To be sure, that was not the first time Bergsten changed his mind on this issue. He expressed support for countervailing duties as part of an aggressive four point plan a little more than one year prior in a December 2012 Peterson Policy Brief with his colleague Joseph Gagnon. But a review of how Sen. Schumer came to choose 27.5 percent as his magic number illustrates why Bergsten’s January 2014 skepticism about applying countervailing duties continues to be warranted.
When Schumer introduced his bill, economists were generally in consensus that the Chinese currency was undervalued. But they disagreed widely about the magnitude. Economists from the IMF, the OECD, the Federal Reserve, the U.S Treasury, think tanks, and academia were all producing different estimates of undervaluation. Schumer chose 27.5 percent because it was the midpoint in a range of dozens of these estimates spanning from 10 percent to 45 percent. More important than the obvious imprecision in Schumer’s approach is the fact that reputable economists from esteemed institutions disagreed widely in their estimates of undervaluation. This meant that they took different approaches to estimating the difference between the yuan’s actual value and its true market value, which reveals what Bergsten implies in his January 2014 quote above: that there is no consensus among economists about how to estimate currency undervaluation because there is disagreement about how to ascertain the true market value of a currency unless it is free-floating and determined by its supply and demand. This conclusion yields some important implications.
First, without knowing the true market value of a currency, it is impossible to calculate accurate countervailing duties to offset the effects of currency manipulation. A 10 percent countervailing duty implies that the currency is priced below its actual market value by 10 percent or that the manipulation amounts to a 10 percent subsidy for exports. But at best, a countervailing duty could only be an estimate of the value of a subsidy conferred through manipulation of the currency. Considering that economists’ estimates of Chinese currency undervaluation varied by as much as 35 percentage points, and that any methodology employed by the U.S. Department of Commerce — in its zeal to protect domestic producers above all else — would certainly differ from one employed by an MIT or IMF economist, countervailing duties would likely worsen any distortions caused by currency manipulation and inflict collateral damage on consumers and import-using producers.
Second, countervailing duties would address only the export subsidy portion of the distortion, leaving in place the import tax effect of the currency manipulation, even magnifying its adverse impact on U.S. exporters by keeping foreign products that would have been bound for the United States, but for the countervailing duty, in the foreign market, increasing the supply and suppressing prices. There might also be overt retaliation. U.S. exporters, in other words, would get no relief and, in fact, would be punished by CVD measures.
Third, if a currency’s true market value is determined by the intersection of its supply and demand curves, it is important to recognize that those curves (their shapes and positions) are affected by underlying economic activity, as well as public policy — monetary, fiscal, and regulatory. In other words, currency values reflect all sorts of policy decisions that it would be improper to indict direct manipulation occurring through currency market interventions, but not indirect manipulation delivered through other policy channels. After all, it is the effect of policy and not its intent that matters to the real economy. It is the effect of policy and not just its intent that is evaluated in WTO dispute settlement.
Accordingly, the Federal Reserve’s policy of quantitative easing, which drove down the value of the dollar by increasing the supply of dollars in circulation had no practical difference in consequence from Chinese or Japanese government currency market interventions, which likely will be indistinguishable from the consequences of the European Central Bank’s decision last week to cut interest rates. Each set of policies has similar depreciating effects on the currencies of the governments engaging in those policies. Though the intent of direct currency market intervention may be to drive down the value of the currency, and the intent of monetary easing may be to stimulate demand, both have the effect of reducing the value of the currency. It is that consequence that matters.
Acknowledging — as Bergsten did, before changing his mind, again — the distortions and other shortcomings of treating currency manipulation as a countervailable subsidy, the American Automotive Policy Council (Detroit’s auto lobby), last year, put forth a different solution based on the recommendations in Bergsten’s January 2014 piece. Rather than attempt to calculate undervaluation and then apply countervailing duties, the AAPC side-stepped the measurement problem and proposed that currency manipulation be inferred from certain actions taken by governments. If a country has a current account surplus over a six-month period, adds to its foreign exchange reserves over that period, and has more than adequate foreign exchange reserves (defined as more than enough to cover three months of normal imports), then that country is manipulating its currency.
