We welcome this opportunity to comment on the Commerce Department's proposal to allow currency undervaluation to be considered as a subsidy to foreign exporters that may be subject to countervailing duties. We support this change provided that Commerce limits the finding of countervailable subsidies to countries and time periods which the Treasury Department has identified as meeting the criteria for "enhanced analysis and engagement" laid out in the Trade Facilitation and Trade Enforcement Act of 2015.
We agree with Commerce's assessment that the new rules would have only a small impact on total duties collected. A far superior policy response to currency manipulation by foreign governments is for Treasury to conduct countervailing currency intervention as we proposed in our 2017 book, Currency Conflict and Trade Policy: A New Strategy for the United States.
When Is Currency Undervaluation a Countervailable Subsidy?
Commerce proposes to limit the new rule to instances of "currency undervaluation resulting from government action on the exchange rate." Commerce further states that it does "not intend in the normal course to include monetary and related credit policy of an independent central bank or monetary authority" in its definition of government action. However, another government policy that has a significant effect on the exchange rate is fiscal, or budgetary, policy.
Finance ministers and central bank governors of G-20 countries have repeatedly stated that monetary and fiscal policies in each economy should be aimed at maximum sustainable growth with low inflation. They also agree not to target their exchange rates for competitive purposes. The implied agreement among G-20 countries is that monetary and fiscal effects on exchange rates are not considered to be targeting of exchange rates for competitive purposes. Policies that target exchange rates for competitive purposes include currency purchases, or intervention, in foreign exchange markets and discriminatory controls or taxes on capital flows. Commerce should limit its application of the proposed new rules to currency undervaluation caused by official actions that target the exchange rate for competitive purposes and not to currency fluctuations caused by monetary and fiscal policies or any non-policy factors.
The proposed new rules will almost certainly be challenged at the World Trade Organization (WTO). Many trade lawyers argue that currency undervaluation is not a countervailable subsidy under the WTO because it lacks the required specificity. But some argue that currency undervaluation is countervailable because it is specific to exporters of the country with an undervalued currency (de Lima-Campos 2014). We agree that undervaluation caused by official policies targeted at the exchange rate is a subsidy to exporters. It is worth testing whether such undervaluation is sufficiently specific to meet the WTO standard. Moreover, even if this subsidy is found to be insufficiently specific, the United States should try to change the rules because the effect of targeted exchange rates clearly violates WTO Article XV, which states that members "shall not, by exchange action, frustrate the intent of the provision of the Agreement."
Commerce proposes to measure the subsidy based on the deviation of the exchange rate used in trade from some measure of the equilibrium real effective exchange rate (REER) of the exporting country. As others have noted, estimating equilibrium REERs is not without controversy. The International Monetary Fund (IMF) publishes three sets of equilibrium REERs annually, using different criteria based on (1) sustainable trade balances with desirable policies, (2) sustainable net international investment positions, and (3) historical relationships of relative prices across countries. The Peterson Institute for International Economics (PIIE) has published estimates based on sustainable medium-term current account positions (Cline 2017).
A widely agreed set of currency norms should not be a requirement for taking action against unfair currency manipulation. If different approaches lead to similar results, there would be a strong case for the agreed level of currency undervaluation. If different approaches lead to widely different results, Commerce should make the case for what it views as the most relevant estimate, in consultation with the Treasury Department.
The Treasury Department's Role in US Currency Policy
The field of economics has long recognized a distinction between macroeconomic and microeconomic aspects of trade. Macroeconomics focuses on the overall balance of trade whereas microeconomics is concerned with the specifics of which goods and services are exported and which are imported. This distinction is embodied in the structure of US government agencies and the design of international organizations.
The Treasury Department is charged with policy towards the dollar, which reflects its role as the primary macroeconomic department in the cabinet. The Commerce Department and the US Trade Representative share responsibility for microeconomic trade policies, including tariffs and trade remedies. Similarly, the IMF covers the international monetary and exchange rate systems, whereas the WTO covers tariffs and trade barriers.
Because it affects all exports and imports, currency policy is inherently a macroeconomic tool. Thus, judgments concerning unfair targeting of the exchange rate for competitive purposes by our trading partners have been delegated to Treasury. Commerce should defer to Treasury in this regard.  It makes no sense for Commerce to try to establish its own expertise in this area.
