The currently proposed legislation that would use
currency-based countervailing duty surcharges to help reduce America's trade
and unemployment problems will have almost no impact because CVDs are designed
to fix firm-level, product-specific problems, not macro-economic imbalances. The
note concludes that a macro-level policy designed to correct the dollar's
global overvaluation is needed instead.
Background
Congress is well aware of the strong desire of Americans to
reduce America's growing trade deficit and to stop the loss of well-paying jobs
to countries like China. Many members of Congress also share the belief that
currency manipulation by countries like China is the primary reason for our nation's
increasing inability to compete profitably in domestic markets with imports and
in global markets with exports.
Trade-related bills such as the Currency Exchange Rate Oversight Reform Act of 2013 and the Currency Reform for Fair Trade Act of 2013,
which were being considered by the Senate and the House during the previous
session, would have sought to reduce America's trade deficits and job losses by
treating undervalued currencies as state-granted subsidies which, under WTO
rules, could be offset with currency-based penalty charges added to normal countervailing
duties (CVDs). The penalty would have been set according to the degree of
currency undervaluation.
Today, Congress is struggling to find a way to deal with the
growing pressure to "do something about currency manipulation" in the
Trade Promotion Authority (TPA) and in the Trans-Pacific Partnership (TPP)
negotiations. This effort is reflected, for example, by a bill recently
proposed by Senators Rob Portman and Debbie Stabenow that would have
strengthened penalties for currency manipulation by TPP partner countries.
A variety of enforcement mechanisms have been suggested to
put real teeth into such legislation. Of these, the mechanism most frequently
recommended has been along the lines mentioned above -- an additional import
duty based on the degree to which a country like China is deemed by U.S.
authorities has an undervalued currency. However, the efforts of Portman,
Stabenow, Brown and others along these lines seems to have failed for now for
various reasons.[1]
Although Congress urgently needs to pass legislation that
will help reduce the misalignment of exchange rates that has lead most recently
to large trade imbalances, especially between the United States and China, the
failure of recent efforts to include currency language in current legislation is
a blessing in disguise. This provides time for economists, trade policy
experts, and Congress to work together to find a better solution than
currency-based countervailing duty surcharges (CBCVDs), virtually the only
approach under consideration so far.
The appeal of attacking currency manipulators like China is
obvious. Americans see stores being flooded with goods from countries like
China that have indeed manipulated their currencies in the past to gain an
unfair advantage in international trade. Americans see talented, hardworking fellow
citizens joining the unemployment lines when their jobs are lost to foreign
producers, many of whom are based in countries regarded as currency
manipulators. They see U.S. trade deficits and debts to foreigners grow as America
borrows from countries like China to pay them to produce goods that could
easily be produced here at home at internationally competitive prices if only
the yuan and the dollar were both closer to their equilibrium exchange
rates – rates that would balance imports and exports.
Unfortunately,
however, trying to solve these serious macro-economic problems by adding currency-based
penalties to countervailing duties is doomed to fail.
Countervailing duties, which have been used for at least a
century, have a very important role to play in protecting American
manufacturers from unfair foreign competition that happens when foreign governments
subsidize their producers. However, subsidies provided through undervalued
currencies are a quintessentially macro-level issue, directly or indirectly affecting
the prices of virtually all goods and services produced in an economy.
The impact on goods and services that can be traded internationally
is clear. For example, if Japan were to undervalue its currency by 20 percent,
all U.S. automobile manufacturers would have to reduce their prices 20 percent
to compete with Japan, not only in export markets, but even in America's
domestic markets. If meeting the "Japan price" means running losses, firms
can manage this for a while, but eventually they will have to close their
factories – just as far too many U.S. manufacturers have done in recent
years. In fact, all U.S. manufacturers are at risk when the dollar is
overvalued and other currencies are undervalued, each with respect to its "fair
value" – the exchange rate that would balance each country's imports
and exports.
In short, while countervailing duties have an important role
to play, their scope is simply too limited for them to handle the
macro-economic problem of currency misalignment. Using such duties to correct
overall currency misalignments would be like trying to demolish an old building
with a few randomly placed firecrackers rather than with charges of dynamite well-placed
at the very foundations of the structure.
