Commentary Type

Our Chance to Slash the High Costs of Currency Manipulation

Op-ed in the Financial Times


The United States and most of its main economic partners are aggressively negotiating large regional trade agreements. Taken together, the Trans-Pacific Partnership (TTP) and the Transatlantic Trade and Investment Partnership (TTIP) could produce the largest trade liberalization in history. They also aim to become templates for global trade rules for the 21st century.

The US Congress, however, has raised a challenge to the successful completion of this agenda, writing to President Barack Obama to demand that "strong and enforceable" foreign currency manipulation disciplines be included in all trade deals. The bipartisan majorities from both houses are right to make that link. Paul Volcker once noted that trade is more affected by 10 minutes of movements in exchange rates than by 10 years of trade negotiations. Allowing members of free trade pacts to offset liberalization through deliberately undervalued currencies can destroy the benefits of those agreements to their partners.

Both congressional letters refer to a study I wrote with Joseph Gagnon. In it we show that intervention in foreign exchange markets by 20 or so countries, to weaken their currencies and boost their trade surpluses, has been averaging almost $1 trillion annually and shifts at least $500 billion of production from deficit to surplus countries every year. This costs the United States millions of jobs, weakens the countries of Europe's periphery, and deepens the euro area crisis. It hits Brazil, India, Mexico, and other emerging markets.

International Monetary Fund rules prohibit such practices. But the IMF has no enforcement tools and has totally failed to resolve the problem. This is the largest gap by far in our international financial architecture. The time has come to fix it.

So, how should "strong currency manipulation disciplines" be defined? Mr. Gagnon proposes a threefold test. First, does a country possess excessive official foreign currency assets, including sovereign wealth funds? A common benchmark for adequate reserves is three months of imports, though six months might be permitted. Second, has a country acquired significant additional amounts of official foreign assets, implying substantial intervention, over a recent period, say six months? Such a medium-run horizon would permit interventions to offset market volatility but avoid a country perpetuating a large undervaluation.

Third, does a country have a substantial current account surplus? Deficit countries should be permitted to intervene defensively, but large surplus countries should not.

Those who fail these tests should face stiff penalties. At a minimum, they should lose the wider market access obtained via free trade pacts. Countervailing duties should be permitted against exports subsidized by deliberate undervaluation. Sweeping import surcharges could also be authorized.

But currency manipulation affects an aggrieved country's exports as well. Hence trade pacts should also authorize "countervailing currency intervention," through which it could offset the manipulators' purchases of its currency by buying equal amounts of theirs.

The prospect of such penalties should deter objectionable currency practices by trade pact participants. TPP and TTIP members could seek to add these disciplines to IMF and World Trade Organization rules so that the same standards would eventually apply to all countries.

Will TPP and TTIP participants accept such provisions? Currency is a sensitive issue, as are other areas of negotiation, such as intellectual property rights and harmonization of health standards. But its impact on trade is much greater: Manipulation hurts most TPP countries and virtually all EU members. Only two countries now involved in the trade pact negotiations—Malaysia and Singapore—have been recent manipulators. All TPP and TTIP participants want enhanced access to the US market, so they would not want to jeopardize congressional approval.

The IMF and finance ministries have failed to resolve the currency issue for 70 years. The US Congress is thus making its approval of the new trade agreements conditional on their effectively countering manipulation. A failure to do so could sink the trade deals that represent one of the biggest potential benefits to the global economy.

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