An Action Plan to Stop the Market Manipulators Now

Op-ed in the Financial Times

March 14, 2005

The world economy faces two major risks in the short to medium run. The rapidly growing US current account deficit, now approaching $700 billion (£363 billion) per year or more than 6 percent of the entire economy, requires a further large decline in the dollar's exchange rate. That fall could occur rapidly and precipitously at almost any time, driving up interest rates and curbing US growth. It would also weaken expansion in the Asian and European surplus countries unless they found ways to compensate for rises in their currencies by sharply boosting domestic demand.

At the same time, oil prices could spike to new highs. They have again broken through $50 per barrel and could easily rise to $60 to $70 per barrel. Every jump of $10 per barrel takes about half a percentage point off annual global growth for several years. The two risks reinforce each other, as we were reminded rudely on February 22, when oil prices surged by almost 6 percent, the dollar dropped by almost 2 percent against the yen and euro, and the Dow Jones Industrial Average fell by 174 points.

The United States bears major responsibility for both problems. Its abysmally low national saving level forces it to borrow heavily abroad, driving up the dollar and producing the external deficits. Its profligate energy consumption drives high levels of world oil demand. The United States must initiate credible reductions in its budget deficits and energy demands in order to sustain prosperity at home and abroad. But massive market interference by various governments is intensifying these threats to the world economy. Orderly adjustment of the dollar exchange rate-and hence global trade imbalances-has been impeded by more than $1,000 billion of direct currency intervention by China, Japan, and other Asian countries in the past three years. Oil prices have been inflated far above market-related levels by three decades of production cutbacks and refusals to expand capacity by Saudi Arabia and the Organization of Petroleum Exporting Countries (OPEC).

It is equally disturbing that key industrial countries and international institutions have done virtually nothing to counter these blatant market distortions. Despite their professed fealty to market principles, the US and European governments have limited themselves to ineffectual consultations with the perpetrators. Massive currency interventions by the Asian countries directly violate the charter of the International Monetary Fund (IMF), which calls on members to avoid manipulating exchange rates in order "to prevent effective balance of payments adjustment." The chief culprit is China, whose continued dollar peg has helped weaken its currency by more than 10 percent since 2002. The other Asians are understandably reluctant to let their currencies rise against the dollar and suffer a parallel rise against the renminbi, so the region needs to coordinate actions through an "Asian Plaza" agreement. Chinese revaluation of 25 percent, and appreciation of half as much by the other Asians, would take $50 billion to $60 billion off the annual US current account deficit and provide about 20 percent of its needed correction.

The United States and the Europe, the IMF's leading shareholders, must insist the fund start implementing its rules. This calls for the managing director to send a consultation mission to each member country suspected of "manipulation" and, if resolution is not prompt, then to refer the problem to the fund's executive board. The list of target countries should start with China. In addition, the Treasury Department must start fulfilling its legislative requirement to label these countries, most notably China, as "currency manipulators" in its next semiannual report to Congress on the topic due later this month.

It is conceivable that Asian violators will be persuaded by such a multilateral "name and shame" campaign to cease violating their international obligations. Failing that, other IMF members could threaten action through counterintervention in the currency markets (in the case of floating convertible currencies, such as the yen) or imposition of import barriers (in the case of inconvertible fixed currencies, such as the renminbi), perhaps after seeking World Trade Organization authorization on the grounds that persistent currency manipulation represents both an illegal export subsidy and "nullification and impairment" of previously negotiated liberalization. China is already being hit by escalating US trade controls, importantly because of its unwillingness to revalue its currency.

Countering OPEC's manipulation of oil prices will be more difficult because there are no clear international rules against such distortions. An initial signal would be for the US government to join several cases brought against OPEC under the Sherman antitrust act in US courts. The next step would be for importing countries, coordinating through the International Energy Agency at the Organization for Economic Cooperation and Development (but including China, India, and other leading developing countries), jointly to sell oil from their strategic reserves of more than 1.5 billion barrels to check price rises, as the United States did so successfully in 1991.

The most effective way to counter the producer cartel would be for the importing countries to work out an agreement with exporters on stabilizing world oil prices within a range seen as fair to both producers and consumers. Existing strategic reserves would be converted into, or augmented by, buffer stocks accumulated when prices were low and sold when high. As with the currency issue, the United States would be better placed to lead such an initiative if it would get its own house in order, first by adopting serious conservation measures such as a substantial carbon or gasoline tax.

Some observers will object to these proposals of government intervention in the currency and energy markets. Such initiatives, however, would counter the distortions resulting from existing governmental interventions. These interventions have not always succeeded; most Asian currencies (though not the renminbi) have risen to an extent against the dollar and OPEC has experienced periodic oil price falls. But the net effect of such intervention has been large. The promarket approach proposed here should appeal to the leading industrial countries and would greatly strengthen the world economy against the most severe risks it faces both now and in the future.