluating their currencies to promote exports.” A Japanese government official describes Washington’s assertiveness in the currency devaluation as “Congress letting off steam with an eye on TPP deliberations.”
The strong dollar could spark currency devaluation in emerging economies and weigh on prices for oil and other natural resources. “[The phenomenon] is not what the world wants,” said a person familiar with international finance. Concerns about the strong yen are dissipating, but market players are closely watching how the authorities will respond. If the currency tensions between the U.S. and Japan escalate at the G-7 financial ministerial session, foreign exchange markets will be thrown into chaos at the initiative of the “authorities.”