That trade and exchange rates are closely linked is not controversial. Ever since the post-gold standard age of adjustable exchange rates was inaugurated in the mid-1930s to facilitate a consensually negotiated depreciation of the French franc, exchange values – and a presumption in favor of stability – has been a legitimate concern of the international community. As per Article I of its Articles of Agreement, the International Monetary Fund (IMF) is tasked with the responsibility to promote exchange stability, maintain orderly exchange arrangements and ensure avoidance of competitive exchange depreciation. To this end, three significant episodes of Fund surveillance reviews have been conducted (1977, 2007, 2012) to supervise a stable system of exchange rates within the international monetary system.
It is controversial that domestic trade policy bureaucrats should now get to usurp the IMF’s (and the U.S. Treasury Department’s) authority and assess and enforce exchange values. A slew of amendments attached to trade-related bills awaiting consideration on the floor of the U.S. Congress would do exactly this. Despite the collective protest of all living U.S. treasury secretaries dating back to 1972, protectionist and anti-China-minded Congressmen would compel the Commerce Department to investigate and apply countervailing duties (CVDs) to offset the ‘benefits conferred’ on merchandise imports from trade partners with ‘fundamentally undervalued’ currencies.
Injecting enforceable currency disciplines into the cross-border trading regime is disingenuous. It is also quite probably illegal.
The congressional amendments purport to rely upon the IMF’s approaches to calculate exchange rate undervaluation, and use the IMF’s surveillance-based list of indicators to determine currency manipulation. In reality, the amendments selectively pick from the IMF’s indicative list and append additional subjective criteria which, by working backwards, could be expected to reliably indict their favorite suspect – China – and lead to countervailing duties.
The IMF’s surveillance-related guidelines require that in order to find manipulation to gain an unfair competitive advantage, the offending country’s exchange rate must be misaligned for the purpose of securing an increase in net exports; the fact that its policies merely have the effect of securing such an increase is not sufficient. Fundamental exchange rate misalignment must be conjoined to purpose to confirm ‘manipulation’. The distinction — one that is lost on Capitol Hill — is an important one.
From 2001 to 2008, the period that is the target of protectionist displeasure, the real effective exchange rates of the yuan and the Indian rupee usually moved in tandem and roughly in parity, yet the two countries’ respective merchandise trade balance positions could not have been more dissimilar. Factors in addition to the yuan’s value —such as China’s large pool of unskilled labor and the productivity of its foreign-invested electronics and light manufacturing sector— had the effect of preventing the adjustment in Beijing’s trade balances. Purposeful manipulation was not the cause. At no time either did the IMF present persuasive analysis that China’s excess reserves constituted a major problem for the international monetary system. And when the global financial crisis did break out in 2008, the extreme disruption in the monetary system was unleashed and transmitted across borders by a leverage-induced ‘global banking glut’, not a north-south trade imbalances and excess reserves-induced ‘savings glut’.
Congress’s currency manipulation amendments, if signed into law, would also fall afoul of U.S. international trade obligations. The WTO Agreement on Subsidies and Countervailing Measures (SCM) states that only enterprise-specific, industry-specific, region-specific or export-contingent subsidies that cause injury in foreign markets are challengeable through countervailing action.
A presumed subsidy that is extensively available and may distort the economy-wide allocation of resources, such as generally applicable tax rates, below-market interest rates or a currency’s value, is not subject to the SCM Agreement’s disciplines. U.S. attempts to designate an undervalued currency to be a subsidy that is ‘contingent upon export performance’so as to qualify under SCM disciplines (even though Congress’fine print readily admits that it could be invoked in circumstances not solely involving exports), stand no chance of passing muster at the WTO’s Dispute Settlement Body. The ruling will only tarnish the already-sorry record of the U.S. in such cases in Geneva.
More generally, it is by no means clear that American consumers are about to reassume the role of consumer of last resort or that American producers are being undercut at home and priced out overseas. The U.S. current account deficit is, at 2 per cent of GDP, at its lowest since the late-1990s. Despite the dollar’s fastest eight-month period of appreciation since the end of the Bretton Woods system in the early-1970s, its real value measured against a broad basket of currencies is still below its historical average and well beneath its 1985 peak. The People’s Bank of China on the other hand has turned to propping up the yuan rather than sterilizing inflows, as capital has exited China at its fastest pace in over a decade-and-a-half.
Looking ahead, while capital growth will eventually recover in the U.S. economy, high levels of public debt, ageing-related spending and slowing productivity will weigh over medium-term growth prospects. This will have knock-on effects on import demand from Asian markets. Meanwhile, implicit beggar-thy-neighbor export outcomes among advanced economies that stem from monetary policy innovations such as quantitative easing, not north-south trade imbalances, will put pressure on the global trading system, much like the introduction of the monetary policy innovation of central bank open-market operations a century ago strained the global monetary order of the day and divided the advanced economies.
Rather than protecting import-sensitive sectors with dubious trade policy tools that would penalize developing country producers from managed currency zones, Congress and global policymakers would be better off updating the fraying architecture of the international monetary system. Global foreign exchange reserves, much of it acquired for self-insurance purposes within developing Asia, have risen from 5 per cent of world GDP in 1995 to 15 per cent today. Admittedly, this vast $10 trillion sum constitutes a drag on global economic growth, given that it could be put to better uses (as for example, the Asian Infrastructure Investment Bank plans to do). As a proportion of cross-border banking assets however, official reserves remain modest and its ratio to external assets stocks has in fact declined since the early 1980s. Volatile cross-border liquidity and capital flows have in the meantime grown nine times faster than world trade during this same period, transmitting external financing shocks across advanced and emerging economies alike.
The system’s reserve management and liquidity insurance tools are plainly failing to keep pace with this cross-border surge in private and (post-global financialcrisis) official liquidity creation. Rising precautionary demand for reserves is a symptom, not cause, of instability in the system.
The adequacy of international liquidity in the face of sudden stops, and the deflationary bias associated with such shocks, has long vexed the international monetary system’s managers. At the Bretton Woods conference in 1944, policy architects devised a system which, within reasonable limits, assured countries that their international balance of payments could be met without having to resort to deflationary measures that reduce real income and employment or via excessive tariffs and other import restrictions. The IMF was itself the center-piece of this architecture.
As the vestiges of that system have faded under the onslaught of cross-border capital flows, so also has the mismatch between global financial risk and global financial resources widened. Devising innovative tools, such as a network of permanent currency swap lines and provision of liquidity risk insurance based on simple ax ante conditionality, which begin to rectify this growing systemic imbalance – not the injection of currency clauses within trade flows, should be the commonsensical way forward.