Countervailing Currency Intervention (CCI) Is a Superior Policy Response
A major problem with Commerce's proposal is that it would not achieve much, as Commerce itself acknowledges. Like all countervailing duties, it would require the petitioning industry to demonstrate that it was injured by the subsidized product. It would cover only US imports of the individual product and exclude the harm caused by all other exports from the subsidizing country as well as the implied protection against all imports to the subsidizing country from the United States and elsewhere. At the moment, it would lie virtually or totally dormant because few if any countries are now manipulating their currencies (though it could help deter them from resuming that practice in the future).
A preferable alternative would thus be to initiate a policy of countervailing currency intervention (CCI) rather than or in addition to, countervailing import duties (Bergsten 2019). When a country buys dollars to keep its own currency weak, the United States would simply buy an equivalent amount of that country's currency to neutralize the impact on the exchange rate and obviate any impact on competitiveness and trade flows. There would be no budgetary cost to the United States. No international rules would be violated. US announcement of such a policy would probably suffice to deter others from resuming manipulation.
CCI would cover US exports and competition in third markets as well as imports. It would hit an entire country, rather than just a subsidized industry, and properly avoid having to demonstrate injury. The operation would be located in Treasury, avoiding the bureaucratic problems that would inevitably occur under the countervailing duty approach as Commerce and Treasury attempt to coordinate. CCI would be a far superior response to currency manipulation than the countervailing duty approach that Commerce is proposing.
Bergsten, C. Fred. 2019. Commerce Department's Proposal to Curb Currency Manipulation Uses the Wrong Tool. Trade and Investment Policy Watch Blog, Peterson Institute for International Economics, June 4.
Bergsten, C. Fred and Joseph E. Gagnon. 2017. Currency Conflict and Trade Policy: A New Strategy for the United States. Washington: Peterson Institute for International Economics.
Blanchard, Olivier, Gustavo Adler, and Irineu de Carvalho Filho. 2015. Can Foreign Exchange Intervention Stem Exchange Rate Pressures from Global Capital Flow Shocks? NBER Working Paper No. 21427. Cambridge, MA: National Bureau of Economic Research.
Cline, William. 2017. Estimates of Fundamental Equilibrium Exchange Rates, November 2017. Policy Brief 17-31. Washington: Peterson Institute for International Economics.
de Lima-Campos, Aluisio. 2014. Currency Misalignments and Trade: A Path to a Solution. Fourth Biennial Global Conference of the Society of International Economic Law (SIEL) Working Paper No. 2014/11. Available at SSRN: https://ssrn.com/abstract=2451289
Gagnon, Joseph, and Christopher Collins. 2019. Despite Minor Changes in Treasury's Foreign Exchange Report, Major Flaws Remain. Trade and Investment Policy Watch Blog, Peterson Institute for International Economics, June 12.
1. In its semi-annual reports pursuant to the Act, Treasury limits its analysis to the largest trading partners of the United States. However, at Commerce's request, Treasury should provide its opinion on any smaller trading partner that Commerce decides to investigate.
2. The other apparent beneficiary of the subsidy is foreign investors, who receive more local currency in exchange for their foreign currency. However, if the currency undervaluation reflects a longstanding and relatively constant policy, then investors will lose any benefit when they eventually repatriate their investments or accumulated earnings in the future. In other words, only a temporary undervaluation benefits foreign investors, whereas exporters benefit from both permanent and temporary undervaluation.
4. One promising line of research suggests that it may be possible to estimate the subsidy directly from the amount of foreign exchange intervention rather than the overall level of undervaluation (Blanchard, Adler, and de Carvalho Filho 2015).
5. Equilibrium estimates based on sustainability of trade balances should take priority over estimates based on relative prices because it is the effects on trade that matter for trade policy actions. Relative prices may differ across countries for indefinite periods of time owing to differences in levels of economic development or the degree of competition in local markets.
6. It is the case, however, that tariffs applied broadly enough can begin to have macroeconomic implications. For example, it is widely accepted that, under a fixed exchange rate system, an across-the-board import tariff combined with an equal export subsidy is economically equivalent to an exchange rate depreciation of the same magnitude. Under a flexible rate system, such an import tariff and export subsidy policy would cause an exchange rate appreciation that would nullify any effects on trade.
7. Nevertheless, we have concerns with the criteria used by Treasury, as explained in Gagnon and Collins (2019).
8. A further advantage of CCI is that it would not require having to estimate the degree of undervaluation.