The remainder of this note demonstrates with actual data the
extremely small impact that currency-based countervailing duty surcharges (CBCVDs)
would have on America's trade balances. Given that these surcharges would act
like additional tariffs, and that the intent of currency-based CVD surcharges
is to reduce total U.S. imports, not just imports of specific products from
specific countries, the probable impact of CBCVDs is calculated here as the
additional import duty that such charges would represent as a percentage of
total U.S. imports.
Furthermore, since China is the key focus of legislative
concern today as far as currency manipulation and thus currency-based CVD
surcharges are concerned, the total tax that would be imposed by American CBCVDs
on Chinese trade is measured as a percentage of total U.S. imports. Including possible CBCVDs on other countries
that are involved in the TPP negotiations would increase the total impact
slightly, but their share in total U.S. trade is likely to remain very small, and
since they have never officially been designated by the IMF as currency
manipulators, it is unlikely that they will become verifiable currency
manipulators in the future.[2]
Reasons why fighting currency manipulation with countervailing duty surcharges will not work
At least as far back as the Omnibus Trade Bill of 1988 that
mandated the twice-yearly reports by Treasury to the Congress on world
currencies and currency manipulation, U.S. law has focused on trying to force
other countries to stop manipulating the value of their currencies to gain
competitive advantage.
The biggest
logical problem with this approach today is that, judged by IMF definitions, none
of the eight countries that account for about 90% of America's overall
bilateral trade deficits (China. Germany, Japan, Mexico, Canada, Saudi Arabia,
Ireland, Italy) are now manipulating their currencies. In fact, the IMF has
never charged any country with currency manipulation, and only one of the
countries in the TPP group, China, has ever been considered a currency
manipulator by the United States. Given that the IMF recently declared the
Chinese yuan to be fairly valued, this removed the last and largest source of
U.S. trade deficits from the list of potentially relevant currency
manipulators.
If none of
the countries with which the United States has significant trade deficits is
guilty of currency manipulation, why should America even think about trying to fix
its trade deficits by penalizing currency manipulators? In fact, if currency manipulation is really
the main source of U.S. trade deficits as some believe, but none of its major
trading partners are manipulating their currencies, why does America still have
such large and growing trade deficits?
Despite
these obvious questions, some Americans continue to argue that America should
use currency-based CVD surcharges to fix its trade deficits, either because
they believe that CVD surcharges will have a far greater impact than they actually
would, or because they believe that the threat of CBCVDs will discourage
countries from becoming currency manipulators in the future. The next two
sections demonstrate the fundamental weaknesses of both of these views.[3]
CVDs cover far too small a share of U.S. trade to significantly reduce U.S. trade deficits.
If China should become a currency manipulator under IMF rules, currency-based CVD surcharges by the U.S. on imports from China would be too small to have any significant impact on total U.S. imports. Given this, we can be sure that CBCVDs would have even less impact on U.S. imports from other smaller trading partners that have even less inclination to become currency manipulators.
Figure 1: The burden of CVD penalties - six
hundredths
of one percent.  |
Figure 1 represents the burden of currency-based CVD
surcharges as a share of total U.S. imports (the blue bubble). Despite the fact
that about half of our trade deficits come from trade with China, our imports
from China represent less than 20 percent of total U.S. imports of goods (the red bubble).
Even if we assume
that the current share of U.S. imports covered by CVDs increases by 50 percent
from the current level – from about two percent of all imports to three
percent – and that the share of imports from China covered by CVDs is the
same, currency-based CVDs would affect barely over half of one percent of all U.S.
imports (the white bubble in Figure 1). If the yuan's undervaluation and thus
the CVD penalty rate are 10 percent, the total burden of currency-based CVD
surcharges on China trade would be only six hundredths of one percent as a
share of total U.S. imports (the black spot). Clearly not enough to fix
America's trade deficits.[4]
CVDs affect too small a share of China's exports to have any real impact on Chinese trade policy.
OK, but maybe just the threat of countervailing duty
surcharges based on estimated currency undervaluation will make China shake in
its boots and abandon any thought of reintroducing currency manipulation. This
is highly unlikely, as shown by Figure 2.
Figure 2. For China,
currency-based CVD surcharges would
be a flea, not an elephant.  |
China's total exports, which represent 28 percent of China's
GDP, are shown by the blue bubble. Of total Chinese exports, only 17 percent go
to the United States (the red bubble), making the U.S. a rather minor player in
terms of China's total exports. If roughly three percent of China's exports would be
subject to U.S. currency-based CVD surcharges, the charges would affect barely more
than half of one percent of total
Chinese exports (the white bubble).
