April 22, 2015

Fast-Track Language on Currency Manipulation: Just a Smokescreen Designed to Fail


The Bipartisan Congressional Trade Priorities and Accountability Act of 2015 (TPA) presented on April 16 includes language on currency manipulation that was added in response to intense pressures from Americans concerned that trade agreements such as the proposed Trans-Pacific Partnership (TPP) will open the doors even wider to foreign imports made artificially cheap by undervalued currencies (see full TPA bill and detailed TPA summary here).

However, the Hatch-Ryan-Wyden TPA bill as drafted will inevitably fail to provide the protection against artificially cheap imports that Americans need and want:
   A.    The bill simply repeats ineffective language similar to what has been in the IMF's rule book for years.
   B.    It does nothing to provide an enforcement mechanism.
   C.    It focuses only on currency manipulation by TPP members and totally ignores the much bigger and more important problem of overall currency misalignment.


In theory, lower tariffs and freer trade will increase the overall well-being of trading partners. Studies of America's recent free trade agreements such as one by Gary Hufbauer and colleagues at the Peterson Institute for International Economics (PIIE) indicate that U.S. exports have indeed risen as a result of these trade agreements, producing increased employment and income, at least in the exporting industries.

Other studies show that jobs have been lost in industries competing with cheaper imports. For example, studies by Rob Scott, Josh Bivens and others at the Economic Policy Institute indicate that the North American Free Trade Area (NAFTA)  and the United States-Korea Free Trade Agreement (KORUS) have led to serious job losses in industries adversely affected by imports.

Despite differences of emphasis, these studies indicate that substantial exchange rate adjustments, as recommended by Bergsten and Gagnon, will be needed to help balance overall trade and reduce the net loss of jobs in the economy.

This conclusion is particularly important in the context of potential trade agreements such as the TPP and the TTIP. America already suffers from excessive trade deficits – clear proof that the dollar is overvalued with respect to its trading partners as a whole. Even if imports and exports were to grow at the same accelerated rate under a free trade agreement such as the TPP, the absolute value of imports would increase faster than the absolute value of exports due to the larger initial volume of imports, leading inevitably to larger trade deficits and higher rates of unemployment.

The only way to prevent this disaster for America is to establish a highly effective mechanism that would bring about the exchange rate adjustments needed to balance U.S. trade.

The following summary demonstrates why the draft TPA legislation language on currency will be as ineffective as language already on the books in protecting America from unfair competition from artificially cheap imports.

A. Old Rules - Old Results

As the world's ultimate authority on exchange rates, the IMF has long sought to impose rules to prevent countries from manipulating their currencies.  However, the IMF's "though shalt not" rules have never had any real teeth because they cannot be enforced as written. 

A country like China is not going to stop manipulating currency values simply because the IMF says it should – especially since currency manipulation has been central to China's highly successful export-based growth strategy. Rules against currency manipulation must be backed up by a credible threat of punishment that would inflict costs greater than the benefits the country believes it derives from manipulating currency values.

America's experience with "thou shalt not" currency rules has been exactly the same as the IMF's. The Omnibus Trade and Competitiveness Act of 1988 mandated semi-annual reports by the Administration that covered, among other topics, currency and exchange rate practices of foreign countries . However, despite widespread evidence that China was an active currency manipulator, the U.S. Treasury has listed China as a currency manipulator only once – over 20 years ago!  Other than the citation of Taiwan and South Korea, also in the early 1990s,  no other country has been labeled a currency manipulator.

Neither the IMF rules nor the Omnibus Act of 1988 has prevented countries from gaining competitive advantage against the United States though currency manipulation. The same will be true for the proposed TPA text on currency.

In fact, without an effective enforcement mechanism, the bill's language on currency seems to be nothing but a smoke screen designed to give the appearance of doing something in response to public pressure for action against currency cheating while allowing America's TPP and TTIP negotiations to move forward, unencumbered by the need to negotiate anything that will actually solve the currency problem.

B. The Impossibility of Meaningful Enforcement Mechanisms in the TPP

The IMF's currency rules lack effective enforcement mechanisms because, like TPP rules, they are the result of international negotiations, and no country – whether represented by an Executive Director on the IMF Board or by a trade negotiator at the TPP sessions – will agree to enforceable provisions that would prevent them from pursuing policies they believe to be in their best interests.
American officials, especially those in the White House and in the Office of the United States Trade Representative, have vigorously opposed including anything meaningful on currency in the TPP negotiations because they know that there is basically no chance that their counterparts will agree to mechanisms that would force them to abandon the exchange rate manipulation that have been central to their export-oriented development strategies.

C. The Real Issue is Currency Misalignment, Not Currency Manipulation

If America wants to protect its factories and workers from unfair competition with artificially cheap imports, Americans should not focus on "currency manipulation" for the following reasons.
   1. "Currency manipulation" as defined by the IMF is a very limited concept. 
   2. "Currency misalignment" is far more important than "currency manipulation."
   3. "Currency misalignment" is far easier to fix.

