The Truth About Currency Manipulation

The image of U.S. President George Washington is seen on an engraving plate for a one dollar bill at the Bureau of Engraving.
The image of U.S. President George Washington is seen on an engraving plate for a one dollar bill at the Bureau of Engraving and Printing in Washington, November 14, 2014. (Gary Cameron / Courtesy Reuters )

U.S. President Barack Obama’s signature international economic initiative, and the centerpiece of his pivot to Asia, is the Trans-Pacific Partnership (TPP), a trade agreement of a dozen Asia-Pacific countries. But the partnership faces a major hurdle. Bipartisan majorities of both houses of Congress insist that the TPP forcefully address the manipulation of exchange rates, the practice through which some countries keep their currencies artificially weak and thus unfairly make their exports more competitive.

The U.S. auto industry, likewise, has indicated that it will oppose the TPP unless the issue is effectively addressed, and it has politically important supporters in the labor unions and the steel industry. At the same time, however, many observers believe that a U.S. effort to raise currency concerns would torpedo the agreement. There is a way to resolve this dilemma, but it will require new initiatives by the Obama administration, Congress, and TPP partner countries.

The critics of the TPP are correct to link currency and trade. Changes in exchange rates can affect trade flows and trade balances far more than any of the border, or even behind-the-border, barriers that are the usual focus of trade agreements. Indeed, it is just as economically distorting to artificially depress currency values—as China and a number of other countries have done over the past decade—as it is to impose high import tariffs and subsidize exports directly. As a result of this behavior, in some periods the United States has suffered much larger trade deficits and sizable job losses than it otherwise would have.

The international economic system has been totally ineffective at responding to such manipulation. The International Monetary Fund (IMF) has clear rules against competitive devaluations. But it has no enforcement mechanism and its decision-making process is highly politicized and easy for the manipulators to block. The World Trade Organization (WTO) can levy tough sanctions, but its rules on exchange rates are vague and have never been tested. Further, despite earlier congressional efforts, U.S. law has proved equally impotent. No administration in the past 30 years has pressed the issue effectively.

The frustration of Congress and of some elements of the business community is thus fully understandable. And now, Congress finally has the leverage to insist on a meaningful response: the administration needs legislative approval for the TPP and perhaps for the new Trade Promotion Authority (TPA)—that is, the authority for the president to negotiate trade agreements that Congress can accept or decline but not amend or delay. It will also need Congress to ratify a Transatlantic Trade and Investment Partnership (TTIP) with the European Union a bit later. The actual trade imbalances and volume of intervention have declined significantly in recent years, with the U.S. global deficit less than half its record peak in 2006 and the Chinese global surplus down by even more, but the problem has recurred repeatedly in the past and will surely arise again, so it cannot be ignored.

PRUDENT PROPOSALS

The main reason that currency problems have never been encompassed in trade agreements is institutional. Monetary and macroeconomic matters are handled by ministries of finance, including the U.S. Treasury, and the IMF. Trade policy is managed by trade, or sometimes foreign, ministries and the WTO. Each coterie guards its turf jealously, and coordination between them is infrequent. This bifurcation is highly unsatisfactory, and has been overcome on rare occasions, but is an unfortunate reality.

There are also understandable substantive reasons why countries have resisted tough international rules on exchange rates. All nations zealously defend their sovereign rights to manage their economies, including their currencies, and those policies are much more important than tariffs and other trade measures that apply only to specific products or sectors.

It is thus widely believed that any U.S. effort to include “strong and enforceable currency disciplines” in the TPP, as a large number of senators and the auto industry demand, would blow up the agreement (and that may indeed be the chief purpose of some of its advocates). This conclusion may not be correct, however. Currently, none of the current TPP countries would be indicted under even a rigorous definition of “manipulation.” China is not involved in the TPP talks and Japan, which is, has not intervened in the currency markets for some time. Singapore and Malaysia are the traditional manipulators in the TPP, but neither has recorded significant reserve increases, the most apparent indicator of intervention, over the past year or so. A currency clause would thus solely deter future misbehavior, including by possible future adherents to TPP, which would be enormously valuable but might make it more acceptable now.

