The dollar has strengthened against other currencies, raising speculation that the administration could actively intervene in the financial markets.

There have been intriguing hints recently of a potential change in the U.S. exchange-rate policy. President Trump has made no secret of his frustration that the dollar has appreciated against other currencies. He has indicated that other countries are manipulating their currencies to the detriment of the United States and that other central banks are weakening their currencies. Investors and financial markets are wondering if some kind of intervention might be on the table or about to be put on the table. After all, over the past couple of years, we have seen today's tweet become tomorrow's policy.

In early August, the U.S. Treasury labeled China a currency manipulator after the Chinese central bank let the yuan depreciate, escalating ongoing trade tensions. The back and forth between the world's two largest economies have sent global financial markets reeling. However, it's really hard to imagine the United States intervening in the currency markets. The likely impact of a policy doesn't seem to be part of the White House's approach for implementing it. Larry Kudlow, director of the National Economic Council, has tried to temper market chatter that the U.S. government could intervene to weaken the dollar (by selling dollars and buying other currencies). In doing so, Kudlow, all but confirmed that there was a high-level meeting to discuss currency policy.

From formal pegs to managed floats

Many other countries take exchange-rate policy seriously. There are nations with formal pegs (Hong Kong), with managed floats (China), and with one-sided limits (the Swiss franc ceiling against the euro). There are also countries where the links between inflation and the exchange rate are so close that the central bank, even when formally committed to an inflation target, ends up being most concerned about the exchange rate. There is at least one central bank (Singapore) that explicitly uses the exchange rate as its monetary policy instrument. There aren't that many countries whose currencies float as freely as the dollar.

There aren't that many countries whose currencies float as freely as the dollar.

It is also the case that intervention designed to weaken a currency is limited only by the inflationary consequences of the action. The current inflation outlook does not suggest that this is a serious constraint. The academic literature explores the very limited circumstances under which intervention succeeds in raising a currency's value. But no one really doubts that a country can sell its currency to weaken its value.

The G7 has a clear agreement not to engage in unilateral intervention to weaken a currency.

The Group of Seven (G7) countries have a clear agreement not to engage in unilateral intervention to weaken a currency — a kind of self-denying ordinance — to prevent tit-for-tat action. The G7 includes Canada, France, Germany, Italy, Japan, the United Kingdom, and the United States. But we know what Trump thinks of international agreements. Moreover, there is not much difference between monetary policy that just happens to weaken the exchange rate and policy that is designed to weaken the exchange rate.

Changing policy milieu

Two senators — one Democrat and the other Republican — plan to introduce a bill that would require the Fed to add "balancing the nation's current account" to the existing Fed mandate. This would impose a "market access charge" on all foreign purchases of stocks, bonds, and real assets. We hope this bill will not move forward. We know that every once in a while, a politician starts talking about the gold standard or some other misplaced fantasy. What is interesting, however, is that discussion around this bill has emphasized the exchange rate.

One of the bill's sponsors blamed foreign investors for driving up the value of the dollar, helping Wall Street prosper while claiming that this prevented stronger economic growth. This argument is riddled with bad economics. Still, what matters is that these ideas are edging their way into the mainstream.

The point is that the policy environment is clearly changing as politicians and their constituents remain unhappy about sluggish economic performance. The policy milieu is currently different than what it was under previous administrations; the list includes central banks that won't give up quantitative easing, the imposition of tariffs after decades of ever-freer trade, and shifting ideas about public debt and exchange-rate intervention. Many of these "new" policy ideas are not at all new, and most of them are bad, but that means very little. Bad ideas can win.

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Global growth is cooling as the trade war continues to erode business investment, manufacturing activity, and investor confidence.