Looming US-China Trade Battles?: Currency Manipulation (Part I)

March 6, 2015 2:15 PM

The pending debate over trade in Congress is setting the stage for two potential megabattles over trade rules that could reach the World Trade Organization (WTO) in 2016. These disputes could shape future trade rules, disputes, and remedies for a long time to come. It could take three or more years for the WTO Appellate Body to issue dispositive rulings that would resolve the battles and clear up the rules.

While different in substance, the two battles have been spurred by the politically charged belief in the United States that China does not play fair, a legacy of many years of trade deficits between the United States and China.

Currency Manipulation

Many congressmen are concerned when foreign central banks manipulate their currencies to boost exports (by making them cheaper in the United States) and restrain imports (by making them more expensive in their markets), thereby stimulating home employment—but with an opposite effect on US trade and jobs. China has been seen as the chief villain in this saga in recent years, though Japan’s practices dating back to the 1970s and early 2000s remain a sore subject for some US companies.1

Accordingly, a majority of congressmen2 are insisting that a currency manipulation provision be linked to Trade Promotion Authority (TPA) and the Trans-Pacific Partnership (TPP)—if not as an integral part of the negotiating objectives in TPA or the actual TPP text, then as companion legislation that imposes US penalties on foreign currency manipulators.

The pros and cons of currency legislation have been debated elsewhere by Peterson Institute fellows.3 Treasury Secretary Jacob Lew urges Congress not to mix trade and currency, while Federal Reserve Chairwoman Janet Yellen cautions that currency provisions could restrict the appropriate use of monetary policy. But influential lawmakers argue that the Treasury and the International Monetary Fund (IMF)—tasked with the responsibility of ensuring that member countries live up to their commitments not to unfairly manipulate currencies—have failed to monitor exchange rates and that the time has come for Congress to act. It remains to be seen how the drama will play out. However, for the purpose of analysis, this blog post assumes that a currency bill will be enacted as a supplement to the existing US countervailing duty (CVD) statute, which imposes tariff penalties when countries are found to have violated trade rules. This posting also assesses the prospects of WTO litigation between the United States and China.

US CVD law permits US companies to petition the government for relief from imports that are proven to be subsidized by a foreign government. As a supplement to the existing US law, the extent of currency manipulation—defined by Commerce Department regulations under the guidance of the new statute—would be treated as an import subsidy and be offset by a penalty duty, assuming other conditions of the CVD law were met in a particular case.4

Even if China were not subjected to the currency provisions—a case can be made that it has eased currency intervention in recent years5—passage of such a law would probably compel China (and other countries) to bring a case in the WTO. Disputes challenging trade remedies are common.6 China has challenged both the procedures and outcomes of US countervailing duty investigations in the past.

There are three scenarios in which China could pursue a case. First, upon passage of the CVD law and short of a formal petition naming China as a manipulator, China could initiate a WTO case. This sort of legal action, called an “as such” case, is common when the law on its face arguably violates WTO obligations. Second, China could bring an “as applied” case to the WTO once a CVD petition is filed on a specific Chinese product. The additional basis for this case would be the loss of Chinese exports caused by a “chilling effect” of a CVD petition at the moment of filing. Indeed, empirical studies have found that the mere act of filing a petition, regardless of whether final duties are levied, can significantly restrict trade.7 Finally, China could wait to initiate a challenge until a petition results in an affirmative duty by the US Department of Commerce—whether the duty is provisional or final.

If a case reaches the WTO, the question is whether an Appellate Body ruling would favor China or the United States. Among the three scenarios, US defenses against a WTO challenge might be strongest in the first scenario: Proving that the new US CVD law on its face is inconsistent with WTO obligations might be difficult for China in the absence of a specific cause of action. Yet, if overall relations between the United States and China are cool, China would be likely to act under this scenario. Once a petition is filed, and even more once CVDs are imposed, US defenses would be weaker, since the United States could no longer argue that the Chinese case was merely “hypothetical.”

Even so, de Lima-Campos (2014) contends that the United States would have a good defense arguing that currency manipulation undermines WTO rules by augmenting the protective effect of tariffs and by making exports more competitive in foreign markets.

While the WTO generally defers to the IMF for exchange rate issues, several GATT rules set the stage for consultation between the two institutions if “exchange actions” undermine trade rules.8 GATT Article XV(4) states that members “shall not, by exchange action, frustrate the intent of the provision of the Agreement.” The elaboration of GATT Article XVI in the WTO Agreement on Subsidies and Countervailing Measures (ASCM) is also relevant. ASCM Article 3(a) explicitly prohibits “subsidies contingent, in law or fact*, whether solely or as one of several other conditions, upon export performance….”9 The * (note 4 in GATT text) reads “This standard is met when the facts indicate that the granting of a subsidy…is in fact tied to the actual or anticipated exportation or export earnings.” The United States could argue, perhaps citing official statements, that a weaker exchange rate was tied to the goal of export promotion.

