Secretary of the Treasury Janet Yellen has provided an early signal of the Biden administration’s approach on currencies and currency manipulation. The US apparently has little intention of using currencies to address US economic problems, including slow growth, huge trade deficits, pervasive inequality, and a lack of good jobs. The economic analysis in the new Treasury report, Macroeconomic and Foreign Exchange Policies of Major Trading Partners of the United States, finds that three significant trading partners, Vietnam, Taiwan, and Switzerland, met all three criteria under US law to be named currency manipulators. And yet, the Treasury declines to name any of them as manipulators.
The refusal to name officially any country a currency manipulator, as well as the non-judgmental language of the report, which seems to praise as often as criticize these countries, suggests the Treasury wants to avoid using currency policy to further America’s economic interests. Indeed, foreign governments may interpret this report as an invitation to persist in policies that deliver economic growth and increased production in their countries by targeting the US market and the US consumer. In recent speeches, administration officials including national security advisor Jake Sullivan have urged the administration to pursue a “foreign policy for the middle class.” After reading the new currency report, Secretary Yellen is in danger of endorsing a currency policy for the Vietnamese middle class.
Currencies and Trade: The Economics
The fundamental economic principle underlying fair currency levels is that national economies should tend towards current account balance in the long term. (The current account includes the trade balance and certain financial flows, but the trade balance dominates most nations’ current accounts.) One proven way for a country to boost its exports and jobs is to intentionally hold down its currency’s exchange rate, in effect “exporting unemployment” to other nations. Since the 1970s, a number of nations, notably Japan and then China, have undertaken deliberate currency undervaluation to support exports into the US market. Congress responded with two laws, in 1988 and 2015, aimed at defining currency manipulation and empowering the US Treasury to take action to stop it. The actions the Treasury can take are vague, mainly threats of greater action if the manipulation continues. Explicitly “naming” a country a manipulator has come to be seen as an important public action, potentially leading to consequences.
In recent years, a number of smaller nations have been identified in the twice-yearly Treasury reports as violating some or all of the three criteria in the law required to be a manipulator. In the April 2021 report, which looked at economic developments in 2020, Vietnam, Taiwan and Switzerland met all three criteria for currency manipulation, but none was formally named a currency manipulator. This is a retreat from the Trump administration’s approach, when senior officials were more willing to publicly name and criticize currency manipulators.
The new report is frank and accurate about the costs currency manipulation can inflict upon the US economy:
“Five major US trading partners—Vietnam, Switzerland, Taiwan, India, and Singapore—intervened in the foreign exchange market in a sustained, asymmetric manner with the effect of weakening their currencies. Three of these economies—Vietnam, Switzerland, and Taiwan—exceeded the two other thresholds established by the Treasury to identify potentially unfair currency practices or excessive external imbalances, which could impede US growth or harm US workers and firms.” (Treasury Report, pg. 2)
Yet by refusing to name those three as manipulators, Treasury sends a signal that this administration will downplay currency concerns. According to the report, those three countries between them accounted for $157 billion of the US goods trade deficit last year. Using the common rule of thumb that every billion dollars of trade deficit costs us 6,000 jobs yields the estimate of 942,000 jobs lost due to the policies of these three manipulators.
Volatile, Unpredictable Currency Markets of 2020
Dramatic events in the foreign exchange market last year help explain why three nations qualified as manipulators. That history also shows how currency manipulation, currency misalignment, and trillion-dollar capital flows are intimately related. As the COVID pandemic took hold in much of the world in February-March 2020, emerging economy governments and international investors grew worried about a global depression and sought to move money into US dollars, the world’s preeminent “safe haven” currency. This drove the dollar’s exchange value up by 9% to mid-March, a huge move in a short time. But once the crisis subsided, the dollar began to fall. By the end of 2020, it was down almost 12% from its peak, although down only 2.7% in 2020 as a whole.
Foreign exchange markets, which are driven largely by international investors including banks, sovereign wealth funds, hedge funds, and corporate treasuries, came to the conclusion that the dollar’s long rise between 2014 and 2020 was now set for a reversal and a long multi-year decline. The decline would ostensibly be based on (a) a slower American recovery from COVID than other countries, (b) a rise in commodity prices which would bid up the currencies of raw material producing nations and (c) the down-leg of a recurring long-term cycle. Also, market participants see the euro as finally getting its act together and becoming more important as an investable currency. The forces behind consensus opinion in the foreign exchange market are harder to interpret and forecast than in many other markets. Foreign exchange markets illustrate the truth of Keynes’s dictum that financial market prices are set by “what average opinion expects average opinion to be.”
