The New US Currency Policy
In the latest chapter of the saga over countries that seek unfair trade advantages from currency manipulation, the US Treasury has released a new report aimed at curbing the practice. Treasury is correct not to indict any countries for “currency manipulation” at this time but also to create a “monitoring list” of five major countries—China, Germany, Japan, Korea, and Taiwan—that could become “manipulators” in the future and thus require close surveillance. The objective is to deter countries from returning to past practices of manipulation, and the new Treasury report should be quite helpful in that regard.
The latest step by Treasury was required by the Trade Enforcement and Trade Facilitation Act (the “customs bill”), which became law in February 2016. Its Title VII “Engagement on Currency Exchange Rate and Economic Policies,” agreed as part of the package of measures associated with the passage of Trade Promotion Authority last summer, mandates a series of new actions on exchange rate policy that the president and the secretary of the Treasury must pursue.1 It was under this mandate that Treasury released its initial implementation of these new requirements on April 29. The customs bill mandates that Treasury “shall (emphasis added) commence enhanced bilateral engagement” with each major trading partner of the United States that meets three objective criteria and then shall (emphasis added) take one or more of four specified actions if offending countries do not initiate remedial action within a year. The criteria, which are the focus of Treasury’s new report, would indict a country that:
- has $55 billion or more of annual trade with the United States (to count as a “major trading partner”);
- runs a significant bilateral trade surplus with the United States, which Treasury defines as exceeding $20 billion over the past 12 months;
- runs a material (global) current account surplus, which Treasury defines as exceeding 3 percent of the country’s GDP over the past 12 months; and
- engages in persistent one-sided intervention in the currency market, which Treasury defines as repeated net foreign exchange purchases exceeding 2 percent of the country’s GDP over the past 12 months.
These objective criteria for determining the existence of currency manipulation represent substantial improvement over the previous legislation on the topic, which dates from the Trade Act of 1988. Its chief operational mandate was to require the secretary of the Treasury to publicly designate countries as “manipulators” if they were judged to be conducting currency policies intended to impede effective correction of their current account surpluses, primarily via direct intervention to prevent strengthening of their exchange rates. Treasury was able to evade the clear purpose of this law, however, by arguing that it was impossible to determine countries’ intentions, even in blatant cases such as China’s massive intervention during the 2003–13 period. The result was widespread frustration in Congress with Treasury’s failure to respond more effectively to such intervention, and the new legislation was adopted as a result.
However, Congress should not have focused on countries that have a bilateral trade surplus with the United States. All that matters for the impact of currency manipulation on the United States is the multilateral current account balance of the manipulators. In today’s world of distributed production, country X may buy materials from the United States, process and sell them to country Y, which then assembles the final goods for shipment to the United States. Country X would have a bilateral deficit with the United States and country Y a bilateral surplus, yet either or both might be guilty of currency manipulation that distorts the overall US current account balance and economy.
Inclusion of the “bilateral surplus” criterion has important practical effects. It excludes several countries that have been past manipulators, such as Hong Kong and Singapore, which have been running bilateral deficits with the United States and could meet the other criteria again in the future. We recommend that Congress delete this variable at the earliest opportunity.
Applying its definition of the three criteria established by the new law, Treasury finds that no country calls for “enhanced engagement” at this time (although the criteria would have caught China in most of the past 15 years and other countries, including Korea and Malaysia, in several). However, it finds that five countries meet two of the three criteria and are thus to be placed on a new “monitoring list”: China, Germany, Japan, and Korea, because they run large bilateral and global surpluses, and Taiwan because it runs a large global surplus and has intervened substantially. Germany, of course, is part of the euro area and there has been no intervention by the European Central Bank, and Taiwan just misses “enhanced engagement” because its bilateral surplus with the United States is only around $15 billion. We concur with these central conclusions of the new report.