And if China's currency were once again to
be undervalued because of verifiable currency manipulation by about 10 percent (roughly
the average between 2008 and the present),[5]
the currency-based CVD surcharge would be 10 percent, creating a tax burden
equal to five hundredths of one percent of total Chinese exports (the black
dot).
Suffice it to say, this dot is not exactly an elephant that
will stomp China into submission if it decides that another round of currency
undervaluation is just what it needs to export its increasingly serious economic
slowdown. In fact, currency-based CVD surcharges would be more like the flea on
the tail of a dog trying to wag the entire dog, and China is likely to respond
in kind – nipping at the flea with its fangs and becoming very annoyed to
the detriment of others – but refusing to change its policies one iota.
If currency-based CVD surcharges are a dead-end approach to
solving America's overall trade deficits and job losses, what can it do instead?
Eliminating the U.S. dollar's overvaluation on a global basis would fix the problem.
A key problem with currency-based CVD surcharges is the
underlying assumption that other countries are to blame for America's trade
deficits. If those countries would only follow the rules, people say, America
would not have any problems.
It is always more comfortable to blame someone else for our
problems than to look into the mirror to see if we have done something that might
be causing the problem. But the road to sanity is paved with accepting reality,
and today's reality is that, while the world has changed dramatically in the
past 50 years, our international trade and monetary policies have remained
mired in the mud of past centuries, causing the dollar to become significantly
overvalued.
More specifically, exchange rates are no longer determined
primarily by the balance of demand and supply for imports and exports, a process
that tended to keep exchange rates at equilibrium levels in the past. Instead,
exchange rates are now determined largely by capital flows because international
trade in these flows grossly exceeds trade in the international flow of real
goods and services. This fundamental paradigm shift in the way exchange rates
are determined means that any similarity between market exchange rates and the
equilibrium exchange rate needed to balance current account transactions is
basically an accident, one that happens rarely.
As home to the world's largest financial markets, the
world's "safe haven" in times of strife, and as issuer of the world's
premier reserve currency, America has been hit far harder by this fundamental
paradigm shift than any other country in the world. The demand for dollars and
dollar-based assets is constantly pushing the value of the dollar to levels
that make it hard for made-in-America goods and services to compete.
Figure 3. Establishing a
competitive equilibrium exchange
rate for the dollar would fix trade deficits.  |
Figure 3 indicates that moving the dollar to a competitive
equilibrium rate, which would currently require a devaluation of the dollar by
about 25 percent [6]
given its amazing run-up in the past year, would make a vastly greater contribution
to improving trade balances, jobs, and factory profitability than
currency-based CVD surcharges ever could. In fact, compared to the six hundredths
of one percent that currency-based CVD surcharges would have as a percentage of
the value of total U.S. imports, fixing the overvalued dollar would have an
impact equal to nearly 50 percent of total U.S. imports (the black bubble).
The main "secret" to the vastly greater impact of
fixing the dollar's overvaluation is that, while CVDs impact only a very small
share of imports, and currency-based CVD surcharges represent an even smaller
percentage of total U.S. imports, the exchange rate affects all U.S. exports as well as all U.S. imports.
Conclusion
Congress should stop thinking about using currency-based CVD
surcharges to fix the misalignments between the value of the dollar and values
of the currencies of its major trading partners.
CVDs will continue to have a very useful role to play in
protecting America's producers of specific products from unfair competition caused
by government-subsidized products from specific producers in other countries.
However, their very narrow focus makes them inappropriate for tackling the far
broader macro-economic problem of fundamental currency misalignments –
misalignments that are driven largely by the profound paradigm shift that makes
capital flows, not the imports and exports of real goods and services, the main
determinant of the dollar's exchange rate in the 21st century.
Instead of focusing on legislation that would require CVDs
to take on a macro-level task for which they are ill-suited, Congress should
focus on legislation that will move the dollar's exchange rate to its overall equilibrium
level. Once the dollar reaches its fair value, all foreign imports will be priced at more realistic levels,
removing the burden of the overvalued dollar currently imposed on all American producers of goods and
services, competing with imports. Furthermore, moving to a fair value for the
dollar would make all American exports
less expensive and more competitive in markets around the world.
