U.S. Dollar Intervention: Options and Issues for Congress

U.S. Dollar Intervention: Options and Issues for Congress

August 21, 2019
U.S. Dollar Intervention: Options and Issues for Congress
After falling to its lowest value since the introduction of
The U.S. government’s ability to intervene to increase or
floating currencies in 1973, the U.S. dollar has appreciated
defend the value of the dollar is limited by its relatively
by 25% between July 2011 and July 2019—its highest
modest FX reserves. Currently, the Fed holds $20.65 billion
value since the early 2000s. President Trump and others
in foreign exchange reserves and the Treasury holds another
have argued that the dollar’s current relative strength is
$20.63 billion in the Exchange Stabilization Fund (ESF).
holding back growth since a strong dollar makes U.S.
By contrast, the government’s ability to intervene to reduce
exports more expensive in foreign markets while at the
the value of the dollar is limited only by the Fed’s
same time making it difficult for domestic producers to
willingness to buy FX reserves.
compete with cheaper imports. This has raised questions
about what policy options are available to potentially
Figure 1. U.S. Foreign Exchange Interventions
reduce the value of the dollar. Interventions are more likely
1973-2019
to succeed if paired with fiscal or monetary policy changes
and supported by major trading partners.
Historical Experience
In the flexible exchange rate period since the early 1970s,
the dollar exchange rate has not typically been an explicit
target of U.S. economic policy, with market forces
determining the value of the dollar instead. Policymakers
typically address concerns about the exchange rate by
targeting underlying fundamental issues, such as the size of
the budget deficit.

Source: Federal Reserve.
At various points over the past several decades, however,
when the U.S. government and others agreed there were
fundamental misalignments or an excessive amount of
Exchange Stabilization Fund. Treasury can conduct
exchange rate volatility, action was taken to directly alter
currency intervention through the ESF. The ESF’s initial
the exchange value of the dollar (see Figure 1). President
objective was to stabilize the value of the dollar by buying
Carter intervened to stem the decline of the dollar in 1978.
and selling foreign currencies and gold. In 1973, with the
The dollar subsequently appreciated sharply during
demise of the Bretton Woods monetary system, where the
President Reagan’s presidency, leading to a group of major
dollar was pegged to gold and other countries were pegged
economies signing agreements in the mid-1980s to
to the dollar, the explicit purpose of stabilizing the
exchange value of the dollar was stricken from the ESF’
collectively intervene, first to weaken and then to stabilize
s
the dollar. The United States stopped intervening, for the
statute. In its place, the Treasury Secretary has broad
most part, in the mid-1990s. Since then, the United States,
authority: “Consistent with the obligations of the
in coordination with other countries, has intervened on
Government in the International Monetary Fund on orderly
three isolated occasions—in 1997, 2000, and 2011.
exchange arrangements and a stable system of exchange
rates, the Secretary . . . with the approval of the President
Policy Options
may deal in gold, FX, and other instruments of credit and
securities.”
The U.S. government can intervene in foreign exchange

