The beneficial thing about rules, as opposed to laws, in the international system is their scope for flexibility. Both rules and laws invoke a sense of order, impartiality and safety, yet the latter are more malleable, carry lower-end consequences, and – written consensually with a sense of fair play – lend themselves to be adjusted to the evolving circumstances.
Simultaneously, the terrible thing about rules, as opposed to laws, in the international system is their scope for flexibility. Re-interpreted unilaterally – and self-indulgently – to suit narrower ends at a time of political, economic and financial upheaval in the international system, they are a catalyst for dissension and weaken the common purpose and trust on which the system is built. The Obama Administration’s recent release of a report on the Foreign Exchange Policies of Major Trading Partners falls, unfortunately, in this category.
For over a quarter century now, the U.S. Treasury Department has released a formulaic report on the currency policy and practices of key economies on a semi-annual basis. In the rare instance, it has hauled up a trading partner as a “currency manipulator” and proceeded thereafter to jawbone that partner to appreciate its currency and shrink its bilateral trade surplus: Korea and Taiwan in 1988; Taiwan, again, and China in 1992. Each citation lasted at least two six-month reporting periods for Korea and Taiwan; for China it lasted five cycles. The jawboning did succeed in the case of Korea and Taiwan (the trade deficit shrank); less so in the case of China – although it did succeed in extracting a reform of Beijing’s foreign exchange currency regime in 1994.
On the last Friday of April, the U.S. Treasury Department released its latest edition of the report – but this time with more bite. It laid out a set of newly-minted thresholds that would inform the rules by which all future determinations of “unfair currency practices” are to be made. The three thresholds are: (a) a bilateral trade surplus larger than (a mere) $20 billion to confirm a finding that it is significant; (b) a current account surplus larger than 3.0 percent of that economy’s GDP to find that it is material; and (c) repeated net purchases of foreign currency to the tune 2 per cent or more of its GDP over a year to find guilt of persistent one-sided intervention.
Should a trading partner satisfy all three thresholds, it is to be subjected to an “enhanced bilateral engagement” process with meaningful penalties attached (which the President may waive) if the “appropriate policies to correct its undervaluation and external surpluses” are not adopted. Based on these new thresholds, the Treasury Department proceeded to create a new “Monitoring List” of five economies – China, Japan, Korea, Taiwan and Germany – that are to be subject to an intensive surveillance process.
The Obama Administration Treasury rules are unhelpful on a number of fronts – not the least of which is the self-regarding gaming of thresholds to lay the future ground to reliably indict its favorable suspect, China.
First, in this day and age of global value chains, trade flows are best measured on a multilateral and value-added basis. Bilateral surpluses or deficits that are measured in ‘gross’ terms fail to capture the value added embedded in production-shared, intermediate goods trade and present a distorted picture of overall trade flows.
Second, the current account balance (goods and services balance + net income and transfers), not solely the goods trade balance, should be the appropriate measure of assessment. The United States, for reasons that have to do with competitiveness, runs a persistent and large services trade surplus. This surplus is no more-worthier of sanction than the goods trade surpluses enjoyed by its East Asian trading partners, notably China.
Third, during the latest monitoring cycle, Beijing enjoyed a significant trade deficit, a material current account surplus, and engaged in persistent one-sided intervention in the currency markets in excess of the 2 per cent (it was 3.9 per cent) threshold. By the Treasury’s own standard, China should have been hauled up as a “currency manipulator.” Beijing however wasn’t because its currency market interventions were on the sell side, aimed at propping up the value of the yuan to counter outflows. Evidently, the Obama Administration’s understanding of a ‘market-determined’ exchange rate is one where the trading partner’s currency only moves upwards. Meantime, the dollar continues to trade well below its post-Bretton Woods historical average against a broad basket of currencies.
Fourth, the International Monetary Fund (IMF), which is tasked with the responsibility to promote exchange stability and ensure avoidance of competitive depreciations, maintains a manipulation-related trigger-list of rules, as part of its surveillance function. The Treasury’s rules selectively pick-and-choose from within the IMF’s list and assign arbitrary thresholds thereafter. Besides, the IMF’s rule that “the pursuit, for balance of payment purposes, of monetary and other financial policies that provide abnormal encouragement or discouragement to capital flows” could well have indicted the U.S.’ own earlier unconventional monetary policies (UMP). As early as 2002, then Federal Reserve Governor Ben Bernanke had noted that the inevitable, and predictable, side-effect of such policies to fight deflationary tendencies was to depreciate exchange rate – and indeed “that there have been times when exchange rate policy has been an effective weapon against deflation.”
In fairness though, it must be noted that the penalties attached to the Treasury’s new “currency manipulation” rules do not entail the imposition of punitive tariffs on trading partners – as some in Congress have persistently harangued. Such tariffs would have been dead on arrival at the World Trade Organization’s (WTO) dispute settlement body.
Finally, the Obama Administration’s currency rules come at a particularly inopportune time, with major global economies under profound economic stress and exchange rates – and associated capital flows – mutating into a transmission belt of “beg-thy-neighbor” unconventional monetary policies. With interest rate-sensitive segments of the economy constrained by existing debt, near-zero policy rates backed by a deluge of central bank money are having little effect on enhancing domestic demand but continue to have ‘demand switching’ effects through the exchange rate mechanism. This has led to a billiard ball-like dynamic as sharp currency weakening (and subsequent reversal) ricochets from economy to economy, drains demand, and traps all participants in a gradually drawn-out beg-thy-neighbor spiral downwards.
There is a better way forward.
The Obama Administration should sit down with China and re-write multilateral rules that significantly patch-up the currently-porous global financial safety net. This would give confidence to China and other emerging economies to continue with their domestic financial deepening and currency internationalization policies, which would, in time, lead to an augmented and diversified supply of globally traded safe assets. A broader such supply would improve global capital allocation and risk-sharing, reduce global imbalances, enhance the international monetary system’s resiliency to shocks while at the same time downgrade the divisive polemics associated with currency values. Concurrently, the Administration should sit down with its advanced economy counterparts and prepare the ground for a coordinated fiscal-monetary injection if the global economy was to tip into a recession.
Self-regarding currency rules that do little more than invite “blame-thy-neighbor” finger-pointing should be kept off-the-table.
