Straight Talk On Currency Misalignment

By Charles Blum

May 20, 2015    Volume 22, No. 7

Manufacturing and Technology News

Americans spend most of their lives in a dollar-denominated world and don’t have as much experience with foreign currencies as non-Americans have with dollars. As a result, much of our public discourse on currency issues over many years has been distorted and unproductive. This is an attempt to set forth a few basic truths about the problem and to identify first steps toward a solution.

Currency misalignment is not a new problem. In the classical mercantilist world centuries ago, trade was a zero-sum game: one nation’s loss was another’s gain. The object was to stockpile financial assets — essentially gold and silver — based on persistent trade surpluses. In today’s world, neomercantilists adopt a persistently undervalued currency to generate trade and current account surpluses and to amass a stock of convertible currencies. It’s still a zero-sum game, and according to the Peterson Institute it distorts roughly 40 percent of the global economy. As such, persistent currency undervaluation is just another form of the mercantilist practices that prompted Adam Smith to write his masterpiece The Wealth of Nations in 1776. Smith argued that a free market would produce greater economic efficiency and shared benefits that mercantilism prevented. Thus, mercantilism in any form is the arch-enemy of free trade and free markets. Adam Smith recognized that; so should we.

Today, a persistently undervalued currency impacts the United States and other countries trading in dollars in a number of ways. This is a systemic, not a bilateral, issue. Since 85 percent of global trade is transacted in dollars, almost everyone is impacted by mercantilist practices. Here are some of the most significant adverse effects of currency misalignment:

  • An undervalued currency constitutes price-fixing on a national scale. It subsidizes the mercantilist country’s exports; its producers earn extra units of their currency only when they export. Exporters can use this subsidy to offer lower dollar prices and still make a profit. The cheaper their currency, the more they get in return for each dollar — provided they export the products.
  • An undervalued currency forces importers in those countries to pay more for foreign goods; imports are artificially expensive in their currency. As a result, it depresses the purchasing power of consumers in those countries.
  • An undervalued currency diverts investment dollars to those countries, providing a hidden subsidy paid for with the proceeds of trade transactions dollars rather than taxes on its citizens.
  • An undervalued currency helps sustain otherwise unprofitable enterprises by shielding them from effective international competition. This enables them to maintain excess capacity and to shift the burden of adjustment to oversupply onto trading partners. That’s what is happening once again in the steel sector.
  • An undervalued currency enables foreign mercantilists to pick winners and losers in our country and elsewhere, punishing those who produce here and rewarding those who import from them.
  • Finally, an undervalued currency provides the mercantilist country with an endless stream of free money — no tax revenues required — to be used in projecting its soft power through foreign aid, the creation of new multilateral financing institutions and so forth.

Well, you say, there ought to be a law. In fact there is. For almost 70 years, IMF Article 4 has obliged members not to manipulate their exchange rates to “gain a competitive advantage” or to prevent the “correction of imbalances in trade and payments flows.” And under the GATT, export subsidies are the most pernicious form of subsidy and they are prohibited. In addition, GATT Article XV obliges members not to use exchange rates to frustrate the intended trade liberalization and elimination of trade distortions that the exchange of concessions is intended to produce.

So, a persistently undervalued currency is a violation of both IMF and GATT rules, in letter as well as in spirit. Unfortunately, the IMF has rules but no tools to enforce them. Moreover, it shows increasingly less willingness to use even moral suasion when large countries are the violators. In the GATT system, it is left to individual nations to resolve trade disputes by consultations and negotiations, through dispute settlement, or for some practices like subsidies through the application of national trade laws in conformance with certain agreed definitional and procedural norms.

The real currency issue is not whether an exchange rate is fixed or fluctuates. In fact, any type of exchange rate is supposed to vary depending on conditions. Persistently surplus countries are supposed to let their exchange rate rise so as to reduce any imbalances. It’s not a matter of currency practices so much as the results of those practices. That’s the common sense meaning of Article 4, but it is ignored in mercantilist practice.

Applying these concepts to trade negotiations aimed at reducing foreign barriers and eliminating distortions, an undervalued currency is a trump card. (Border adjustable taxes are another.) Such a trump card can more than make up for the trade concessions that American negotiators gain by making concessions of their own. Take the case of Japan. Prime Minister Abe was elected in large part on the basis of his pledge to reduce the value of the Japanese yen and expand Japan’s exports. That’s hardly a recipe for combating Japan’s longstanding problem of deflation as imports are becoming more expensive and it’s an implicit rejection of Japan’s obligations under Article 4. Abe doesn’t want to correct imbalances; he wants to perpetuate them. His approach — based on easing of money supply, higher taxes on consumption and a cheaper yen — has failed to reinvigorate the Japanese economy, but it has put money in the pockets of exporters such as car companies. The yen at the time of the election was trading freely at a rate of about 78 to the dollar; today it trades at about 119 to the dollar — a depreciation of almost 55 percent. What has the IMF done about that? Nothing. What has the Treasury done about that? Nothing.

