The Third Japanese Campaign
Jude Wanniski
February 13, 2004


Memo To: Alan Greenspan, Fed Chairman
From: Jude Wanniski
Re: Dollar Helping Close Trade Gap?

I watched both days of your testimony before the House and Senate banking committees this week and for the most part enjoyed your performance. The one real problem I had was in your prepared testimony, where you said the cheaper dollar will help close the U.S. trade deficit. I’ve known you for more than 30 years, Alan, and I don’t remember you ever saying such nonsense. Here is how Bloomberg reported what you said:

Greenspan Says Dollar Helping to Close Trade Gap
By Simon Kennedy

Feb. 11 (Bloomberg) -- Federal Reserve Chairman Alan Greenspan said the two-year decline in the dollar will eventually narrow the U.S. current account deficit at an accelerating rate.

The dollar has declined 13 percent against a basket of foreign currencies since early 2002. That will help pare the $500 billion current account shortfall at a faster pace as companies' short-term currency hedges expire, he predicted. ''Although hedging may delay the adjustment, it cannot eliminate the consequences of exchange rate change,'' Greenspan said in testimony before the House Financial Services Committee. ''Accordingly, the currency depreciation we have experienced of late should eventually help to contain our current account deficit as foreign producers export less to the United States.'

Such hedging ''cannot go on forever,'' he said in response to questions later. The deficit should also narrow as U.S. firms find the export market ''more receptive,'' he said. A decline in the dollar makes U.S. goods cheaper abroad.

Greenspan said the dollar's decline has also failed to trigger higher import prices and domestic inflation. ''The recent performance of inflation had been especially notable in view of the substantial depreciation of the dollar,'' he said.

For goodness sakes, Alan, this contradicts everything we should have learned since President Nixon fell for this baloney in 1971 when he demolished the Bretton Woods gold standard on the promise from his economic team that devaluing the dollar against the Japanese yen – also by 13% at the time – would end the US trade deficit with Japan. Over the years we’ve devalued the dollar against the yen by 300% and they still run a trade surplus with us. The very idea that a cheaper dollar will force the US to buy fewer foreign goods and cause foreigners to buy more US goods is stupid to begin with. If we are trading a loaf of bread for a bottle of wine, why do you think it is a good thing for you to jigger the exchange rate so that we have to give up two loaves of bread and only get half a bottle of wine in return? Producers aren't dopes and will always adjust nominal prices to maintain the terms of trade. Didn’t you learn the axiom of classical economics: “You cannot change the terms of trade by changing the value of the unit of account”?

In the Q&A, you did seem to back away a bit from the prepared text, indicating eventually prices would adjust through a domestic inflation, but you still seem to be playing into the hands of those who push competitive devaluations to gain at the expense of trading partners, “beggar thy neighbor policies,” as they became known in the mercantilist era. To help remind you about the foolishness of trying to inflate our way to prosperity via currency devaluation, I dug out an editorial I wrote for the Wall Street Journal on September 13, 1976, “The Second Japanese Campaign.” That is, if your theory does not work the first time around, try it again. Shall we call this effort “The Third Japanese Campaign”? Change the names of the players, and this nearly 28-year-old editorial could have run in today’s Journal.

Review and Outlook
The Second Japanese Campaign

The first Japanese campaign was mounted in 1971. Throughout the West, but especially in New York, Washington and London, policymakers, academics and journalists complained that the reason unemployment was so high in Schenectady, Newark, Manchester and Rome was because the Japanese were keeping their currency, the yen, undervalued.

The notion behind these complaints was that the Japanese were being bad trading partners because they were not charging enough for their goods. They were, it was said, “exporting unemployment” to the other industrial nations by rigging their exchange rate. If they would only appreciate the yen by, say, 10% or 15%, their goods would become that much more expensive on world markets, Japan would lose business and jobs and the rest of the world would gain.

In the Smithsonian Agreement of December, 1971, the objective was met. The yen was sharply revalued upward against the dollar. And when the advertised economic benefits did not appear, it was argued that the dollar devaluation had not been sufficient. The Bretton Woods par value system was abandoned and currencies set afloat, pushing the yen up some more.

It is not now possible to persuade us that the first Japanese campaign succeeded in benefiting the United States at the expense of Japan. There were not only no benefits to anyone, but the breakdown of the international monetary system was followed by the worst global inflation and recession in memory.

What troubles us now, having gone through this international economic crisis, is that there are still so many policymakers and academics around who argue that the first Japanese campaign was a limited success, in that the global inflation and recession that followed would have been worse without these currency alignments. And that it is now time for a second Japanese campaign, because Japan has been intervening on the exchange market to support the dollar in order to keep the yen from rising against it.

Michiya Matsukawa, Japan’s Vice Minister of International Finance, argues correctly that while Japan has indeed intervened to buy dollars with yen this year, in the last six months of 1975 it was even more aggressively mopping up yen with dollars. The objective is to smooth out sharp swings in the rates, to prevent importers from being crippled when the yen falls and prevent exporters from being crippled when the yen rises.

But a far stronger argument available to him is that the theory on which the critics of Japan rest their case is wrong. Supporting the price of someone else’s currency, or devaluing your own, may have short-term effects on certain export products. But the widely accepted idea that there is a positive effect on the entire economy is not supported by experience.

If the theory that devaluation expands domestic employment were correct, the British would be cleaning up, the pound having fallen 30% against the dollar in about a year. But British unemployment is at a record high and their aim of an “export-led recovery” is nowhere in sight.

The principal benefit to Japan from its efforts to keep the yen-dollar exchange rate stable is to protect commercial transactors who have written contracts that have assumed a stable rate. It can hardly be faulted for limiting windfall profits and losses that occur because of exchange rate movements. And it can be faulted even less when it is recognized that the burden of this effort falls mainly on Japan itself.

That is because the major economic effect of Japanese intervention, buying dollars with yen, is to reduce the short-term impacts of U.S. inflation and increase the amount of inflation in Japan. Japan could just as easily keep the dollar-yen rate stable by simply printing more yen through domestic open-market operations. But then both Japan and the United States would suffer more from inflation.

After all, Japan is not buying dollars because it likes dollars, but simply to keep Japanese commercial transactors from being punished by U.S. monetary policy. The source of these surplus dollars is the Federal Reserve, which should take Japan’s mopping up of dollars as a sign that it, the Fed, is printing too many of them. Then both the United States and Japan would have less inflation.

There are still outposts in New York and Washington demanding that the Japanese “behave,” and “stop exporting unemployment.” But this second campaign, for good reason, doesn’t have the enthusiasm of the first. Very few of the journals of opinion have signed up in earnest against Japan. The U.S. Treasury, at least at the top, is not part of this campaign as it was the last time around. Undersecretary Yeo and Vice Minister Matsukawa seem to be eye-to-eye on how to finesse the critics. For everyone’s sake, maybe it will just fizzle out.