Any one of these points is worth a blog post if not a complete article, but the following summary underscores why the Hatch-Wyden-Ryan TPA bill will do nothing significant to protect America from artificially cheap imports.

     1. "Currency manipulation" as defined by the IMF is a limited and often ambiguous concept

Article IV, Section 1 (iii) of the Fund’s Articles provides that members shall “avoid manipulating exchange rates or the international monetary system in order to prevent effective balance of payments adjustment or to gain an unfair competitive advantage over other members.” The same document goes on to say that, “Manipulation of the exchange rate is only carried out through policies that are targeted at—and actually affect—the level of an exchange rate." 

This apparently straightforward language is full of traps that make "currency manipulation" a non-issue compared to "currency misalignment." The latter means that a currency is not in line with its "equilibrium exchange rate," a rate that would balance imports and exports. Although the language may look similar, the differences are enormous, and even a cursory review of the definitions indicates why focusing on currency misalignment is far more important than focusing on the far more narrow issue of currency manipulation.

  • Currency manipulation can only be done by a government. Manipulation generally involves central bank interventions in foreign currency markets, while currency misalignment can be driven by anything, including currency manipulation, that creates a gap between the market exchange rate and the currency's equilibrium exchange rate. Other than currency manipulation, the most common factors that create currency misalignment gaps include differences between domestic and foreign rates of inflation, productivity growth, discovery and exploitation of natural resources, demographic changes, trading patterns, tariff and non-tariff barriers.
    Given the restrictive definition of "manipulation," countries can easily evade charges of manipulation by making purchases of foreign currencies and other foreign assets indirectly. For example, such purchases by state-owned sovereign wealth funds would generally not be counted as manipulation, even though the effect would be the same.
  • Currency manipulation involves the purchase of foreign currency with domestic currency. This means, for example, that Japan's (and America's) massive quantitative easing does not count as currency manipulation even though QE clearly affects currency values.  Likewise, the focus on "currency" provides a free pass for governments to purchase foreign assets other than currency.
  • Currency manipulation must involve the intent to gain international competitive advantage. This means that quantitative easing and most other policies that affect exchange rates can be "excused" as being designed to stimulate domestic growth, not to gain competitive advantage.
In short, currency manipulation as officially defined is a mouse compared to currency misalignment, which reflects the entire range of market and non-market forces that affect exchange rates.

    2. "Currency misalignment" is far more important than "currency manipulation"

As Dr. Bergsten mentioned in a recent note to the author, "When the Chinese intervention and surpluses, and the US deficits, were at record highs around 2006-08, Joe [Gagnon]’s estimates implied that manipulation was causing half or even more of our deficits.  Today, by contrast, intervention is much less and the macro-economic/monetary differences among the advanced countries are much greater.  So, the share of manipulation in the total is much smaller."  These words from one of the world's leading experts in the field of international finance indicate that, even if currency manipulation problems could be solved, which is very doubtful given the political and technical problems involved, doing so would fix only a small part of America's overall trade deficit and ot America's related problems--lost jobs and closed factories. Hence the conclusion:
Congress should focus on fixing currency misalignment, not currency manipulation.

    3. Currency misalignment is far easier to fix that currency manipulation.

Overall currency misalignment is actually easier to fix than country-specific currency manipulation for the following reasons:

  1. Subjective vs. Objective Indicators. Unlike currency manipulation, which can be disguised and hidden in a number of ways, currency misalignment is obvious to anyone looking at a country's trade balance or current account deficit. A deficit indicates an overvalued currency, while a surplus indicates an undervalued currency.
  2. Blame Games. Trying to fix currency manipulation always involves a blame game where one sovereign country such as the United States must pin the red badge of "Manipulator" on another sovereign country such as China. This game is virtually impossible to win, and it can lead to serious geopolitical and economic repercussions including currency wars, military aggressiveness in zones of influence, and a general breakdown of good trading relations --- key reasons that most Presidential administrations have refused to declare countries as manipulators under the Omnibus Trade Act of 1988.
  3. A country can fix misalignment directly rather than depending on other countries to act. At least as far back as the Plaza Accord of 1985, the United States has tried to solve its trade deficit problems by forcing other countries to revalue their currencies. This puts foreign countries in control of America's economic destiny. Not very smart! In contrast, the United States could easily fix the dollar's overall misalignment with respect to trading partner countries by moderating the inflows of foreign capital that drive the dollar's exchange rate up to levels where U.S. factories and workers are no longer internationally competitive.
The next post in this series will present a proposal for moderating capital inflows to levels consistent with a competitive exchange rate, a proposal that will, at the same time, provide excellent incentives for continued foreign direct investment in increased U.S. productivity. This proposal, which could and should be implemented before the TPP goes into effect, would be fully consistent with international law and with America's treaty obligations to its trading partners.

The currency language in the Hatch-Wyden-Ryan TPA bill offers virtually no protection to American factories and workers from imports made artificially cheap by distorted currency values. America needs and deserves more. Freer trade can bring great benefits to the American people -- but only if the dollar is at a competitive equilibrium level -- a level that allows Americans to earn as much producing exports as they spend on imports.

America Needs a Competitive Dollar - Now!