Contents
1) Currency Policy Agreements in the US-China Trade Agreement (USCNTA)2) General Enforcement Provisions in the US/China Trade Agreement
3) Market Access Charge (MAC) may be Prevented by the Agreement
4) Competitive Devaluation Ban
5) Market Determined Exchange Rates: A Dangerous Mandate
1) Currency Policy Agreements in the US-China Trade Agreement (USCNTA)
Overview:Little if anything has been gained on the currency front with the Phase 1 Trade Agreement with China. Both partners were already bound to most if not all of what is in the USCNTA by previous agreements – especially the IMF Articles of Agreement.
In Chapter 5, the USCNTA generally follows the standard model for current US trade agreements (c.f. the USMCA) with provisions like: don't manipulate; be transparent about your international currency transactions; let the market determine your currency's exchange rate; if you violate the rules, we will have to talk; if we still have an issue, we will retaliate with tariffs; if that doesn't work, the deal is off.
Although basically a copy of ideas on currency from previous agreements, the US/China Trade Agreement unfortunately added some serious inconsistencies with standard IMF language on currency practices, inconsistencies that the Chinese could exploit to make it difficult for the United States to restore balanced trade by moving the dollar to a trade-balancing exchange rate with, for example, the Market Access Charge (MAC). For more on this, see Section 3 below ("The Market Access Charge may be Prevented by the Agreement").
2) General Enforcement Provisions in the US/China Trade Agreement
Summary:In addition to the enforcement language specifically for currency agreements in Chapter 5, Chapter 7 contains language regarding overall enforcement of the US/China Trade Agreement that apply to currency practice agreements. The provisions do not seem to break new ground compared to other US trade agreements or give the US additional leverage to force compliance. In fact, the enforcement provisions mark a step backwards. The Agreement does not provide for any disputes go to a neutral arbitrator. Instead, if China and the US cannot work out their differences, the United States could impose tariffs — and the deal could unravel.
Discussion:
The Enforcement section of the USCNTA is structured as follows:
• Articles 7.1 and 7.2 establish the purpose and structure of a "Bilateral Evaluation and Dispute Resolution Arrangement."
• Article 7.3 discusses "Requests for Information" in a normal way – the only possible red flag being that the parties are not obliged to provide "confidential information." (Who knows what the Chinese may declare to be "confidential.")
• The "Dispute Resolution" procedure in Article 7.4 is also routine – and relatively toothless, calling for consultations if one of the parties complains. If agreement is not reached, "the Complaining Party may resort to taking action based on facts provided during the consultations, including by suspending an obligation under this Agreement or by adopting a remedial measure in a proportionate way … ", thus opening the door to retaliatory tariffs, and possibly exit from the Agreement. And as noted in the summary above, the absence of a provision for a neutral arbitrator increases the risk of agreement failure.
3) Market Access Charge (MAC) may be Prevented by the Agreement
Summary:Senior officials in the Trump administration offered assurances before signing that the US/China Trade Agreement will not create a barrier to implementing the MAC. Despite these assurances, the Agreement contains specific language could, as written, make the MAC's implementation impossible. The most problematic phrases in the Agreement are the following:
1. The Parties shall refrain from competitive devaluations and not target exchange rates for competitive purposes… .
2. Each Party should achieve and maintain a market-determined exchange rate regime;These two critically important issues are discussed separately in the next two sections.
4) Competitive Devaluation Ban
Summary:The Agreement's provision that, "The Parties shall refrain from competitive devaluations and not target exchange rates for competitive purposes… ." is highly problematic. The key purpose of the MAC is to devalue the dollar by enough to make it and American goods sufficiently competitive with foreign goods to bring the America's international trade back into balance.
This provision in the US/China Trade Agreement categorically prohibits competitive devaluations for competitive purposes. This language could potentially prevent the US from implementing the MAC. Alternatively, the MAC's implementation could provide a basis for China to retaliate or to abandon the Agreement entirely, either of which could mean a renewed tariff war.
Discussion:
China could easily use the Agreement's unfortunate language regarding "competitive devaluations" as the legal basis for various forms of retaliation. However, such an interpretation would be inconsistent with the following provisions elsewhere in this same article of the Agreement:
• The Parties shall … avoid unsustainable external imbalances.Upon joining the IMF, China and the United States each agreed to abide by the IMF's Articles of Agreement. By signing the US/China Trade Agreement, they may have violated the terms of their IMF membership because, by forbidding exchange rate adjustments for competitive purposes, they may have made it virtually impossible in today's world for either party to attain the "effective balance of payments adjustment" called for by the IMF's Articles.
• Each Party confirms that it is bound under the International Monetary Fund (IMF) Articles of Agreement to … prevent effective balance of payments adjustment or to gain an unfair competitive advantage.
The IMF is the ultimate international arbiter of exchange rate issues, and the IMF language in essence says that (a) adjustment to achieve an effective balance of payments on the external account is a priority, (b) exchange rate management for competitive purposes is forbidden only if done to gain an unfair competitive advantage, and that (c) balanced trade, the goal of the MAC, can never reflect an unfair competitive advantage.
