At her recent Senate confirmation hearing,
was asked for her views on the dollar. Hearing the question, she may have felt some nostalgia for her time as chairman of the Federal Reserve, when such issues could be deflected to the Treasury secretary. But the challenge of managing the dollar is now firmly on her shoulders.
Without missing a beat, Yellen moved into the new terrain. She underscored her belief in “market-determined exchange rates.” Under the Biden administration, the dollar’s value would be determined by foreign exchange markets, and the United States would not “seek a weaker currency to gain competitive advantage.” Further, the United States would “oppose” attempts by other countries to unfairly weaken their currencies—“the intentional targeting of exchange rates to gain commercial advantage is unacceptable.”
Notably absent from Yellen’s response was the refrain that “a strong dollar is in U.S. interests.” For a generation, secretaries of the Treasury—Democrat and Republican—had answered using those words.
Although debate has raged as to whether a strong dollar really is in U.S. interests (a weaker currency tends to support exports), this formulation offered two benefits. First, it was an implicit endorsement of the disciplined economic policies necessary to achieve a strong dollar. Second, the United States was precommitting to respect global norms for managing its currency and, in particular, not seeking a weaker dollar. This also reinforced U.S. leadership in the global system.
As a former U.S. Treasury official, with bruises from many international negotiations, I can attest that this precommitment provided leverage. Concretely, the Obama administration’s willingness to absorb a stronger dollar in 2015-16 gave the U.S. heightened influence in currency discussions with China and other countries. Global currency markets were more orderly and transparent than if the U.S. had taken a different tack.
Like much else, currency management was thrown into turmoil during President
tenure. His administration never coalesced into a consistent framework for the dollar, with Trump and Treasury Secretary
sometimes making conflicting statements within a single afternoon.
The new administration, of course, comes to these issues with its own priorities and political constraints. With President
emphasizing a revival of U.S. manufacturing, an enthusiastic commitment to a strong dollar might have, at least, created tensions with that narrative. Thus, Yellen’s step back from the strong-dollar policy was hardly surprising.
While Yellen’s “market-determined” dollar adroitly avoids such concerns, it still inherits many of the benefits of the strong-dollar approach. The United States continues to precommit to follow key international norms in managing its currency, which should allow the same leverage in negotiations.
Importantly, Yellen’s framework also keeps the heat on China. First, echoing the G-20, she rejects any efforts to artificially weaken currencies. Second, given China’s strong cyclical performance—as the only major country to achieve positive growth in 2020—the case for renminbi appreciation is particularly strong at present. Advocacy of a market-determined currency will give Yellen a cudgel to press the Chinese to allow their currency to strengthen.
Nevertheless, these are still early days for Yellen’s new approach, and many questions remain unanswered. For example, what exactly was her rationale for retiring the strong dollar policy? Does the change suggest that a strong dollar is not in U.S. interests? And is she saying that markets always get currency valuations right?
In responding to the first two of these questions, Yellen could briefly say, “I’m not going to comment on levels of the exchange rate. The framework that I have discussed is appropriate for the dollar under present circumstances and is consistent with the administration’s economic priorities.” The last question, whether markets always get currency valuations right, is tricky because, simultaneously, the administration will be building macroprudential policies designed to address potential market excesses. But her answer could be, “Global currency markets are the deepest and most liquid in the world. But if I ever have concerns, I will work collaboratively with partners, respecting the established protocols of the G-7, G-20, and International Monetary Fund.”
Implementing this new approach would be challenging enough, but Yellen may face yet another obstacle. The dollar’s value was on a declining path through the second half of last year. With the Fed expected to remain stimulative for as far as the eye can see, coupled with the gaping political divisions that weigh on the country’s capacity to resolve its challenges, some market participants are anticipating a cyclical—and perhaps also structural—shift away from the dollar.
To the extent that these expectations materialize, Yellen’s challenge might not be a currency that is too strong but, rather, one that is weakening. Actively affirming the merits of a market-determined currency in the midst of a sustained depreciation, might be seen as endorsing—or even pursuing—dollar weakness. This, in turn, could kick-off self-reinforcing downward dynamics for the dollar.
As Janet Yellen arrives at the Treasury, her inbox is overflowing with challenges. Even so, issues regarding dollar management will continue to merit her attention. The first glimpses of her new approach are promising, but there is still much that will need to be worked out as economic and market conditions evolve.
Nathan Sheets, PhD, is chief economist and head of global macroeconomic research at PGIM Fixed Income. He served as undersecretary of the U.S. Treasury for international affairs under President Barack Obama.