That means that U.S. exporters can expect little or no benefit for U.S. exports by the elimination of Japan’s tariffs. On a trade-weighted basis, Japan’s import duties average about 2 percent; its hidden currency tariff on all imports has risen by 55 percent thus far. Why would we expect to sell more autos, rice or anything else when our prices in yen have risen so dramatically — and could rise even more without any response from the IMF, the U.S. Treasury or the USTR? Until the currency problem is effectively resolved, we are bargaining for theoretical market access. Without effective action on currency misalignment, we’re left holding a paper agreement while mercantilist countries like Japan hold the trump cards.

Or take the case of Germany, number one in the world in terms of manufacturing exports and current account surplus. The Treasury mildly rebuked Germany in its April 2014 semiannual report on exchange rates. Chancellor Merkel sarcastically replied: “If you Americans had good policies, you’d have a surplus, too.” In the wonderful world of Merkel Math, it seems that every country could have a surplus if only they would adopt the right policies like Germany. What nonsense!

That lays bare the basic premise for today’s global economy: every country can run a surplus or at least minimize its deficit so long as the United States is willing and able to amass ever greater amounts of foreign debt, borrowing back money to finance sustained consumption that our incomes won’t support. We’re at $17 trillion in foreign debt now — the equivalent of one year’s GDP — and the number rises every day. Those dollars are claims on our future production and the assets we own; they threaten our standard of living and our standing in the world. The longer we take to address and reverse this growing imbalance, the more painful the adjustment for Americans and indeed for the entire world.

What can we do? We need to devise and implement a coherent, comprehensive and multi-pronged strategy. The elements of such a strategy might include:

  • Recognize the problem for what it is, and factor that understanding into all of our trade and economic policymaking.
  • Learn the lessons of history. In the 1970s, President Nixon forced a realignment of currencies, and the Tokyo Round of trade negotiations was able to proceed to a conclusion in 1979. In the 1980s, President Reagan forced a realignment of currencies and the Uruguay Round was able to proceed to a conclusion in 1994. The clear lesson of history is that currency realignment and trade negotiations go hand-in-hand.
  • Take action where we can. The obvious first step is HR-820, the bipartisan Currency Reform for Fair Trade Act. It’s the same uncomplicated bill that passed the House in 2010 by a decisive 348-79 vote. All it does is to direct the Commerce Department to treat currency subsidies as it does every other subsidy, using the procedural standards of the WTO and the measurement techniques of the IMF. Similar provisions have passed the Senate in 2011 and were approved by the Senate Finance Committee as part of the customs enforcement bill that is being bundled with the new TPA bill. Enactment and implementation of currency countervail legislation would be a small first step. It would not be applied across the board but on a case-by-case basis and then only when the particular petitioning domestic industry persuaded the U.S. International Trade Commission that the subsidy had caused injury to it.
    Nonetheless, implementation of a countervailing duty remedy law would send an across-the-board message that the United States is determined to correct the currency problem and will use legal means at its disposal to do so. Every House member who signs on as a cosponsor to HR-820 sends a helpful message to the mercantilist countries as well as to the many other countries that are waiting for effective American leadership in this area.
  • Make existing obligations under the WTO and IMF enforceable — at least among members of free-trade clubs. We should see new and existing agreements as a vehicle for validating the objectives of existing rules on currency. For example, under each agreement countries could simply restate their IMF/WTO commitments and agree to resolve disputes about them through the same dispute settlement process used to enforce other rights and obligations.
  • Perhaps there is another, better approach. But you cannot discover areas of potential agreement by refusing to consider proposals as this administration has done. To say in advance that something is a “deal-breaker” is capitulation, not negotiation. Let’s at least try. Let’s find out who our allies are. And let’s remember that in every mercantilist country consumers are being punished by undervaluation; these are the people we are bargaining to gain improved access to. The more effective purchasing power they have, the better for them as well as for our exporters.
    That’s why it makes eminently good sense to include in the TPA bill the Portman-Stabenow amendment that is expected to be considered soon on the Senate floor. It would make negotiation of enforceable currency disciplines a Congressionally-mandated negotiating objective. An even stronger formulation — for example, making this a mandatory objective for access to fast-track procedures or an “instruction” in the language of the Levin substitute amendment — might be considered to provide even more of the leverage American negotiators seem to lack.
  • Revamp the monetary system. In the long run, we need to plan to construct a monetary system better suited for the 21st Century than the creaky relic we have now. That will take time, vision and leadership. The first steps in that direction should be the judicious exercise of our legal rights, determined negotiations and an unshakable commitment to overcome mercantilism, not perpetuate it.

— Charles Blum is president of IAS Group in Washington, D.C., and is Government Relations Director for the Coalition for a Prosperous America. He was Assistant U.S. Trade Representative for Multilateral Negotiations from 1985 to 1988