Solution:
We must conclude that the USCNTA article regarding devaluation for competitive purposes as cited above is not well worded and that more appropriate language would read as follows (added language in bold):
"Except as required to eliminate balance of payments deficits, the Parties shall refrain from competitive devaluations and shall not target exchange rates for unfair competitive purposes.A Definitions section should be added that states:
"Unfair" means actions taken to attain or maintain a balance of payments surplus.Unfortunately, the Administration's decision to negotiate and implement this Agreement in secret with no public input, review or approval means that America is now saddled with a document that will be hard to correct in a manner that protects America's legitimate desire for balanced trade unless a way can be found to insert the missing words highlighted in the preceding paragraph. Perhaps this problem could be solved with an appropriate side letter signed before the Agreement goes into effect. Incidentally, a similar approach was used to cover currency issues in the Trans-Pacific Partnership (TPP) negotiations.
5) Market Determined Exchange Rates: A Dangerous Mandate
Summary:The Agreement's requirement that both countries "achieve and maintain a market-determined exchange rate regime" likewise creates potentially serious problems for the MAC's implementation because it is explicitly designed to fix a market-determined problem: For nearly fifty years, the market-determined exchange rate for the dollar has been overvalued, leading to unending trade deficits and associated problems.
A market-determined exchange rate is the cause, not the solution, for America's trade deficits. The Agreement has done a potentially serious disservice to America by insisting that we continue to sacrifice our prosperity and our future on the false altar of market-determined exchange rates. Instead of more market fundamentalism, we need a tool like the MAC to restore a solid, dynamic link between the dollar's exchange rate and balanced trade.
Discussion:
Today, the dollar's exchange rate is "market determined," and this is the true source of America's trade deficits. If the United States does "maintain a market determined exchange rate" as required by the signed agreement, the US will face unending trade deficits, lost growth, lost employment, lost leadership in advanced technology, lost resources to develop and implement improved and green infrastructure, even worse income distribution than we have today, and mounting debts to foreign countries that will deplete America's wealth and seriously reduce the prospects of future generations for a better life than we have enjoyed. This is totally unacceptable.
Markets can produce optimal results – providing highly specific requirements such as perfect knowledge and perfectly rational behavior are met. Unfortunately, thanks to highly asymmetric and imperfect information flows across national boundaries, and to the "herd behavior" of investors that is so common in financial markets, forex markets rarely meet the "perfect market" standards. The forex markets' ongoing market failure – the failure to set the dollar at a trade-balancing equilibrium exchange rate – also reflects (a) the global glut of foreign savings by trade-surplus countries, (b) the consequent excess demand for dollars and dollar-based assets, and (c) the absence for nearly fifty years of any link between balanced trade and exchange rates.
With well over forty years of unbroken trade deficits as proof of global currency market failures, it is hard to imagine why anyone would think that insisting on "market-determined exchange rates" is the solution – just as it is hard to imagine why anyone would think that predatory, mercantilist currency manipulation as practiced over the years by many of the export-oriented "Asian Tigers" including, most recently, China is the solution. Any currency agreement should reject with equal vigor purely "market-determined exchange rates" and purely "mercantilist currency manipulation."
The case for using a tool like the MAC to keep foreign money inflows and thus the dollar's exchange rate consistent with balanced trade is strengthened by the fact that, for over a hundred years, America has depended on the Federal Reserve to keep domestic money flows consistent with the dual mandate of maximum employment and stable prices.
The key tools used by the Fed are the targeted Federal Funds Rate and the Fed's discount rate (the interest rate charged to commercial banks and other depository institutions on loans they receive from their regional Federal Reserve Bank). When domestic money flows are excessive and are threatening price stability, raising the Fed Funds rate and the discount rate serve as a charge that moderates the domestic demand for money, thereby keeping the flows consistent with price stability. In like manner, the MAC charge will keep foreign monetary flows consistent with exchange rate competitiveness and balanced trade.
In fact, the MAC charge is really the long-missing partner of the Fed's domestic monetary policies, doing for cross-border money flows what those policies do for domestic money flows. Given that a very significant portion of increased domestic monetary flows come in from abroad, the MAC will directly complement the standard tools of the Federal Reserve while, at the same time, assuring trade-balancing exchange rates for the dollar.
Solutions:
As with the Agreement's language on "devaluations for competitive purposes," it is hard to know how to get out of the problem that the agreement has created for America with its language on "market-determined exchange rates."
Perhaps, as with the competitive devaluations problem, the solution may lie in a side letter signed in advance of the agreement's going into effect, a letter that makes subtle but very important changes in the agreed language as reflected in the following: (shaded text to be deleted; bold italic text to be added)
Each Party should achieve and maintain a market-determined an exchange rate regime that depends primarily on market-based incentive mechanisms such as fees and charges, not on direct currency market intervention, to move and keep market exchange rates at levels consistent with basic balance on the current account.A Definitions section along the following lines should be added to further reduce any ambiguity:
- Market-based mechanisms are those that moderate cross-border capital flows by using ad valorem charges on such flows proportional to the current degree of trade imbalance as would be done, for example, with the Market Access Charge (MAC).
- Basic balance on the current account is an aggregate current account balance with all trading partners that does not deviate from zero by more than one percent of GDP on average over the previous three years.
Besides solving potentially serious problems that could prevent America from eliminating its overall trade deficit, the solutions suggested here would eliminate serious internal inconsistencies in the Agreement as signed.
These improvements would, in turn, reduce the risk that China, accusing the United States of violating the agreement, would renege on pledges regarding the purchase of US exports, increase retaliatory tariffs and non-tariff barriers against US exports, or abandon the agreement entirely. Finally, to the extent that the US/China Trade Agreement becomes part of a new USTR standard model for trade agreements world-wide, fixing the language as suggested here would significantly improve the quality of future trade agreements.
America Needs a Competitive Dollar - Now!
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