Today we are fortunate to have a guest contribution written by Jeffrey Frankel, Harpel Professor of Capital Formation and Growth at Harvard University, and former Member of the Council of Economic Advisers, 1997-99. This post is an extended version of an earlier column at Project Syndicate.
President Obama is still pressing his campaign to obtain Trade Promotion Authority and use it to conclude negotiations across one ocean for the Trans Pacific Partnership (TPP), and then across the other ocean for the Transatlantic Trade and Investment Partnership (TTIP). Many in the Congress, particularly many Democrats, insist that the trade agreements must include mechanisms designed to prevent countries from manipulating their currencies for unfair advantage.
The President is right. The congressmen are wrong. More suitable venues for discussing exchange rate issues with our trading partners include the IMF, the G-20, the G-7, and bilateral negotiations.
Here are the top ten reasons why including currency manipulation language in the trade negotiations would be unwise.
- If the US were to insist that “strong and enforceable currency disciplines” be part of trade negotiations, that would kill the negotiations. Other countries would not go along. And yet both the US and its trading partners stand to gain from these deals.
- Other countries would not go along with the manipulation language for good reason: It is a bad idea. True, there are times when particular countries’ currencies can be judged undervalued or overvalued and times when their trading partners have a legitimate interest in raising the question with their governments. But even in those cases when the currency misalignment is relatively clear, trade agreements are not the right venue to address it. The undervalued RMB was addressed in bilateral China-US discussions, 2004-11, eventually with success. China allowed the currency to appreciate 35% over time. Today it is well within a normal range.
- Most often it is impossible to tell whether a currency is overvalued or undervalued. Manipulation is not like the existence of a tariff or quota that can be verified by independent observers.
- A necessary condition for a country to be judged as manipulating its currency is that the authorities are intervening in the foreign exchange market. The People’s Bank of China, for example, bought up a record quantity of dollars in exchange for renminbi from 2004 to 2014, and thereby kept its currency from appreciating as fast as it otherwise would have. But, in the first place, the Chinese aren’t doing that anymore. If anything, they have been selling dollars in exchange for renminbi over the last year, keeping the value the currency higher than it would otherwise be. (Accordingly China’s reserves peaked at $3.99 trillion in July 2014 and then declined to $3.73 trillion by April 2015.) The implication is that US congressmen who say they want China to stop manipulating the currency might be unhappy with the consequences if that happened. Under current conditions, the renminbi would weaken, not strengthen, and American firms would find themselves at more of a competitive disadvantage, not less.
- In the second place, there are often legitimate reasons for intervening in the foreign exchange market, including even in cases of intervention to push the currency down. An example would be the overvalued dollar in 1985, when the US joined with Japan, Germany, and other G-7 countries in concerted intervention in the foreign exchange market –- associated with the Plaza Accord — to push the dollar down, bringing it off of a perch that at the time was much higher than where the dollar is today. Certainly intervening to prevent a currency from appreciating, which is what China did over the last decade, is not per se an illegitimate policy. Indeed a heavy majority of countries pursue either fixed exchange rates, exchange rate targets, or managed floating, all of which are legitimate policies that by definition entail buying and selling of foreign exchange to moderate or eliminate fluctuations in the exchange rate.
- In the third place, China isn’t even in the TPP, nor in the TTIP, the two sets of trade negotiations in which the US is involved and for which President Obama wants Congress to give him Trade Promotion Authority.
- Japan is in the TPP and it is true that the yen has depreciated a lot over the last year. Some US economic interests, particularly the auto industry, accuse Japan of manipulation to keep the yen unfairly undervalued. Many congressional critics cite Japan as the target of their proposals to insist that currency manipulation language be part of the TPP. But the last time the Bank of Japan intervened in the foreign exchange market was 2011. (This was an appropriate move, in the aftermath of its tsunami, to bring the yen down off a perch that was its post-war record high.) In 2013 Japan joined other G-7 countries in agreeing to a proposal from the Obama Treasury to refrain from foreign exchange intervention. The agreement is still in effect.
Similarly with Europe: members of the Eurozone are in the TTIP negotiations; the euro too has depreciated a lot over the last year; and some US trade critics accuse Europe of currency manipulation. But the European Central Bank has not intervened in the foreign exchange market since 2000, and that was to support the euro not depress it. The ECB was party to the 2013 agreement not to intervene as well.
- The critics who accuse Japan and other countries of currency manipulation presumably know that they haven’t been intervening in the foreign exchange market in recent years. They generally point instead to recent loosening of monetary policy, such as the quantitative easing, i.e., the purchases of domestic bonds, that the Bank of Japan and the European Central Bank have prominently pursued with the predictable side effect of depreciating their currencies. But countries can hardly be enjoined from easing monetary policy when domestic economic conditions warrant, as was so obviously the case in Japan and Europe.
- If monetary expansion does not merit the charge of currency manipulation just because it can be expected to keep the value of the currency lower than it would otherwise be, still less do other sorts of economic policies. Some have argued that even though the People’s Bank of China has stopped buying US and other foreign assets, China’s Sovereign Wealth Funds still do, and that this too counts as manipulation. But for China to put some of its saving abroad is a perfectly sensible and legitimate thing to do. The United States would worry if China and other countries did not want to buy its assets.
Moreover, think of the reductio ad absurdum. Every country makes policy decisions of many sorts every week, many of which can be expected to have an indirect side effect on the exchange rate in one direction or the other direction. (Often stupid policies are the ones that weaken the currency – think of Argentina, Russia, or Venezuela. But not always.) That a particular policy might have the effect of weakening the currency does not mean that the country is a manipulator.
- Finally is the point that if legal language were written to include the actions of the major trading partners’ central banks that US congressmen accuse of currency manipulation, then it could also be applied the other direction, against the United States. This would not be a case of misusing a tool – which is common enough among trade remedy cases when interest groups lobby for protection against foreign competition. (An example is the use of Anti-Dumping measures that were originally supposed to address cases of predatory pricing.) Rather it would be a case of using the tool in precisely the way it was written to be used. The Fed adopted quantitative easing in 2008 in response to the weakening US economy, just as trading partners have done recently. It continued to pursue QE up until recently. This had the effect of depreciating the dollar from 2009 to 2011, prompting the same charges of “beggar thy neighbor policies” [allegations of attacks in a supposed currency war] that US congressmen now level against others.
In either direction, whether by the United States or against it, such charges are on shaky ground. Monetary stimulus in one country may even have a beneficial effect on the rest of the world, as its own restored income growth leads to increased imports from its trading partners. But in any case, other countries are free to adopt whatever monetary policy suits their own economic circumstances. Whether one considers charges levelled against the US in 2010, against its trading partners in 2015, or against some unknown defendant in the future, it would be asking for trouble to set up a trade agency or institution to rule on them.
This post written by Jeffrey Frankel.