One persistently bad American idea, periodically raised in the context of trade negotiations, is to build into the text of any agreement some clauses that prevent countries from “manipulating” their currencies. The inclusion of such a clause at this point in the Trans-Pacific Partnership (TPP) negotiations may be the straw that breaks the proverbial camel’s back, leading to the collapse of the entire enterprise.
Any sort of currency manipulation clause is unlikely to solve the problem it is ostensibly trying to address. Worse, in order to ensure that American interests are not undermined, the provisions would have to be carefully crafted such that they might never be triggered. The final point of damage—even if there are virtually no circumstances under which such clauses might be used, America’s trade partners in the TPP might simply refuse to conclude negotiations at all.
Despite three excellent reasons for not moving ahead with such an idea, more than half the members of the last Congress already went on record supporting the inclusion of currency manipulation in all U.S. trade agreements. Last week, a bill to address manipulation was introduced in both Houses.
So what is the problem so many backers of such legislation are trying to address? In brief, governments can give a competitive advantage to their export industries if their currency is lower in value than their export partners. The difference in currency values effectively makes imported goods cheaper in the foreign market, encouraging consumers and producers to buy more, relatively cheaper, foreign goods than relatively more expensive domestic items.
How would a government go about making this happen? If a government intervenes in currency markets, it can drive down demand for its own currency (or drive up demand for foreign currencies) by buying and selling currency.
Another way to accomplish the same thing is to print more money domestically. If there is more money in circulation now, the value of any given note is lower. However, governments engaged in such behavior often argue that such policies are not aimed specifically at artificially depressing the value of the currency for the purpose of generating an unfair trade advantage. Therefore, such behavior is not considered currency manipulation, at least as members of Congress appear to want to define it.
The purchase of assets by the government can also change the value of currencies, even if the objective is to stimulate the domestic economy.
Singapore loosened monetary policy two weeks ago in response to weaker oil prices and low domestic demand. The government argued it was using one of the primary items in its tool kit to address low inflation, since it does not use interest rates as a tool.
Thus, governments may have lots of legitimate reasons for adjusting currencies without the specific intention of getting a leg up for exports.
It may be important to note that not every country is able to manipulate currencies. If the country is small, especially with limited demand, the value of the currency is more likely set by market forces. A country with limited resources cannot intervene very much to buy or sell currencies. And, finally, the United States has a unique position in the global economy. Since the U.S. dollar functions as a reserve currency, it allows the United States to have different options than anyone else in the markets (for the moment, at least, but that is another story). Let me also note that because of this position, the United States does not have to intervene in currency markets like anyone else.
Efforts to stop countries from “unfairly manipulating” their currency will not work.
There are many reasons why not, but start with the fact that most countries in a position to manipulate currencies also have complex economies. These economies rely on both exports and imports. For many firms, exports can only be produced with imported content. By depressing the value of the currency to make exports cheaper, imports become more expensive. As a result, firms may not actually be competitive in the export market since the price of imported content of the final goods might be more than offset by whatever the discount on the export side might be.
Equally key, for the most complex products, the value of the benefit from a depressed currency is likely to be small. Consider an i-Pod, for instance. Imagine that China were, in fact, manipulating their currency to a massive extent—say 50% off the presumed “normal” value of the yuan. In this hypothetical context, it might appear that Chinese intervention is dramatically affecting the price of the device in the American market. But, in fact, the total amount of Chinese content in an i-Pod could be as little as $4 of the $150 sales price. Thus, the extent of the “unfair” advantage of Chinese currency might make a whole $2 difference to the final buyer.
Recall that this example gives figures for a truly exceptional rate of currency intervention at 50%. The actual extent of manipulation is likely to be considerably smaller. This means that the total price difference could be literally pennies.
While other products may not show such dramatic figures, the point is that—in most complex, higher value items—the content is likely to be provided by multiple countries. As a result, even crazy high manipulation is unlikely to affect the final price very much.
The Big 3 auto companies are driving the issue of currency manipulation in Washington. But a car in the modern, globalized economy is very much like an i-Pod. Even if you could determine that a China or a Japan was intervening to depress currency prices by a lot, the total difference in the price of a finished car is still likely to be much more modest than people realize.
To make this pressure by the Big 3 auto companies more surprising, many of the cars sold in the United States today are actually manufactured in whole or part in the United States (or NAFTA countries). Thus, the value of potential manipulation on the total cost of a car is small.
Practically speaking, a currency manipulation clause has additional challenges. How can the specific amount of currency tweaking be measured? Currencies change regularly in the open market, so a trade agreement has to take this into account somehow. Even in the alleged cases of Japanese or Chinese manipulation, few could agree on the extent of intervention—was it 10 or 45% or something in between?
What is the appropriate response to such intervention? Even if a trade agreement could specify the triggers for determining manipulation, then what? Many of the proposed “solutions” appear to run afoul of other laws and regulations.
The United States, clearly, does not want to become ensnared in its own rules either. Depending on how defined, basic American policy in the independent Federal Reserve could be challenged by foreign governments. Problems like this make whatever provisions that might end up in trade agreements so tightly restrictive that they can never be applied or it might mean that the United States breaches the rules and argues for non-intervention in its own affairs.
Finally, none of the specific partners currently negotiating the TPP are keen to see rules on currency manipulation included. This agreement has been under discussion for nearly five years. To add a controversial (to put it mildly) item so late in the game is to risk imploding the whole deal.
Some may argue that TPP partners have already accepted proposals and provisions that they do not like. What is different about currency manipulation from other American ideas? At some point, however, pushing too hard may make others snap. This is likely to be that point. Adding a very unpopular and unworkable idea like currency manipulation clauses into the TPP mix at this late day is a truly dreadful idea that should be discarded immediately.