August 7 2019 – A brief history of global currency markets must always address the various attempts by central governments to influence the exchange rate of their native currencies. Japan, South Korea, Taiwan, and Switzerland have all had notable instances when they were publicly accused of aggressively trying to maintain or otherwise manage the exchange rate of the yen, won, new Taiwan dollar, and Swiss franc. In truth, however, from the very advent of floating exchange rates almost every government has thought about, talked about or actually schemed about achieving a certain exchange rate in the hopes of solving some particular domestic economic problem: inflation, GDP growth, economic “stability”, etc.
As is so often the case, the only thing these efforts usually achieve is the revelation of the actual depth and width of institutionalized economic ignorance.
The difficulty of attempting to manage a currency for the achievement of a particular economic goal is that the goals are often contradictory. For example, if one would wish to have a strong currency as a quick fix for inflation (the strong currency serving to reduce the cost of imported goods and services), that same strong currency will threaten the sales growth of firms competing in global markets, slowing domestic economic growth and leading to lay-offs. This development would, indeed, reduce inflationary pressures but not in the way intended by the politicians hoping to restrain inflation without economic pain. Conversely, a weak dollar that benefits domestic exporters and boosts growth in the manufacturing sector – still, all too often, the sole focus of fiscal policy – raises the cost of many consumer goods and imported capital goods and equipment, negatively impacting a broad swath of domestic economic activity.
Even more challenging, however, is the issue of exactly how to exert economically exogenous, central government influence on a currency with a value set (vis-à-vis other currencies) by the vast, fluid, global currency market. Exchange rates are nothing more than prices for currencies (as opposed to prices for goods and services valued in those currencies) established by supply and demand. If an importer in country X wishes to buy a product from a company in country Y, that importer will demand country Y’s currency. Ceteris Paribus – one of the greatest CYA excuses ever invented – that increased demand for country Y’s export will raise the price (exchange rate) of country Y’s currency. Floating exchange rates are intended to allow this mechanism to be self-equilibrating; as the exporting country’s exchange rate rises, it’s goods become more expensive and the importing country’s goods become relatively less expensive, ultimately facilitating a shift of trade flows and a rebalancing of exchange rates. Any country wishing to “permanently” raise or lower its exchange rate is continually swimming against this tide.
As a practical matter, the desire to manage a currency in a certain direction is executed with the assistance of the central bank. Raising interest rates serves the purpose of attracting monies seeking higher yields than available in the currency in which the money is held. As these monies are converted into the currency offering the higher yield (thank you, Central Bank), the increased demand for that currency raises the exchange rate. But exactly how does a central bank change rates of interest? By buying and selling financial instruments that impact the money supply. In the United States, the Fed sells US Treasuries in order to decrease the money supply and raise interest rates (because the sale of those Treasuries absorbs the free cash that would otherwise be loaned out or spent), and conversely buys Treasuries to lower interest rates. Another way the central bank can influence the exchange rate is with the direct buying and selling of the relevant currencies, of which they often have a storehouse of reserves. Since currency manipulation is, by definition, an action working against market forces, the central bank executing these maneuvers must have an almost unlimited supply of financial instruments, currencies or cash (a “printing press”) allowing it to continually support the exchange rate at its intended level. And this is a fight against a global currency market estimated today as having an average daily turnover of more than $5 trillion US dollars.
Average Daily Turnover In The Global Foreign Exchange Market (USD$ Billions, 1998-2016)
Note: Suggested changes of methodology post-2016 have resulted in lowering these totals by a third while keeping the relationship over time unchanged. Historical re-estimations are not currently available.
As far back as the 1980s, when Japan was under severe political pressure from the United States to strengthen the yen and thereby reduce the perceived competitive pressure on US automakers and other manufacturers from a weak yen, the then-mighty Bank of Japan gave up after a few days. It was simply too difficult to fight the market forces keeping the yen weak relative to the dollar – high US interest rates, Japanese exports and imports largely denominated in dollars and tight restrictions on the international use of the yen in financial markets. Only when borrowing in yen was allowed and became popular in the second half of the 1980s (the County of Los Angeles became one of the first municipalities to borrow in yen in 1986), and when Japanese factories started to relocate to the United States did the yen begin to strengthen against the US dollar. To belabor the point: the central bank could not achieve the desired result; wrenching structural and institutional changes were required. Said the general manager of Sanwa Bank in New York at the time: “It will mean the restructuring of the Japanese economy.” (For a useful trip down memory lane, see Nicholas Kristof’s August 31, 1986 article in the New York Times “The Yen Rapidly Come of Age.” https://www.nytimes.com/1986/08/31/business/the-yen-rapidly-come-of-age.html
Currencies that do not freely float in global currency markets are best thought of as currencies that are aggressively managed, with a variety of consequences and seldom any great success. The peg of the Argentine peso to the US dollar in the 1990s was intended to ensure stability, but instead contributed to capital flight and hyper-inflation. The Chinese yuan (renminbi), also pegged to the US dollar , was allowed to float within a narrow range only starting in 2006, and was thought to be pegged at below market at the time: since then, its wide use in currency markets (unlike the Japanese yen in the early 1980s) has served to establish a value generally judged to be quite close to freely floating market exchange rates.
A slowing Chinese economy, with Chinese exporters blocked by tariffs and overseas investment in China threatened by trade wars, should, not surprisingly, result in a weaker yuan. This may have been the very recent message from China in letting the yuan fall versus the dollar – no doubt with some political messaging included. However, it is financial market history, not politics, that tells us that trying to fight global market forces with currencies is mostly unsuccessful and almost always accompanied by uncertainty and its twin, volatility.
Finally, we return to the observation that almost every country at some time has toyed with the idea of manipulating their currency through interventions in supply and demand for that currency in global markets. The interventions themselves tend to be short-lived and usually unsuccessful. Yet very few currency manipulators have been formally charged in the United States as being a Currency Manipulator (capital letters assigned with intention). A Currency Manipulator – an official term with legal import — is designated by the US Dept. of Treasury and carries a number of penalties, including prohibition from government procurement contracts. It is highly unlikely that this latter penalty is a major new issue for Huawei, but for other Chinese companies and/or investors, the implications could be varied and adverse.
Investment advisory services offered through Robertson Stephens Wealth Management, LLC (“Robertson Stephens”). Robertson Stephens is an SEC-registered investment advisor and wholly owned subsidiary of Robertson Stephens Holdings, LLC (“RSH”). RSH is majority-owned by investment funds managed by partners of Long Arc Capital, LP (“LAC”), a private equity investment firm, and receives management and strategic advisory services from LAC-related entities. The information contained within this letter was carefully compiled from sources believed to be reliable, but Robertson Stephens cannot guarantee its accuracy or completeness. This material is for general informational purposes only, does not constitute investment advice or a recommendation or offer to buy or sell any security, has not been tailored to the needs of any specific investor, and should not provide the basis for any investment decision. Information, views and opinions are current as of the date of this presentation and are subject to change. Indices are unmanaged and reflect the reinvestment of all income or dividends but do not reflect the deduction of any fees or expenses which would reduce returns. Past performance does not guarantee future results. Investing entails risks, including possible loss of principal. Robertson Stephens does not provide tax advice and any discussion of U.S. tax matters should not be construed as tax-related advice. © 2019 Robertson Stephens Wealth Management, LLC. All rights reserved. Robertson Stephens is a registered trademark of Robertson Stephens Wealth Management, LLC in the United States and elsewhere.