Understanding the Falling Dollar

How do you do that? How do you intervene in the foreign exchange market?

Well the United States has some euros and yen that it holds. The Treasury has some euros and yen that it holds. And it could sell euros and buy dollars. Typically, the intervention would be done jointly, it would be done with, say, the European Central Bank, which would also buy dollars.

There's some concern that China will rapidly sell down its dollar reserves and that that will push down the dollar even further. How fast could they do that, feasibly, and is it a problem for the United States?

I would define the problem a little differently. We are in a world where Chinese reserves are growing rather rapidly, and China's holdings of dollars are growing rapidly, and the rapid increase in China's dollar holdings is providing a rather significant amount of financing to the United States. It's helping finance a significant share of the U.S. current account deficit. So the issue isn't whether China sells its existing dollars. It's whether China remains willing to add to its already large holdings, to add even more dollars to its large holdings. Chinese reserves increased by $250 billion in the first half of this year. The pace of growth slowed a little bit in the third quarter, but it's not clear whether all of China's foreign asset accumulation is showing up at the central bank in the form of higher reserves. Add those things up and China is on track to add between $450 and $500 billion to its assets this year. And the real issue is whether it's willing to put as large a share of that increase into dollars as has been the case in the past. I think there's an increasing debate within China about whether the rapid increase in its dollar holdings continues to serve China's interest.

But in my mind, so long as China resists more rapid appreciation of the renminbi [China's currency] versus the dollar, it's rather difficult for China to diversify in any meaningful way against the dollar. If China really started to diversify away from the dollar, I think it's a big enough player that it would put downward additional pressure on the dollar. So long as China itself pegs to the dollar or manages its currency primarily against the dollar--technically China has a crawling peg, and it's clear from a range of economic analysis that it's crawling mostly against the dollar, not against a true currency basket--then if it puts pressure against the dollar, it's also putting pressure against its own currency. And given current economic conditions in China, I'm not sure that's something China wants to do. So that's a meaningful constraint on China's ability to change its portfolio. But I would note that since maintaining the current value of the renminbi versus the dollar requires China buy a lot of dollars, not just hold onto its existing stock of dollars, means that keeping the dollar from falling and keeping the value of China's current dollar holdings constant, means that China has to continually increase its exposure.

Are countries in East Asia concerned that a falling dollar will hurt their exports?

Countries that peg to the dollar are seeing the value of their currencies fall against the euro and are seeing a rapid increase in their exports to Europe. So for many countries, the concern isn't that a fall in the dollar will lead to a fall in their exports. It's that economic weakness in the U.S. will spread to Europe, and that the broader reduction in global growth will lead to a reduction in their export growth.

Now there are specific concerns in countries like India and Thailand that have let their currencies appreciate against the dollar and the renminbi--they are a little worried that China will undercut them in global markets. As a result, they've been resisting further appreciation in their currencies. But I would put a great deal more emphasis on concerns that U.S. weakness may be the leading edge of a broader global slowdown. Specific Asian economies, particularly those like China that are doing very well and are pegged to the dollar, worry that there's a growing difference between the domestic needs of their own economies--their own economic conditions likely call for probably higher interest rates and a stronger currency--and the economic and monetary policy that they're importing by virtue of their peg to the U.S. dollar.

The above interview was conducted by Lee Hudson Teslik, Assistant Editor of CFR.org.