International Economic Law and Policy Blog

New Paper: "Currency Manipulation" and World Trade

Robert Staiger and Alan Sykes have a new Working Paper on "'Currency Manipulation' and World Trade."  Here's the abstract:

Central bank intervention in foreign exchange markets may, under some conditions, stimulate exports and retard imports. In the past few years, this issue has moved to center stage because of the foreign exchange policies of China. China has regularly intervened to prevent the RMB from appreciating relative to other currencies, and over the same period has developed large global and bilateral trade surpluses. Numerous public officials and commentators argue that China has engaged in impermissible "currency manipulation," and various proposals for stiff action against China are now pending on Capitol Hill. This paper clarifies the theoretical relationship between exchange rate policy and international trade, and addresses the question of what content can be given to the concept of "currency manipulation" as a measure that may impair the commitments made in trade agreements. The analysis goes to the proper relationship between IMF obligations and WTO obligations and to the question whether trade measures can be an appropriate response to exchange rate policies. Our conclusions are at odds with much of what is currently being said in Washington. For example, it is often asserted that China's currency policies have real effects that are equivalent to an export subsidy. In fact, however, if prices are flexible the effect of exchange rate intervention parallels that of a uniform import tariff and export subsidy, which will have no real effect on trade, an implication of Lerner's symmetry theorem. With sticky prices, the real effects of exchange rate intervention and the translation of that intervention into trade-policy equivalents depend critically on how traded goods and services are priced. We show how the effects differ, according to whether exporters invoice in the local currency of the producer, in the currency of the buyer, or in a "vehicle" currency such as dollars. The real effects of China's policies are thus potentially quite complex, are not readily translated into trade-policy equivalents, and are dependent on the time frame over which they are evaluated (because prices are less "sticky" over a longer time frame). Accordingly, we are skeptical about many of the policy responses now under consideration in Washington both on economic and legal grounds.

The paper has lots of good economic and legal analysis (including GATT Article XV, the SCM Agreement and Non-Violation Nullification or Impairment) of many of the issues surrounding currency manipulation and trade rules.  Here's a brief excerpt from the paper, on the issue of whether such manipulation constitutes an "export subsidy":

The specificity requirement is met if exchange market intervention can indeed be characterized as an export subsidy -- i.e., as a subsidy "contingent upon export performance." Article 2.3 provides that all such subsidies are "specific." Exchange market intervention, of course, does not expressly confer benefits on firms "contingent" on their export performance. All firms will operate in the environment of an altered exchange rate irrespective of their export performance. A respectable argument might be made, however, that an undervalued exchange rate tends to favor exporting firms if it has any real effects at all (assuming that prices have not adjusted to offset it). Even if not formally contingent on export performance, therefore, any export stimulus resulting from an undervalued exchange rate is plausibly characterized as an export subsidy.

For me, this raises the fundamental question of what "export contingent" means.  Does export have to be a necessary and/or sufficient condition for receiving the subsidy?   Does export simply need to be "tied" to the subsidy, the term used in footnote 4?  If "tied" is the standard, what constitutes evidence of a "tie"?  The authors describe the issue as follows: "an undervalued exchange rate tends to favor exporting firms."  I see two ways to interpret this.  First, the undervalued exchange rate favors exporting firms over their foreign competitors.  But all subsidies do this, so I don't think this what they had in mind.  Second, the undervalued exchange rate favors domestic exporting firms over domestic non-exporting firms.  I think they probably had this one in mind.  I hope they did, anyway, because I've always thought something like this should be the standard for export contingency.  I had thought of it in these terms: whether the subsidy provides an incentive for domestic firms to engage in export sales rather than domestic sales.

Anyway, that's a bit of a digression away from the currency issues, which are elaborated at great length in the paper.

