International Monetary Power

6. The Exchange-Rate Weapon and Macroeconomic Conflict

          The Exchange-Rate Weapon and Macroeconomic Conflict C. Randall Henning 117 Monetary statecraft, understood as efforts to influence the policies of other states by manipulating monetary conditions, has been a recurring feature of the global economy since World War II. At critical moments over the last four decades, the United States has exploited the vulnerability of countries in Europe and East Asia to changes in their currencies’ exchange rates vis-à-vis the dollar in an effort to extract policy adjustments from their governments and central banks. More successful in some episodes than in others, this “exchange-rate weapon” has played a central role in international conflicts over balance-of-payments adjustment. This instrument of leverage is critical to explaining the behavior of governments and central banks and the distribution of the costs of adjustment among conflicting states. When collective management of the international monetary system has been required, currency coercion has often underpinned agreements among the larger players. The exchange-rate weapon—a concept that I have developed elsewhere and elaborate here—can take two forms, one passive and the other active.1 U.S. officials can The author is grateful to Clas Wihlborg, Benjamin J. Cohen, Robert Hancke, Eric Helleiner, Louis W. Pauly, David M.Andrews, Jonathan Kirshner, Matthias Kaelberer, Saori Katada, andThomas D. Willett for comments on previous drafts, as well as to Youliana Ivanova for superb research assistance. 1. My earlier treatments of the exchange-rate weapon include C. Randall Henning, Macroeconomic Diplomacy in the 1980s: Domestic Politics and International Conflict among the United States Japan, and Europe , Atlantic Paper, no. 65 (London: Croom Helm for the Atlantic Institute for International Affairs, 1987): 1–4, 30–39; “Europäishe Währungsunion und dieVereinigten Staaten,” in Europa auf dem Weg zur Währungunion, ed. Manfred Weber, 317–40 (Darmstadt: Wissenschaftliche Buchgesellschaft, 1991); “Systemic Conflict and Regional Monetary Integration: The Case of Europe,” International Organization 52, no. 3 (summer 1998): 537–73. Cases of deployment of this weapon are treated in I. M. Destler and C. Randall Henning, Dollar Politics: Exchange Rate Policymaking in the United States (Washington, D.C.: Institute for International Economics, 1989), 50–56; Robert D. Putnam and C. Randall Henning, “The Bonn Summit of 1978: A Case Study in Coordination,” in Can Nations Agree? Issues in International Economic Cooperation, Richard N. Cooper, Barry Eichengreen, Robert D. Putnam, C. Randall Hen- allow the exchange rate to shift, perhaps even overshoot, in the knowledge that a partner country is more vulnerable and thus subject to incentives to adjust its fiscal or monetary policy. U.S. authorities can also actively encourage a shift in the rate to induce a shift in a partner’s macroeconomic policy. The two forms are deliberate, often coincide empirically, and have similar effects, namely the encouragement of domestic policy change on the part of partners. When successful, they can both delay the continuing costs and deflect the transitional costs of adjustment, in the terminology advanced by Benjamin J. Cohen (chap. 2 in this volume). By deflecting and deferring adjustment costs, deployment of the exchange-rate weapon has helped to sustain political support for open trade and investment policy in the United States at junctures when that support has been in jeopardy. However , this leverage has also generated resentment on the part of foreign partners, who consequently developed defenses against currency coercion. Both unilateral and regional in nature, these countermeasures contributed substantially to altering the international terrain over which balance-of-payments conflicts will be fought in the future. This chapter provides an overview of the conceptual foundations of the exchangerate weapon and then surveys the use of this instrument of international monetary statecraft since the dissolution of the Bretton Woods regime. I then address the countermeasures pursued by Europe, Japan, and EastAsia and the resulting changes in the structure of international monetary relations.The chapter concludes by evaluating the limits of the weapon’s effectiveness in light of structural shift. The Exchange-Rate Weapon: Concepts and Mechanisms The exchange-rate weapon becomes particularly relevant when current account imbalances become unsustainable and conflict erupts among key states over remedial action. In this situation, each country individually faces three basic choices: (1) persuade other states to change their macroeconomic policy, (2) accept a change in the mutual exchange rate, and (3) alter its own monetary and/or fiscal policies.2 The hi118 C. Randall Henning ning, and Gerald Holtham (Washington, D.C.: Brookings Institution...