As investors sold down the dollar, they moved money into many other currencies, driving up those countries’ exchange rates. Countries like Vietnam, Switzerland, and Taiwan make no secret of the fact that they closely manage their currencies as key tools in their global competitiveness strategy. When those governments saw their currencies rising, they immediately began to intervene in the currency markets, selling their own currencies to drive their exchange rates down. According to a recent analysis by Joseph Gagnon and Madi Sarsenbayev of Peterson Institute, the eight countries that the authors identified as manipulators in 2020 purchased $446 billion in official assets (i.e. foreign currencies or securities) in 2020, compared to just $160 billion purchased by manipulators in 2019.
The Treasury report does such an excellent job praising the economic management at the three alleged manipulators that they might want to post it on their national websites as an endorsement. The Treasury report credits Taiwan’s industrial policy, undervalued exchange rate, high national savings rate, and quality educational system for enabling Taiwan to become a major manufacturing center with real GDP growth averaging 10% a year. After the praise, it does criticize Taiwan’s policies:
“Decades of active exchange rate management, direct intervention in foreign exchange markets that have largely weakened the TWD [Taiwanese dollar] … have thus resulted in a structurally undervalued TWD exchange rate that failed to adequately adjust in the face of Taiwan’s persistently large current account surpluses.” (Treasury report, pg. 42)
That sounds like an indictment of the costs Taiwan inflicted on its trading partners. But the penalty meted out by Treasury is no more than “enhanced engagement,” in other words meetings.
But the economic record is clear: Taiwan, with its undervalued, carefully managed exchange rate, has delivered outstanding economic performance. The US, with its unmanaged, overvalued exchange rate, not so much. In 2020, Taiwan ran a current account surplus of 14.1% of GDP and despite COVID, registered inflation-adjusted GDP growth of 3.1%. The US, on the other hand, saw a deteriorating current account deficit of $647 billion in 2020, or 3.1% of US GDP, a decline of 3.5% in real GDP, and our international investment position deteriorated to $14.1 trillion owed to foreign governments and the private sector.
Clearly, active management of the foreign exchange rate works to stimulate economic growth, create jobs, and raise living standards. Insisting that currency manipulators allow their currencies to rise against the dollar would be just one part of managing the dollar to make the US economy more competitive. But US governments have long resisted even this approach, despite congressional backing. Elsewhere, we have advocated a more aggressive approach for managing capital flows to move the US dollar to a more competitive level.
In our view, the Treasury continues to act and think as if the US is an impartial manager of the international currency system when in reality, the US is struggling with great economic challenges at home. We have seen 20 years of reduced economic growth, rising inequality, a decline in good jobs, and the health and social ills that follow from those problems. The Treasury report strikes a lofty tone, talking about “sound policies that are essential to the stability of the international monetary system” while scarcely mentioning America’s own economic interests. In other words, the report upholds the appearance of American global leadership while it is crumbling beneath our feet.
Vietnam’s economic progress drives the same point home. In the two years from 2018 to 2020, Vietnam raised its goods exports to the US by a stunning 63% to $80 billion. Last year, in spite of the COVID pandemic, Vietnam’s economy still grew, by 2.9%. Vietnam’s GDP was only $262 billion in 2019, so some 30% of its GDP goes to the US in exports. It runs a trade deficit with the rest of the world, so it is essentially an assembly platform for goods going to the US. Vietnam’s economic strategy is being propelled by deteriorating US-China relations, as multinationals move production out of China and into Vietnam. Over the past decade, Vietnam has chalked up consistent inflation-adjusted economic growth rates of 4% a year every year, rates we in the US can only dream of. The IMF estimated the Vietnamese currency was 7.8% undervalued as of 2019, but other estimates put the undervaluation as high as 15%.
And so the kabuki play continues. The US government pretends to be concerned about “unfair currency practices or excessive external imbalances,” and foreign government pretend to care about pronouncements out of Washington. Meanwhile, foreign governments aggressively manage their currencies to drive their own economic growth, often at US expense. And US foreign exchange policy is like one of those Teslas going downhill at 90 miles an hour with nobody in the driver’s seat.