Currency markets: Which one is not like the others?

One of the points I recently stressed as to why the US economy is stuck in neutral is that other countries, through their currency markets management, are sopping up what little demand we have. I don’t think this is the whole or even the half of the story relative to the other matters on the list (e.g., our unwillingness to stimulate), but I do think it’s important.

The problem here is that a very useful adjustment mechanism that naturally kicks in, ala econ 101, is blocked. The weak economy and the Fed’s response leads to lower interest rates. That takes down the value of the dollar in international markets which gives our exports a boost. And, in fact, the decline in the dollar has helped manufacturing employment (since that sector does better when our exports are more competitive), at least up until a few months ago.

Lots of analysis of the Greek debt crisis notes the absence of this mechanism when your country is a member of currency zone. By dint of their Eurozone membership, so-called “external devaluation” is blocked and you have to do internal devaluation—reduce labor costs to boost your exports—which is a lot less fun.

But the fact is, we suffer from a bit of that problem too. This figure shows one currency that floats relative to the dollar (the euro, in this case), bipping and bopping around, and one that doesn’t, the yuan. It glides along until Chinese monetary authorities decide to let it move for a while, often to appease the complaints of exporters squeezed out by China’s currency peg.

As the second figure reveals, the yuan rose a bit relative to the dollar in recent months (which moves the trend downward in the graph, since a dollar buys you fewer yuan). Our exports got a bit of a pop out of that and manufacturing employment is up about 170,000 jobs since its trough last October. You don’t want to make too big a deal out of such correlations—there are many moving parts.

But that’s why this problem of currency management by our global competitors made the list of why we’re stuck. We should do something about it.