Gary Hufbauer and Yee Wong (“Grading Growth: The Trade Legacy of President Bush,” Summer 2004) ably assessed US President George W. Bush’s trade efforts. I question two points: their criticism of US Treasury Secretary John Snow’s comments supporting the strength of the US dollar, and their concern over the pegging of the Chinese yuan.

Hufbauer and Wong complain of Snow’s “Orwellian doublespeak,” but I believe the best comment any Treasury Secretary can make about the dollar is “no comment.” There are four reasons. First, the Secretary does not control the currency exchange rate. The US Federal Reserve affects the exchange rate through money creation, which influences the supply of dollars and expectations of inflation. Comments by the Secretary only disturb markets. Second, the Federal Reserve should not use the exchange rate as a policy tool, although it might watch the exchange rate to obtain information to guide the setting of other policies. Third, normal movements in exchange rates reflect differences in the rates of inflation in different currency areas, and have no lasting impact on trade. Finally, currency market interventions by central banks to alter exchange rates and, consequently, trade balances are either sterilized, in which case they fail to move the money supply and hence the exchange rate, or not sterilized, in which case there is a shift in the money supply that changes the domestic price level and negates any cost advantage to domestic producers from the change in the exchange rate.

The strength of the dollar in 2000 and 2001 reflected excessive monetary tightening by the Federal Reserve. Other indicators of tight money in 2001 were falling commodity prices and slowing inflation. Falling nominal interest rates from 2001 to 2003 signaled falling inflationary expectations. Another influence on the dollar was the strengthening US economy. Capital flows swung in favor of the United States as a superior destination for investment. Both events raised demand for the dollar. The rising dollar should have convinced the Fed to tighten less than it did; subsequent easing by the Fed eventually brought the dollar down.

Second, Hufbauer and Wong should not have such a pessimistic view on China pegging of the yuan to the dollar. China’s pegging is beneficial, not harmful. It reduces exchange rate risk that would hinder trade and investment flows. It would hurt only if China tried to maintain a domestic price level inconsistent with the dollar peg by sterilizing the impact of net foreign exchange earnings and capital flows on the domestic money supply. Otherwise, the price adjustments in China to an influx of dollars would negate any real price advantage to Chinese producers. Put another way, a revaluation of the yuan would not permanently raise the cost of Chinese exports, but instead would quickly retard the growth of prices in China, eliminating any rise in the real price of Chinese products. Exchange rate manipulation is not the powerful trade lever that its proponents hope and its opponents fear. Note that China has a net capital inflow, which requires a matching current account deficit. China may have a trade surplus with the United States, but that is exceeded by deficits with other nations.