President Donald Trump has long claimed that China gained competitive advantage in trade by manipulating its exchange rate. That was true 15 years ago but not in recent years. No matter, Trump administration officials continue to raise the specter of past goblins to rally support for their efforts to erect new import restrictions against Chinese goods and services. And that remains the case despite the recently announced US-China “phase one” trade deal and its new obligations on currency practices.
Currency manipulation is a widely cited but imperfectly understood concept. In brief, it occurs when a country intervenes in foreign exchange markets to artificially suppress the value of its currency in order to boost exports and curb imports. China was widely accused of buying dollars and selling its own currency in the first decade and more of this century, contributing to its export boom.
Using Trade Measures to Enforce Currency Obligations
Under the phase one deal, China has accepted substantial and enforceable obligations on its exchange rate practices. For the first time, the entire currency chapter will be subject to the pact’s dispute settlement procedures, thus allowing the United States to challenge Chinese currency manipulation and impose trade measures to counter the impact on bilateral trade.
Why did China agree to bilateral enforcement provisions? In brief, the pact’s obligations simply codify recent practices of the People’s Bank of China (PBOC) that comply with its G-20 and International Monetary Fund (IMF) commitments to avoid competitive devaluation and currency manipulation. And, in return, the US Treasury lifted its controversial designation of China as a currency manipulator, issued in August 2019.
On that calculus, China didn’t seem to give up much to satisfy US demands. But it underestimated how much the United States would move the goalposts regarding what constitutes manipulation and thus open the door for new protectionist actions.
To date, the US Treasury has been the arbiter of currency disputes. Under separate statutes enacted in 1988 and 2015, Treasury is required to report twice a year on whether major trading partners, including China, have manipulated their currencies; each statute contains different criteria for assessing currency manipulation. The 2015 criteria include whether the trading partner has racked up a big bilateral trade surplus and global current account surplus and has persistently intervened in foreign exchange markets to keep its currency undervalued. The laws require the United States to take specific “remedial” actions against the manipulating country, but these do not include imposing tariffs. Until last August, no US administration had labeled China a currency manipulator since 1994.
But Treasury’s designation of China as a currency manipulator in August 2019 showed that the statutes are open to differing interpretations as to what constitutes currency manipulation. Moreover, Congress can always change the requirements, as it has tried to do over the past 15 years when frustrated by Treasury’s unwillingness to designate China, to tip the scales of Treasury’s assessment of foreign currency practices so that it produces more positive findings of currency manipulation or to authorize the Commerce Department to counter currency undervaluation under US unfair trade laws (as Senators Charles Schumer and Lindsey Graham sought to do 14 years ago).
Currency enforcement actions under the US-China phase one pact would be initiated by the US Treasury secretary (or PBOC governor) and then referred to the Bilateral Evaluation and Dispute Resolution Arrangement co-chaired by the United States trade representative (USTR) and a Chinese vice premier. If the two sides don’t agree after extensive consultations on what needs to be done, the United States would be authorized to unilaterally retaliate “by suspending an obligation…or by adopting a remedial measure in a proportionate way” (Article 7.4:4b). Note that a “proportionate” US response to currency manipulation could involve across-the-board tariffs on all US imports from China!
In other words, the US-China pact enables USTR to act against what it deems to be Chinese currency manipulation if US complaints about Chinese currency practices are not resolved to its satisfaction during bilateral consultations. The new enforcement mechanism contains elaborate consultative requirements and explicit retaliation rights, but it would essentially lead to the same stand-off and subsequent unilateral actions that have occurred throughout the two-year trade war. China can either accept the US actions or withdraw from the pact, presumably reigniting the trade war.
Currency Practices and Unfair US Trade Laws
Allowing the use of trade measures to enforce exchange rate policy obligations greatly expands the prospective remedies that US officials may pursue under current US law when confronting currency manipulation. It also would likely have knock-on effects on other US laws that could be deployed to counter foreign currency practices.
With USTR as judge and jury of currency disputes with China, protectionist lobbies will be emboldened to push Congress to revise US trade law so that US officials can impose trade measures to manage exchange rates. And there is now a new channel for currency protectionism under trade laws administered by the Commerce Department.
It is probably not a coincidence that the Commerce Department issued final regulations on February 3, 2020, that define currency undervaluation as a countervailable subsidy liable to penalty duties under US unfair trade laws. US imports from China benefiting from “unfair currency subsidies” could potentially face countervailing duties for “causing harm to [US] industries.” Bluntly put, Commerce has manipulated the definition of currency manipulation for protectionist purposes. Though Commerce officials decry their innocence, this regulatory change conflicts with current Treasury practice and almost assuredly violates World Trade Organization (WTO) subsidy obligations, which I helped write 40 years ago. Look for Congress to resolve the Treasury-Commerce conflict through new, bipartisan legislation that (1) codifies Commerce practice under the new regulations in line with past efforts pursued by Senators Schumer and Graham and (2) rejects concerns that changes in US law would violate WTO obligations and prompt retaliation against US exporters.
Treasury Secretary Steven Mnuchin, inadvertently or not, has accepted a deal that will likely further politicize exchange rate policymaking and spark new trade tensions. US currency policy has become a political football with USTR and Commerce, not the Treasury secretary, at quarterback.
1. The United States-Mexico-Canada Agreement (USMCA) also includes currency provisions in its core text. However, enforcement actions in the USMCA are limited to violations of transparency and reporting provisions under USMCA Article 33.5.
2. Treasury Secretary Steven Mnuchin lifted that financial indictment on January 13, 2020, but kept China on a special currency watch list.
3. In addition, either country could ask the IMF to monitor policies or initiate consultations with the “Party Complained Against” (Article 5.4:2).
4. Under the Trade Facilitation and Trade Enforcement Act of 2015, remedial actions must include one or more of the following measures: block Overseas Private Investment Corporation (OPIC) financing or federal procurement of goods and services (consistent with WTO obligations); consider not entering into bilateral/regional trade pacts; and call for more IMF surveillance.