Clinton and Obama on Currency

From the campaign trail, Hillary Clinton takes on the China currency issue:

The China Currency Coalition ("CCC") today greeted enthusiastically the announcement by Senator Hillary Clinton (D-NY) that she has become a co-sponsor of S. 796, the Fair Currency Act of 2007, also known as the Bunning-Stabenow-Bayh bill after Senators Jim Bunning (R-KY), Debbie Stabenow (D-MI), and Evan Bayh (D-IN).

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The Fair Currency Act of 2007 and its counterpart, H.R. 2942 in the House, recognize exchange-rate misalignment - whether by China or by any other country - as an export subsidy.  Under this bill U.S. companies and workers will finally be able to take corrective action under U.S. trade laws.

And Obama is on board, too:

Democratic presidential candidate Barack Obama said on Thursday he supported a Senate bill to offset China's "currency manipulation," one day after his rival Hillary Clinton added her name to the list of legislation's co-sponsors.

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The Stabenow-Bunning bill would define currency manipulation as a subsidy under U.S. trade laws, opening the door for the Commerce Department to impose countervailing duties on a broad array of Chinese goods. Individual companies or industries would still have to petition for the relief before duties are imposed.

Tough Talk on China's Currency

The Democratic candidates were talking to the Alliance for American Manufacturing today, and they had some strong words on the Chinese currency issue.

From Obama:

It’s not just that China is following the path taken by so many other countries before it, and dumping goods into our market while not opening their own markets, something I’ve spoken out against. It’s not just that they’re violating intellectual property rights. They’re also grossly undervaluing their currency, and giving their goods yet another unfair advantage. Each year they’ve had the chance, the Bush administration has failed to do anything about this. That’s unacceptable. That’s why I co-sponsored the Currency Exchange Rate Oversight Reform Act. And that’s why as President, I’ll use all the diplomatic avenues open to me to insist that China stop manipulating its currency.

I thought the reference to "all the diplomatic avenues" was interesting.  Does that include WTO litigation, which as we know has become less diplomatic and more legalistic over the years?  Are his trade advisers carefully wording his statements to make sure he has not committed himself to bringing a complaint?

From Clinton:

With our trade deficit with China now at a record $256 billion, Hillary believes it is time for aggressive action to crack down on China's unfair trade practices. Hillary Clinton will not take a passive line on unfair trade practices and will work to level the playing field for American workers, reducing our trade deficit and keeping more jobs here at home.

1. Take a Tough Line on Currency Manipulation. Foreign countries manipulate their currencies to make American goods expensive in their markets and to make their own goods artificially inexpensive. This practice hurts American workers and domestic producers, and it must end. Hillary is a co-sponsor of legislation that will require the administration to take definitive steps to stop China and other countries from harming American interests by undervaluing their currencies.

• As President, she will move aggressively to address currency manipulation in China and other countries. Hillary has supported legislation to take one or more of the following actions to pressure China to revalue its currency, and will consider all of these actions as President: 1) adjusting export prices to account for the price distortion caused by currency misalignment; 2) disallowing the federal government to purchase products or services from China; 3) directing U.S. banks to pause in issuing loans to China; 4) pressuring the IMF to consult with China; and/or 5) imposing a 27.5 percent tariff on all Chinese goods.

No mention of a WTO complaint here.  Some of the actions listed seem likely to generate a WTO complaint against the U.S., though.

ADDED:  More from Clinton in the transcript of her remarks:

China should be a trade partner, not a trade master. I'll start with currency manipulation. It is outrageous that China and other countries continue to manipulate their currencies to put our goods at a disadvantage.

I've already cosponsored legislation to crack down on currency manipulation as president and I will finish the job.

House Ways and Means on China's Currency

From a letter to President Bush from the House Ways and Means Committee:

China's currency manipulation needs to be addressed through the WTO, as well as the IMF. WTO rules are clear. A member country "shall not, by exchange action, frustrate the intent of the provisision this Agreement."

Here's the press release.

