NYT: How to Stop Currency Manipulation

WASHINGTON — IF the new Congress can agree on anything this year, it may well be the Trans-Pacific Partnership, a trade deal between the United States and 11 other countries throughout the Asia-Pacific region. Passions run high when it comes to trade deals these days, and the Obama administration is working hard to sell it to labor unions, which roundly oppose it.

[Reposted from The New York Times  |  Jared Bernstein  |  January 9, 2015]

So far the pitch has been about what the deal, as written, will do to help the American economy — a pitch that hasn’t won over many, on either side of the partisan divide. But there’s one thing the administration can do that will both win over some opponents and address one of the biggest issues in global trade: add a chapter on currency manipulation.

It is not unusual for countries to manage their exchange rate — the value of their currency relative to others — to make their exports cheap while making others’ exports to them more expensive. This method has been used extensively by, among others, China, Japan, Malaysia and Singapore — aside from China, all signatories to the partnership.

The American dollar is a prime target for these currency managers. First, the dollar is the global trading system’s premier reserve currency, meaning dollars are freely traded and confidently accepted by international investors. And Americans are a highly acquisitive people — a nice way of saying we buy a lot of stuff. Consumer spending as a share of gross domestic product is about 70 percent here, 55 percent in Europe and 35 percent in China. We’re steady customers for export-led economies.

There’s nothing wrong with that, until these exporters start buying dollars to raise the value of the dollar relative to their own currencies, thus subsidizing their exports and taxing their imports. In the United States, the result is persistent trade deficits that have been a drag on growth and jobs — better-than-average manufacturing jobs — for decades.

In a compelling argument for including a chapter in the Trans-Pacific Partnership to restrict currency manipulation, C. Fred Bergsten of the Peterson Institute for International Economics estimated that America’s trade deficit “has averaged $200 billion to $500 billion per year higher as a result of the manipulation” by the rest of the world, resulting in the loss of one million to five million jobs.

The challenge is in the details. Countries buy foreign currencies for various reasons, not just to gain a trade advantage, and they shouldn’t necessarily be held to account for doing so. Moreover, opponents of such a chapter argue that it would cover the actions of our own central bank, the Federal Reserve, and open it to charges that it also manipulates exchange rates. (When the Fed lowers the short-term interest rate, or engages in “quantitative easing” to lower longer-term rates, one clear consequence is to lower the value of the dollar.)

But that argument doesn’t quite hold. It’s a matter of intent, and there is a clear test: whether the central bank is engaging in domestic demand management or currency management, and the simplest way to tell is to observe whether the bank is buying foreign currencies. The People’s Bank of China does a great deal of that. Our Fed does almost none.

It’s important to recognize that deals like the Trans-Pacific Partnership are not necessarily about “free trade.” They are instead a set of rules; some, like lowering tariffs, lead to freer trade, while others, like expanding patent protections, are more protectionist. Rules governing currency tactics certainly fit the framework.

Some purchasing of foreign currency should be fine under the Trans-Pacific Partnership. Some developing economies collect dollars to cover their external debts in case of financial crises and large outflows of private capital. With this in mind, Mr. Bergsten suggests that holding enough foreign currency to cover a year’s worth of external liabilities might be a sound benchmark; anything more would be questionable.

Once we’ve agreed on what currency management looks like, what actions would a chapter on it take? These could include a tax on the imports of offending countries, fines, the temporary canceling of certain trade privileges and my favorite, reciprocal currency intervention: If countries can go into currency markets and buy dollars, then we must be able to do the same with their currency. That’s not currently possible with China and other countries, which use capital controls to block such large purchases.

Speaking of China, even though it’s not part of the partnership talks, rules like these, especially reciprocity, should be applied to it as well. Not to do so would put the signatory countries at a distinct disadvantage to a trade behemoth with a history of undervaluing its currency to maintain trade surpluses.

As a White House economist in the first few years of the Obama administration, I learned that many of my colleagues shared my concerns about currency management. But all administrations believe the only way to do something about it is through quiet diplomacy. They believe that writing down rules in a trade agreement is too risky, with the potential to scuttle the whole deal.

Diplomacy hasn’t worked. A more direct approach is needed. If the trade deal’s supporters want an agreement worthy of broad support, this is a chance they can’t afford to miss.