(FX) markets in an effort to raise or lower the value of the
dollar relative to foreign currencies (i.e., the exchange rate).
In addition to its initial capitalization ($2 billion), Congress
If the government wishes to raise the value of the dollar, it
allowed the ESF to remain outside of annual appropriations.
buys dollars and sells its FX holdings. If it wishes to reduce
Instead, the ESF retains all of the earnings from its
the value of the dollar, it does the opposite.
operations. The main limitation on the ESF’s ability to
intervene to reduce the value of the dollar is the amount of
The 1934 Gold Act assigned the Department of Treasury
dollar-denominated assets in its portfolio, which are $22.48
the primary responsibility for FX policy. Both Treasury and
billion as of March 2019. In order to secure more dollars for
the Federal Reserve (Fed), an independent agency, can
foreign exchange operations, Treasury could (1) seek an
intervene in FX markets. However, they have typically
additional appropriation from Congress; (2) monetize its
intervened jointly, with the Fed conducting operations on
holdings of IMF special drawing rights (SDR, an
Treasury’s and its own behalf.
international reserve asset), valued at $50 billion, by
temporarily selling them to the Fed; or (3) engage in a
currency swap arrangement called “warehousing,” in which
the ESF sells foreign currency to the Fed and agrees to
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U.S. Dollar Intervention: Options and Issues for Congress
repurchase it at a later date, during which the Fed credits
to private trading volume (daily turnover for the dollar in
dollar reserves to the ESF for the duration of the swap.
foreign exchange markets was $4.4 trillion in 2016.)
Federal Reserve. The Fed can also purchase foreign
Intervention and Fed Independence. While the Fed has
currencies to reduce the value of the dollar; but unlike the
the more powerful tools to influence the value of the dollar,
Treasury, it is not limited in how much it can purchase.
it defers to the Treasury in articulating the government’s
Because the Fed controls the money supply, it can create
dollar policy. Yet the Fed’s independence from the
bank reserves as desired to purchase foreign currencies.
Administration means that Treasury cannot require the Fed
to support its currency policy, which would be necessary if
In addition to foreign exchange intervention, economic
the intervention were to be unsterilized, conducted by the
theory predicts that short-term interest rates, the Fed’s main
Fed, or involve the Fed buying SDRs from the ESF or
policy tool, also affect the value of the dollar. The value of
warehousing the ESF’s foreign exchange. The Fed’s
the dollar is determined by the relative demand for U.S.
independence has already been put under a spotlight by the
goods and services and U.S. assets. In practice, capital
President’s repeated calls for the Fed to lower interest rates.
flows dwarf trade flows, so the value of the dollar is
Arguably, the rarity of the Fed’s foreign exchange
particularly sensitive to interest rates in the United States
interventions would highlight the implications for
relative to the rest of the world. Foreign capital can only
independence if it were called on to intervene.
flow into the country on net (i.e., when foreign purchases of
U.S. securities or physical capital exceed U.S. purchases of
Economic Effects
foreign securities or capital) through the exchange of
United States. If the government could successfully sustain
foreign currency for dollars. Theory predicts that if the Fed
a lower dollar policy, it would increase foreign demand for
lowers interest rates relative to the rest of the world, it
U.S. exports and increase U.S. demand for goods that
would reduce the demand for U.S. capital, thereby reducing
compete with foreign imports. This would boost total
the value of the dollar. This is one of the standard channels
spending in the economy, while making some groups worse
through which lower interest rates stimulate the economy.
off (e.g., it would reduce the purchasing power of U.S.
Although U.S. interest rates are currently low, they are even
consumers.) Whether this was positive or negative depends
lower for many major trading partners.
where the economy is operating relative to full
employment. If the economy were operating below full
Deficit Reduction. Congress also has a tool at its disposal
employment, a boost in spending would be welcome, as it
if it wishes to reduce the value of the dollar—it can reduce
would help move the economy closer to full employment.
the federal budget deficit. Economic theory predicts that, all
But if the economy were at or above full employment, a
else being equal, government budget deficits push up
boost in spending could be unwelcome, as it could push
interest rates and the value of the dollar because the deficit
inflation higher. With the unemployment rate in 2019 at its
is financed by selling debt to private investors. That debt
lowest level since the 1960s, the economy appears to be
competes with private investment for investors’ finite pool
very close to full employment. However, inflation has been
of saving, pushing up interest rates on all securities. When
persistently low despite low unemployment, so the risk of
the government reduces the deficit, there is less competition
unwelcome inflation may currently be lower than typical.
for that saving and interest rates fall. Lower interest rates
make U.S. investment relatively less attractive, thereby
Since, as discussed above, dollar interventions alone are
reducing demand for the dollar and lowering its value.
typically not large enough to have a lasting impact, were a
lower exchange rate sustained, it would likely be because of
Effectiveness: Sterilized vs. Unsterilized Intervention.
a change in fiscal or monetary policy or because private
According to the Fed, it routinely sterilizes foreign
investors reduced their demand for U.S. assets. These
exchange interventions. Sterilized intervention is when the
developments would also have effects on the U.S. economy
Fed takes offsetting steps to neutralize the impact of
not captured in the analysis above.
intervention, whether it be by the Fed or the ESF, on
interest rates. Unsterilized intervention is when the Fed
Rest of the World. One theme of economic research on
accommodates the decline in the dollar by lowering interest
currency intervention is that efforts must be coordinated to
rates. As discussed above, lower interest rates would
be successful. In contrast to the 1980s, when there was
support the depreciation by reducing demand for the dollar.
broad concern among global powers about the strength of
the U.S. dollar and its effect on the global economy, current
Economic theory predicts that foreign exchange
concerns are not shared by major trading partners, who
intervention only has a lasting effect on the dollar if it is
largely view the dollar’s strength as a result of the strength
“unsterilized.” Economists debate whether sterilized
of the U.S. economy relative to the rest of the world and
intervention is ineffective in reality, with some evidence on
recent U.S. budget deficits. Such diverging views raise the
both sides. For example, interventions in the 1970s to boost
prospect of tit-for-tat competitive devaluations if the United
the value of the dollar were seen as ineffective because the
States were to pursue dollar devaluation on its own, which
Fed was not willing to simultaneously rein in inflation. By
could negate any U.S. trade gains. It might also trigger
contrast, intervention set off a lasting decline in the dollar
financial market instability. Countries such as China and
in the 1980s, although some economists question whether
Japan have shown a willingness to engage in significant
macroeconomic conditions were the true cause of the
foreign exchange interventions in the past.
decline. In practice, sterilized intervention could be
ineffective because the amounts involved are small relative
Marc Labonte, Specialist in Macroeconomic Policy
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U.S. Dollar Intervention: Options and Issues for Congress

IF11296
Martin A. Weiss, Specialist in International Trade and
Finance

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