So far, however, the U.S. negotiators have made no apparent effort to raise the issue despite clear congressional signals for the past two years. It is also undeniable that injection of such a major issue into this late stage of the TPP talks could significantly delay, and even possibly derail, an extremely valuable agreement. In part, this is because a currency chapter would have to be negotiated by finance officials, who have not previously been part of the discussions.

It might therefore be prudent for the United States to propose, or at least be prepared to accept, rules against currency manipulation that would be more modest but could still catch the most egregious cases. This would mean simply proscribing countries from running very large current account surpluses and conducting very large amounts of intervention, and perhaps setting these as norms or guidelines rather than as legally binding commitments. It would be a mistake, however, to dilute the basic principle of banning competitive devaluation or to exempt the issue from the agreement’s dispute settlement mechanism and sanctions, under which a violator could lose its TPP benefits until the problem was resolved.

Legislators could provide the foundation for such an approach by giving the administration flexibility to implement Congress’ currency directive. However, draft TPA legislation offered by the trade leadership during the previous Congress, after arduous negotiations with Treasury, would make it far too easy for the administration to avoid taking any action at all. This is the problem with the present legislation, dating from 1988, and is partly responsible for creating the current impasse.

SMART STRATEGY

An even better strategy for the United States, whether or not currency manipulation is addressed at least partially in the TPP, would be to implement an effective new currency policy on its own. This would respond to legitimate congressional and industry concerns, and should suffice to win passage of the pending trade legislation. In fact, it would be superior to including currency in trade agreements because it could be applied to countries outside as well as inside those agreements, such as China and other major manipulators. It would also avoid putting the FTA partners at a competitive disadvantage to important non-members, which would be unfair to them.

Three measures could be adopted. First, the administration should start obeying current law by formally designating countries that are currency manipulators. Both the former and current administrations have refused to do so, even when the practice was obvious, as when China was intervening at a rate of $2 billion per day a few years ago and running an external surplus equal to ten percent of its whole economy. This failure totally undermined U.S. credibility on the issue with the manipulators themselves, with potential U.S. allies on the problem including the IMF, and with Congress.

Second, the administration should authorize the imposition of countervailing duties on imports from countries that manipulate their currencies, whether or not they are members of trade agreements with the United States. Such manipulation is as much an export subsidy as any other against which the United States would normally countervail, and failure to do so is an absurd anomaly. The House and Senate have separately passed bills calling for this change, but it could almost certainly be carried out by executive action. Countries hit by the new approach might take the United States to the WTO, but the United States should be quite willing to fight that legal battle, which would take several years to play out.

Third, Treasury should announce that it is prepared to conduct “countervailing currency intervention” against manipulators to offset their distortions of the markets. If China buys one billion dollars to keep the dollar artificially strong and its currency artificially weak, for example, the United States would buy one billion dollars worth of Chinese renminbi to offset the exchange-rate impact. The principle is equivalent to the imposition of countervailing duties against subsidized exports, but this method would be far superior because it would affect all trade rather than only imports of individual products. A few implementations of this policy, or perhaps even just its announcement, should be enough to deter future currency manipulation. There would be no budget cost and the policy would almost certainly make money for the United States. The Senate authorized this approach in a currency bill in 2011 but it, too, could be implemented under current law. There are no international rules against it, so no counter-retaliation could be justified.

The United States has paid a major economic price for never having established an effective currency manipulation policy. Now it could suffer a huge defeat in trade policy, and indeed foreign policy, for the same reason. The TPP and other prospective trade legislation provide a compelling point of departure to take decisive action, as Congress and key stakeholders are insisting, whether in the new trade agreements themselves or otherwise. The administration is commendably and courageously conducting the most ambitious trade program in the history of the United States, with potentially enormous benefits for both its economy and foreign policy, but the administration must handle the currency issue much more adroitly to bring its strategy to fruition.

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