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Another View on the Currency Wars



The Center for American Progress (CAP), a think tank founded by former members of the Clinton administration, has released a wide-ranging report entitled 300 Million Engines of Growth: A Middle-Out Plan for Jobs, Business, and a Growing Economy. Its primary focus (and about half the report) is on education reform, but it includes a section entitled "Balance Trade." Most of that section contains unobjectionable but modest proposals for stronger enforcement of current US trade agreements and litigating more trade cases, but it also proposes a series of "policies to introduce a currency misalignment trigger" that draw heavily on the work of the Peterson Institute, including policy papers that I coauthored with Joseph Gagnon on the problem of undervalued currencies. It makes several suggestions that are worthy of comment.

The basic CAP idea is to pass legislation that would force the administration to apply "countervailing tariffs" at a rate of 10 percent of a currency misalignment (which must be greater than 10 percent) per year that it is not eliminated. The report has several virtues as it:

  • calls for eliminating the US "trade" deficit by 2020;
  • accurately identifies the vagaries and other weaknesses of current US law and policy on these issues; and
  • would force Treasury to act in cases of substantial misalignment.

The proposal has several important flaws, however:

  • Reserve buildups would be one of three possible automatic triggers for policy reaction but would not be required if the other two (misalignment greater than 10 percent, bilateral deficit exceeding 5 percent of total US global deficit) were met. Hence misalignments could be countervailed even if not associated with intervention by the offending country, which would produce endless debates over how to measure misalignment.
  • The third trigger is bilateral current account deficits exceeding 5 percent of the total US current account deficit. But bilateral imbalances are economically irrelevant and there is no mention of the target country’s global imbalance, the proper measure of whether it needs to adjust.
  • Their misalignment calculations would be based on the traditional analyses of Fundamental Equilibrium Exchange Rates (FEERs) by William R. Cline and John Williamson at the Peterson Institute, which seek only to reduce the US current account deficit to 3 percent of our GDP, so are inconsistent with their own goal of totally eliminating the "trade" deficit (which, if trade means merchandise, would actually produce a current account surplus, but in any event would require much greater dollar depreciation and foreign appreciation per the "aggressive rebalancing scenario" in the latest exchange rate estimates by Cline).
  • Their remedy of countervailing tariffs covers only half the trade account (the import side) so is inferior to my alternative proposal of countervailing currency intervention, which would directly counter the currency manipulation in the foreign exchange markets and thus address the entirety of the trade accounts (including exports).
  • Their remedy of countervailing only 10 percent of the misalignment per year (i.e., a 2.5 percent tariff versus a 25 percent misalignment) is far too small to be convincing (especially in light of the previous point) and would take 10 years to fully remedy the problem solely on the import side; it would be far better to countervail at least the full amount if this route were to be chosen.

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