We would underline the importance of Treasury’s decision to limit “allowable” current account surpluses to 3 percent of a country’s GDP. We at the Peterson Institute for International Economics have analyzed “fundamental equilibrium exchange rates” for years and have concluded that any imbalance above 3 percent of GDP, on either the surplus or deficit sides, is excessive and probably unsustainable; Treasury itself has often cited our estimates in its semiannual reports as authoritative. The staff of the International Monetary Fund has developed norms for current account positions that are even tougher, suggesting that both China and Japan should run no surpluses at all. There has been some discussion of defining a “material” (global) current account surplus at a higher level, perhaps 4 percent of GDP, and Treasury itself sought international agreement on such a norm at the G-20 meetings in Korea in 2010. Hence they are to be commended for concluding that “allowable” surpluses should not exceed 3 percent.
This difference has an important practical effect at the current time and potentially in the future. China and Japan, which have been the main focus of congressional concern over the currency manipulation issue, are both now running global current account surpluses in excess of 3 percent but less than 4 percent of their GDPs. The lower target thus prompts their inclusion on Treasury’s “monitoring list,” which is highly appropriate in light of their heavy currency intervention in previous periods as well as their importance to the global trading system as the world’s second and third largest national economies.
Neither China nor Japan has been manipulating its currency recently, however. China has in fact been intervening heavily on the other side of the market over the past year or so, buying at least $500 billion of its own currency to keep the renminbi from weakening even more than it has due to market forces. Japan has not directly intervened to keep the yen from strengthening since 2011, though it did apply a large dose of oral intervention around the start of the Abe government in late 2012.2 Treasury is thus correct not to indict either for “manipulation” at this time, but it is prudent to place both on the “monitoring list” as a signal of US concern over their growing surpluses, their very large levels of reserves, and any possible return to their previous practices.
Our main criticism is that Treasury’s definition of “major US trading partners” is too restrictive. It covers only the top dozen countries and thus misses such past, and potential future, manipulators as Hong Kong, Malaysia, Thailand, and Vietnam. These countries individually are less important trading partners than China or Japan, or even Korea or Taiwan, but taken together their economies are quite significant, and our previous research shows that their cumulative manipulation in some years was as great as that of China even at the peak of its own manipulation.3 Treasury should thus widen its net to cover at least the top 25 trading partners of the United States, which would reduce the cutoff to $30 billion of annual trade from its present threshold of $55 billion.
Another question is whether Treasury’s “allowance” of intervention amounting to 2 percent of a country’s GDP over a 12-month period is too generous, especially for large countries that already hold very large levels of reserves such as China and Japan. Under that definition, China could buy over $200 billion annually without indictment and Japan could buy over $100 billion annually. The problem is compounded by the absence of real-time data on the countries’ intervention practices. Treasury will need to continually review its implementation of this criterion as experience develops.
The Treasury Department should be applauded for publishing its new criteria well ahead of the deadline mandated by the customs bill, for its careful analytical approach, and for indicating its readiness to consider suggestions for modifying its approach as it moves forward. Its central conclusions, that no country should be indicted now but that several should henceforth be watched closely, are correct. However, it should cover more countries by reducing its threshold for “major trading partners” to $30 billion of annual trade. It should reassess its definition of “persistent one-sided intervention in the currency market.” It could also initiate “enhanced engagement” with Taiwan now by modestly tightening its definition of a “significant” bilateral surplus with the United States. Future changes in both market conditions and currency policies by the relevant countries may of course change their positions in the future, so Treasury will have to monitor them closely and continuously to determine whether and when “enhanced engagement” might need to be initiated.
1. A detailed analysis of the role played by currency issues in the debate over Trade Promotion Authority can be found in C. Fred Bergsten, “Time for a Plaza II?” in International Monetary Cooperation: Lessons from the Plaza Accord After Thirty Years, ed. C. Fred Bergsten and Russell A. Green (Washington: Peterson Institute for International Economics, 2016).
2. Japan is also diversifying its national pension fund portfolio into foreign assets, which has some of the effects of currency intervention, as is Korea. Treasury should consider this practice in its future evaluations.
3. C. Fred Bergsten and Joseph E. Gagnon, Currency Manipulation, the US Economy, and the Global Economic Order, PIIE Policy Brief 12-25 (Washington: Peterson Institute for International Economics, December 2012).