But China could mount a strong case as well. Historically, an undervalued exchange rate was not regarded as a subsidy in the sense of a government’s “financial contribution” to an industry, nor was an undervalued rate seen as specific to “an enterprise or industry, or group of enterprises or industries”—the test for a domestic subsidy to be actionable under the GATT. Furthermore, an undervalued rate was never defined as an export subsidy under GATT and WTO reports and agreements dating back to the 1960s. Finally, whether or not a currency is undervalued, and whether or not central bank intervention in the foreign exchange market equates to currency manipulation, are terra incognita questions to the GATT. All in all, the argument that an undervalued exchange rate violates GATT Article XV, Article XVI, or the ASCM appears likely to face an uphill battle under current WTO jurisprudence (Schott and Hufbauer 2012).10

It’s worth speculating on the timeline of prospective WTO litigation: The mandatory consultation period is 60 days. Thereafter, the average time for completion of panel reports runs 470 days. Following the panel report, Appellate Body decisions average 130 days.11 Based on these averages, a currency case could take roughly 2 years from the date it was initiated, but since currency questions are novel and complicated, resolution could easily take 3 years. If the US Congress enacts currency legislation in 2015, the final Appellate Body decision might well wait until 2018 or beyond.  Even if the Appellate Body rules against the United States, China would not enjoy retroactive refunds for countervailing duties collected prior to the ruling.

Stay tuned for Part 2 of this blog post, which will be published on Monday, March 9, 2015.


1. The Abe government’s current monetary policy of quantitative easing, which has devalued the yen as a byproduct, is not the current target of concern, but rather Japan’s practices in previous decades when the central bank intervened heavily in the foreign exchange market, buying dollars and selling yen. Purchases of foreign exchange in large quantities by the People’s Bank of China have been the more immediate concern.

2. In June 2013, 230 members of the House of Representatives sent a bipartisan letter urging the Obama administration to address the currency issue in TPP; 60 senators sent a similar letter in September 2013.

3. We do not rehash the debate in this blog post. However see, for example, Edwin M. Truman, “Don’t Involve the TPP Negotiations in Currency Wars,” Trade and Investment Policy Watch, February 20, 2015; and C. Fred Bergsten (2014), Addressing Currency Manipulation Through Trade Agreements, Policy Brief 14-2, Peterson Institute for International Economics.

4. Most importantly, imports of the product in question must inflict “material injury” on complaining firms—as determined by the US International Trade Commission. In practice, “material injury” means loss of sales, employment, or profit.

5. China has been a major currency manipulator in the past decade but in recent years has allowed the steady appreciation of the renminbi against the dollar. Intervention rebounded in early 2014 causing some concern. William Cline’s fundamental equilibrium exchange rate (FEER) calculations—which estimate the real exchange rate adjustments that would correct for current account imbalances—suggest China’s currency undervaluation has lessened: The renminbi went from being undervalued by 13 percent in May 2013, to 2 percent in May 2014, to no misalignment in the November 2014 estimates.

6. Out of 486 requests for consultations brought to the WTO from 1995 to 2014, roughly one-third involved antidumping and countervailing measures. Analysis of such cases through the mid-2000s found WTO Panels and the Appellate Body ruled that at least one element in nearly every trade remedy case was inconsistent with WTO rules. See James P. Durling (2003), Deference, But Only When Due: WTO Review of Anti-Dumping Measures, Journal of International Economic Law 6, no. 1: 125–53.

7. For example, see R. W. Staiger and F. A. Wolak (1994), Measuring Industry-Specific Protection: Antidumping in the United States, in Brookings Papers on Economic Activity: Microeconomics,  ed. M. N. Baily and P. C. Winston; and Thomas J. Prusa (2001), On the spread and impact of anti-dumping, Canadian Journal of Economics 34, no. 3: 591–611.

8. Several studies have analyzed the GATT clauses and the relationship between the WTO and IMF with respect to currency issues.  Among others, see Aluisio de Lima-Campos (2014), Currency Misalignments and Trade: A Path to a Solution, Working Paper No. 2014/11, Society of International Economic Law; Gary Clyde Hufbauer, Yee Wong, and Ketki Sheth (2006), US-China Trade Disputes: Rising Ride, Rising Stakes, Policy Analyses 78, Peterson Institute for International Economics; Gary Clyde Hufbauer and Jeffrey J. Schott (2012), Will the World Trade Organization Enjoy a Bright Future?, Peterson Institute for International Economics; and Vera Thorstensen, Daniel Ramos, and Carolina Muller (2013), Exchange Rates Measures, Who Judges the Violation? Sorting out prerogatives, December.

9. Since Annex I of the ASCM does not mention exchange rates, and since that annex is illustrative not exhaustive, the language of the annex does not shed much light on the exchange rate question.

10. In the mid-2000s, congressional pressure mounted to hold China accountable for its undervalued currency and to take action through a “Section 301 petition” to the WTO, alleging that China violated Article XV(4) of the GATT and the ASCM. Section 301 of the US Trade Act of 1974 authorizes the president to take measures against “unjustified and unreasonable” foreign barriers; in this case, action would be a petition of the WTO seeking a declaration that China’s currency regime violated its obligations. At the same time, parallel legislation (H.R. 1498) was proposed to unilaterally declare undervalued currency a prohibited export subsidy. The petition was not filed and legislation failed to pass, in part because of their perceived legal weaknesses under WTO jurisprudence.

11. Average periods are based on recent WTO dispute cases; see Hufbauer and Schott (2013), tables 10.1 and 10.2.


Earle Campora

Very neat blog post.Really looking forward to read more. Will read on...

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