Economist Arthur Laffer lent his support to this inferential approach to identifying currency manipulators in a recent paper published by the Laffer Center, which the AAPC has seized upon in its efforts to convince free market types that they, too, should support measures to rein in currency manipulation. But Laffer’s paper is less a convincing exposition that currency manipulation requires a response than it is a lesson in the virtues of floating exchange rates. His failure to acknowledge that indirect currency manipulation through other policy channels can have the same effect as direct intervention lends itself to the remedy prescribed by the AAPC — forfeiture of trade agreement benefits for one year — without really endorsing that solution. But the AAPC’s proposed conditionality test and remedy are both problematic.
First, as a trade agreement provision this would never fly because its terms are asymmetric. As the issuer of the world’s primary reserve currency, the United States has little need to accumulate reserves. Likewise, the United States hasn’t had a current account surplus in decades and, barring a collapse in demand and a massive increase in savings rates, won’t anytime soon. Under the AAPC’s definition of manipulation, the United States would be free to engage in additional rounds of quantitative easing or other policies that depress the dollar’s value without meeting the triggering criteria of the provision, as long as its current account remains in deficit. However, countries that traditionally run current account surpluses — such as Japan, Singapore, Vietnam, Malaysia, and Brunei among TPP countries — would already be one third of the way toward losing their tariff benefits.
Second, the proposal whiffs of financial imperialism and is an affront to national sovereignty. Governments engage in foreign reserve accumulation for a variety of reasons — as insurance against capital outflows, to attract foreign investment, to prepare for leaner economic conditions, to share today’s exhaustible bounty (in the case of commodity-dependent economies) with future generations, and so on. Reserve accumulation far in excess of “three-times imports” is not at all uncommon. Governments that accumulate reserves also tend to run current account surpluses. By targeting conditions that may also reflect benign intentions, these rules would impose de facto limitations on the policy options available to foreign governments to exercise their domestic sovereignty. Therefore, it is certain to be opposed by other TPP negotiating partners, causing delay or derailment of the deal.
Third, the penalty of withdrawing trade agreement benefits is anything but targeted. It would hurt U.S. businesses that have begun cultivating relationships with foreign suppliers, disrupt production and supply chains, deter inward foreign direct investment, and penalize consumers, rendering the cure worse than the ailment.
Fourth, the measures would do nothing to remedy the distortions on the export side. Currency manipulation is said to pose a de facto tax on U.S. exports, but none of the remedies considered by the currency hawks does anything to alleviate that burden, as if these producers are interested only in protecting their home markets and not in competing for market access abroad. Why else would they content themselves with the remedies they support?
Fifth, currency hawks have exaggerated the impact of currency values on trade flows. Of course they matter, but with the proliferation of global supply chains and cross-border investment, the overwhelming majority of trade flows today are intermediate goods, so the effect of currency values on final prices cuts in different directions. That’s why, despite a 38 percent appreciation of the Chinese Renminbi vis-à-vis the dollar between 2005 and 2013, the bilateral U.S. trade deficit with China didn’t decrease, but rather increased by 46 percent. That’s why Yen depreciation, by increasing the cost of imported inputs priced in foreign currencies, raises the cost of production in Japan and can make Japanese producers less competitive in the global economy, not more. If only 50 percent of the value of a country’s exports reflects domestic value (and the other 50 percent reflects foreign value), as is the approximate case with China, a depreciating yuan cuts in both directions. Globalization is the best remedy for currency manipulation.
Finally, the claims of Bergsten, Laffer and others that currency manipulation, through a persistently high current account deficit, has led to lower GDP and fewer jobs belies the facts of a strongly positive relationship between deficits and jobs and between deficits and GDP. Why is it that in times of rising trade and current account deficits we tend to see faster economic growth and job creation? It must have something to do with the fact that a current account deficit is matched by a capital account surplus, which means that the net outflow of dollars that occurs when Americans buy more goods and services from abroad than they sell to foreigners is matched by a net inflow of dollars from foreigners who invest more in the United States than Americans invest abroad. In other words, there is no “leakage” of economic activity. Foreign investment in the United States (direct, equity, debt) contributes to U.S. economic activity and job creation here. So, for those who claim that foreign currency manipulation drains the economy through a persistent trade deficit, the problem would seem to be self-regulating through the capital account surplus and global supply chains.
The TPP, the TTIP, and other trade agreements represent opportunities for economic growth. Saddling them with provocative and unnecessary currency provisions would be a grave mistake.
