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President Donald Trump touts the historic nature of his new trade agreement with Mexico and Canada (USMCA). He is correct in one respect: It is the first trade agreement in history to directly address an issue that has aroused opposition to such agreements in the past—currency manipulation by trading partners. The United States has long sought to deter manipulation of the foreign exchange markets by partner countries seeking to gain trade advantages. The practice has triggered political backlash against trade agreements and against globalization more broadly.
The currency chapter in the USMCA is unlikely to affect Mexico or Canada, as neither has been a currency manipulator and both run global current account deficits in any event. But it could become an important template for later deals with other countries.
How currency manipulation evolved as a trade policy issue
Currency manipulation became a central issue for trade policy during 2003–13 (Bergsten and Gagnon 2017), when about 20 countries intervened heavily in the foreign exchange markets, averaging over $600 billion per year. By keeping their currencies undervalued, they made their exports less expensive and imports more expensive, thereby strengthening their international competitive positions and building their trade surpluses. Manipulation was carried out by manufacturing countries, mainly in Asia; oil exporters; and financial centers, especially Switzerland and Singapore.
The resulting currency misalignments transferred more than $250 billion of trade balances annually from deficit to surplus countries. The United States lost at least one million jobs as a result, especially during the Great Recession when unemployment was already high. European countries were major losers as well.
China was by far the largest manipulator, amassing $4 trillion of reserves and growing its current account surplus to an unprecedented 10 percent of GDP. Currency manipulation accounted for all of China’s current account surpluses and was the major cause of the “China shock” that adversely affected manufacturing employment in the United States (see Autor, Dorn, and Hanson 2016).
China sharply cut back on manipulation after 2013, and its current account surplus has fallen to less than 2 percent of GDP. However, a few countries have continued to manipulate on occasion, and the practice could return on a more widespread basis at any time.
Trade agreements become arena to combat currency manipulation
In the Trade Promotion Authority (TPA) legislation in 2014–15, Congress mandated “avoidance of manipulating exchange rates” as a principal US negotiating objective in future trade agreements and passed separate legislation requiring “enhanced engagement” with any country that violated those precepts and action against it (Bergsten 2014). The Obama administration negotiated a side agreement on currency to the Trans-Pacific Partnership (TPP), from which Trump withdrew after taking office last year.
The currency chapter in the new USMCA agreement has three parts:
- First, the parties continue to disclose and publish, with various lags, all data relevant to their activities in the foreign exchange markets: intervention totals, reserve levels, and the like. This is the only part of the new agreement that is legally binding and enforceable.
- Second, the parties must consult one another “when” they intervene. This clause was inspired by the G-7 agreement of February 2013, which was prompted by the aggressive oral intervention (“jawboning”) of the new government of Prime Minister Shinzo Abe in Japan to talk down the yen in late 2012. It would be preferable if the new arrangement called for consultation “before” rather than “when” intervention takes place, but in practice the G-7 commitment has apparently been interpreted to encompass prior consultation and has been fully observed to date.
- Third, and most important, the parties confirm that they will “avoid manipulating exchange rates or the international monetary system in order to prevent effective balance of payments adjustment or to gain an unfair competitive advantage.” Each party should let their exchange rates float freely in response to market forces and “refrain from competitive devaluation, including through intervention in the foreign exchange markets.” Their policies would be subject to surveillance by the International Monetary Fund (IMF) if they deviate from these norms and cannot reach accommodation with their USMCA partners.
The new currency criteria are not all enforceable but strengthen international norms against manipulation
These criteria should be included in future US trade agreements as enforceable obligations rather than simply as hortatory presumptions. The usual free trade agreement enforcement tools could then be invoked, notably snapbacks of tariff reductions encompassed in the same agreements, a provision that would ease congressional concerns over the issue. But despite lacking teeth, the USMCA currency chapter now strengthens the presumptions of what constitutes proper behavior in the foreign exchange markets, making it harder for participants (or even nonparticipants) to revive manipulation.
Such a hardening of international norms on currency manipulation could be quite important in any future agreements with Korea, Japan, or China (Bergsten, Hufbauer, and Miner 2014). While the sharp decline in manipulation after 2013 occurred to a large extent because of market forces, the substantial international backlash against manipulation was also a factor, especially because it contributed so much to congressional skepticism over the entire trade liberalization agenda of the Obama administration (including TPA and TPP).
USMCA will not constrain responsible monetary policy
The United States has an important defensive interest in this area: making sure that any new disciplines on currency intervention do not limit the flexibility of the Federal Reserve, or central banks in other countries, to conduct expansionary monetary policies to stimulate their economies when needed. While such monetary stimulus can weaken the country’s exchange rate, and be seen by some as “manipulation,” stimulus policies are almost always motivated by domestic considerations, and IMF studies show that their external impacts are largely neutral (or even beneficial) for the rest of the world.
The new agreement contains an explicit carveout that excludes monetary policy from its purview. And as its commitments, other than those related to transparency, are not legally binding, there should be no concern that the agreement or any likely successors could constrain the responsible conduct of future monetary policy.
Further steps are needed to build a fully effective architecture on these very important topics. But the USMCA’s currency chapter represents a positive, if not revolutionary, step forward in strengthening US trade and international monetary policy. It should allay congressional concerns on currency manipulation and facilitate approval of the agreement.
