Currency intervention is a type of monetary policy. This is when a country's central bank purchases or sells its own currency in the foreign exchange market to influence its value.
Learn why countries choose to do this form of intervention and how it works.
What Is Currency Intervention?
Anyone can trade currencies on foreign exchanges. This allows traders to profit off of how the value of one currency moves in relation to another. When a country's central bank enters into those foreign exchanges and trades its own currency, that is currency intervention. By trading large amounts of its own currency, these central banks can influence the money's value.
- Alternate names: Forex intervention, foreign exchange intervention
International financial policy is the Congressionally-mandated responsibility of the Treasury. But in practice, the Treasury often coordinates with the Federal Reserve on these decisions.
How Does Currency Intervention Work?
At some points, a central bank feels like its currency is quickly appreciating (gaining value) or depreciating (losing value). This may be cause for it to decide to step in. It will conduct currency intervention to slow the movement.
It can be used to influence movement in either direction. But currency interventions often aim to keep the value of a domestic currency lower relative to foreign currencies. Higher currency valuations cause exports to be less competitive. This is because the price of products is then higher when purchased in a foreign currency. On the other hand, a lower currency valuation lowers the relative cost of a country's exports. This can help increase exports and spur economic growth.
If the U.S. wants to decrease the value of the dollar, for instance, the Fed will sell U.S. dollars. If the U.S. wants to increase the value of the dollar, the Fed will buy more U.S. dollars.
To keep a consistent amount of money in bank reserves as it buys and sells dollars, the Fed will "sterilize" the intervention. This sterilization involves selling or buying bonds in proportion to the size of the currency intervention.
Central bank currency interventions do trade large amounts of money. But the values aren't as significant in the scope of total forex trading. That means currency intervention doesn't immediately increase or decrease a currency's value. Instead, it signals the direction that a country's government is trying to push its currency, which may affect the decisions investors make. As more investors follow the Fed's movement, the currency value begins to shift.
Currency Interventions Throughout History
In a broader sense, the first instance of currency intervention took place long ago. It happened well before the globalization of currency trading and the establishment of a forex market that any trader could access from their computer or phone. As early as the 1920s, the Fed conducted a sort of currency intervention by simultaneously buying gold and selling U.S. dollars.
The U.S. engaged in currency intervention in 2011 to reduce the relative strength of the Japanese yen. Japan had just suffered a massive earthquake. In only five days, the yen's value against the U.S. dollar increased by 5%. The U.S. joined other G7 countries in currency intervention to stabilize the value of the yen as well as the broader forex market.
Currency intervention is fairly rare. From August 1995 through December 2006, it happened in the U.S. only twice.
Currency intervention isn't always an international cooperative effort, as it was in the wake of Japan's 2011 earthquake. In August 2019, for instance, Treasury Secretary Steve Mnuchin accused China of manipulating its currency. He believed they were doing so to create an unfair advantage in the global marketplace. Mnuchin said China was devaluing the yuan so that other countries would choose to import more products from China and fewer from the U.S.
- Currency interventions occur when a central bank buys or sells its own currency in the global forex market.
- Most currency interventions are done to contain appreciation of a currency; this can hurt certain sectors.
- Currency interventions can take place using a few strategies. But central banks ultimately don't have that much power in the scope of the broader forex market.