This double whammy – reducing unfair competition from
underpriced imports and improving the profitability of production
for export markets – is the biggest
single advantage of using an economy-wide tool like exchange rate changes
instead of a firm-level tool like CVDs. Furthermore, focusing on the dollar's
global exchange rate instead of focusing on tweaks that would affect only
selected products from specific countries would help keep the playing field
level so that all U.S. producers have an equal chance of competing with
imported goods – and of competing in export markets.
Other
notes on this blog site such as the post entitled "Balance U.S. Trade with a MAC Attack on Currency
Misalignment" (May 1, 2015) describe how a Market Access Charge (MAC)
could easily be used to move the currently overvalued dollar to a level that
would make U.S. manufacturers and other producers fully competitive
internationally, thereby helping to assure balanced trade, the restoration of
thousands of factories, and the creation of millions of new well-paying American
jobs.
John Hansen, PhD, World Bank
(ret.) June 23, 2015
[1] The most
persuasive argument commonly made against having the TPA require that
enforceable anti-manipulation language be included in the TPP is that this
would make it impossible to agree on a TPP, thereby foregoing the many benefits
that such an agreement could produce. For example: Countries do not want to tie
their hands when it comes to monetary policies such as quantitative easing,
which can devalue exchange rates. Countries do not like the idea that America
will be in position to impose additional import duties if American officials
decide that a country is manipulating its exchange rate according to IMF rules
(something that the IMF itself has never been able to do, by the way). Free
trade negotiations are conducted by experts in trade, not in monetary policy.
And finally, adding currency language to the TPP would require adding an entire
new chapter to a document, further protracting a discussion that has already
been underway for years.
[2] The
calculations for this note were based wherever possible on actual data from the
World Bank's World Integrated Trade System, the IMF, the U.S. International
Trade Administration, the Census Department, the Bureau of Economic analysis
and the Peterson Institute for International Economics. For values that cannot
be determined empirically such as the future share of China's exports that
might be subject to U.S. currency-based CVD surcharges at some point in time,
reasonable estimates were based on existing data. To facilitate sensitivity
testing, such parameters can easily be modified in the model.
[3] Other
reasons that the CVD approach will not fix America's trade deficits will be
discussed in future notes.
[4] In the
latest edition of Estimates
of Fundamental Equilibrium Exchange Rates, Cline
reports that, for the nine countries in this the report where appreciation is
needed to correct undervalued currencies, the average amount required is 8.2
percent (without Singapore, which needs to revalue by 25 percent, the average
is only 6.1 percent). Thus, assuming that CBCVDs would be set to countervail a
10 percent currency undervaluation probably overstates the actual impact of the
CVD policy option.
[5] Cline
(op. cit.) reports that, while China's currency is no longer undervalued, it
had been undervalued by an average of about 10 percent between 2010 and 2014. Successive
issues of the PIIE currency reports have placed the Chinese yuan below its
fundamental equilibrium exchange rate at about 20 percent in 2008–09, about 15
percent in 2010–11, and in the range of 2 to 5 percent in 2012–14. (op. cit., and
see Cline's interactive FEERs map, available at http://www.piie.com/interact/feers/map.html).
[6] This
overvaluation figure for the dollar is calculated as follows: Cline's latest
study indicates that the U.S. dollar is currently overvalued by 7.9 percent.
However, instead of targeting a zero balance in external trade, he follows the
PIIE tradition of using a target of +/- three percent of GDP which, for the
United States, is equivalent to accepting the unemployment of an additional 3-5
million workers compared to employment with fully balanced external trade.
Therefore, for this blog post, the dollar overvaluation figure of 7.9 percent
is adjusted with balanced international trade as the target.
This is easily done as follows. The "impact
parameter" used in Cline's report indicates that changing the exchange
rate by one percent would change the trade balance by 0.17 percent of GDP.
Inversely, the dollar would need to be devalued by 5.9 percent to attain a
one percent of GDP improvement in the current account balance.
Using this relationship, the adjustment in the dollar's
exchange rate that would be required to accomplish a truly balanced U.S.
current account rather than a three percent deficit can thus be estimated as
the required 7.9 percent devaluation noted in Cline's report, plus three times
the inverse of Cline's impact parameter. The resulting total devaluation
required is (7.9 + 3*5.9) or 25.6 percent. Because the examples used in this note
assumes that the dollar only needs to be devalued by 20 percent, they
understate the positive impact of moving the dollar by 25 percent to its true
equilibrium exchange rate.
America Needs a Competitive Dollar - Now!
