The limits of “irregular coordinated intervention” without fiscal resources
The Financial Times of the United Kingdom (FT) reported on the 7th that U.S. authorities’ euro-selling and yen-buying intervention was a “surprise” for the European Central Bank (ECB). It said that after the euro-selling intervention, ECB President Christine Lagarde and U.S. Treasury Secretary Janet Yellen spoke by phone.
Euro-selling intervention by the United States and yen-buying intervention by the European market ripple – Nikkei
“According to IMF principles concerning exchange-rate interventions, the interests of other countries, including the country or region where the intervention is conducted, should be respected.” It is well known in financial circles that Europe has long disliked interventions by other countries using their own currencies even before monetary union. It is impossible that Yellen, who understands both the surface and the depths of financial markets, would be unaware of this.
With the ECB facing a “surprise” from the intervention, it was within the expected range for Yellen to have prepared a scenario toward a “coordinated intervention,” such as making Reuters take a deliberate “To Do” memo, as described.
“I assured Europe that the euro-selling (in this instance) was only a reallocation of the United States’ foreign currency reserves.”
Yellen’s statement reflects that the U.S. euro-selling was, image-wise, using euros held in the Exchange Stabilization Fund (ESF), which is akin to Japan’s foreign exchange special account.
※ The ESF, unlike Japan’s “special accounts,” is a “fund,” so about 90% of its total assets are SDRs and non-marketable U.S. Treasuries, with euros and yen held as foreign currencies.
The ESF is a fund managed by the Ministry of Finance and can be moved at the direction of the Secretary of the Treasury with the President’s approval. The reason the United States conducted euro-selling and yen-buying through a “partial coordination intervention” without selling U.S. Treasuries or requiring market sales of Treasuries was that the funds available for sale were euros under the Secretary of the Treasury’s sole decision. Even if the ESF’s foreign currency allocation were shifted from euros to yen, the total foreign currencies held by the ESF would not change. That is the core of the Secretary of the Treasury’s argument to the ECB.
The problem is why the Secretary of the Treasury did not give the ECB any advance notice or engage in prior consultation before carrying out euro-selling and yen-buying.
That would almost certainly have been rejected if discussed with the ECB. In addition to IMF principles noted above, Europe’s well-known aversion to interventions by other countries using their own currencies, and the ECB’s 21-member structure, make it difficult for Lagarde to approve a unilateral euro-selling and yen-buying intervention.
On the other hand, Japan had strongly urged “coordinated intervention.” If Japan’s demand had been ignored and a “unilateral intervention” had been forced, Japan might have resorted to selling U.S. Treasuries held in the foreign exchange special account to secure intervention resources.
Given that the effectiveness of a non-coordinated intervention is limited, as proven by the previous April’s “warning intervention” and “smartphone intervention,” it was necessary to establish a context for a “coordinated intervention” to deter the sale of U.S. Treasuries in the market.
From the perspective of the Secretary of the Treasury who prioritized preventing U.S. Treasuries’ market sales, balancing the risk of being refused by the ECB to conduct euro-selling and yen-buying with the risk of Japan being cornered into selling U.S. Treasuries in the market, reporting to the ECB after the fact would have been a rational decision.
What matters in implementing a “coordinated intervention” is to do it without selling U.S. Treasuries.
Using euros held in the ESF was also for that reason. The ESF holds 25.5 billion dollars’ worth of assets in foreign currencies, including “non-marketable U.S. Treasuries” and deposits, making it easy to secure a basis for dollar-selling interventions. However, to use ESF’s dollar-denominated assets as intervention funds would require the Treasury to issue new bonds, which would stress the short-term money market.
Given that the selling of U.S. Treasuries would create market stress and that there was only euros left as a feasible instrument for a “coordinated intervention” without selling Treasuries or issuing new bonds, the United States opted for an “irregular coordinated intervention” using euro rather than dollar selling.
There was another reason the United States chose an “irregular coordinated intervention” using euro selling and yen buying.
This was to avoid sending the market a distorted message that the dollar was weakening or that the dollar/yen rate targeted a specific level.
If the United States had carried out dollar-selling and yen-buying intervention with Japan, markets—prone to oversimplification—would have almost certainly misperceived that the intervention level was a defense line against further dollar strength and yen weakness beyond that level.
For Secretary of the Treasury Yellen, the next challenge after choosing the “irregular coordinated intervention” is to sustain its effects for a longer period, and her argument that the yen is significantly undervalued and that many Asian currencies move in tandem with the yen—while not mentioning U.S. dollar issues—appears to be aimed at avoiding suggesting a specific dollar level.
The next task for Secretary of the Treasury Yellen, who launched the “irregular coordinated intervention” on the basis of the yen’s specific circumstances, is to sustain the intervention’s effects for a longer period.
Right before the intervention, Secretary Yellen allegedly had a note on her desk reading “To Do” followed by “Buy Japanese Yen (JPY) $5-10 bil.” for Reuters to photograph, which was likely a maneuver to reinforce the impression that the intervention on the 31st was a form of “coordinated intervention.”
The problem with the “irregular coordinated intervention” is that its funding is finite and the supply of ammunition is limited.
Fortunately or unfortunately, information disclosure on U.S. financial matters is more advanced than Japan’s, and the ESF’s balance sheet is disclosed monthly.