And from the Administration:

US Treasury Secretary Henry Paulson will tell his Chinese counterparts next week in Beijing that the yuan's recent currency appreciation is 'significant' and 'welcome,' though it is not yet at the point where the US would like it to be, a top Treasury official said today.

Mattoo and Subramanian on WTO Currency Rules

Joel recently mentioned a new paper by Aaditya Mattoo and Arvind Subramanian entitled "Currency Undervaluation and Sovereign Wealth Funds: A New Role for the World Trade Organization."  I had been planning for a while to do a short post on it, but was distracted by other things.  What interested me was the currency undervaluation part (I don't have strong opinions on sovereign wealth funds, at least not yet).  As I've said before, while I am generally skeptical of expanding trade rules to cover new areas, this is one where I think trade rules would be useful.

Here is the passage from the paper where the authors explain their view of what WTO rules in the area of currency undervaluation could be:

Content of New WTO Rules

If there are plausible push and pull reasons for the WTO to regulate exchange rates, the question is how this should be done. The current provision in Article XV that “Contracting parties shall not, by exchange action, frustrate the intent of the provisions of [the WTO] Agreement …,” is too vague an obligation to provide a basis for effective regulation. Indeed, there is no jurisprudence on this provision of the GATT.

Any new rules should not be expedient and ad hoc, targeted at specific countries and tailored just to meet today’s problems. Rather they should be such that their rationale and usefulness outlive current circumstances. In terms of content, procedures, and caveats, new rules could draw upon existing ones.

First, any new rules would need to stipulate that undervalued or substantially undervalued exchange rates that stem clearly from government action act like import tariffs and export subsidies. The rule would therefore have two conditions: a clear finding of undervaluation and its demonstrable attribution to government action.

Once these two conditions are established, it would be as if GATT rules that prevent tariffs and other charges beyond previously specified ceilings and export subsidies in any form are violated.

Is it possible to make pronouncements on the issue of exchange rate misalignment with a high level of confidence? The answer is probably not, but that could be a strength rather than a weakness because the WTO would regulate only egregious cases of misalignment—where the technical determination is relatively robust and criticism-proof—demonstrably caused by government action such as intervention. The high bar would act as a disincentive to frivolous litigation on this issue.

Is it possible to attribute undervaluation to government action? Establishing this is important
because most WTO obligations relate to policy instruments themselves, but undervalued exchange rates are an outcome rather than a policy instrument. Undervaluation can result from a number of factors, including fiscal and monetary policies, policies related to capital flows, taxes and subsidies, and intervention in foreign exchange markets. A finding that a country has an undervalued exchange rate would not be justiciable unless it translates into some clear remediable policy action that a country can take to change the outcome.

In the case of undervalued exchange rates, there is a clear hierarchy of policy actions in terms of proximate causation (see Mussa 2007 for a clear discussion of this issue). Prolonged one-way intervention in foreign exchange markets by the central bank or by government and quasi-government agencies, redenomination of domestic debt into foreign currency, and extensive forward market operations are policy actions that can clearly be identified as causes of undervaluation.

The more difficult cases will involve undervaluation caused by fiscal, monetary, or trade policies. Here Mussa’s (2007) suggestions for a case-by-case determination seems the most pragmatic way forward.On the one hand, domestic objectives (full employment) will typically drive many of these policies, and the exchange rate consequences will be secondary. In these instances, countries should get the benefit of the doubt even in the event of a finding of undervaluation. But if it could be demonstrated that the mix of policies is clearly aimed at the external objective of gaining a competitive advantage, a country could then be asked to change its policy mix.

Third, who should determine whether there is undervaluation and what its policy causes are?
Recall that the IMF retains jurisdiction over exchange rates, and furthermore, technical expertise on exchange rates still resides with the IMF. Here again we draw on a precedent for joint Fund/WTO oversight over policy instruments. In the GATT, developing countries, for long, used trade restrictions for balance of payments (BOP) purposes. The assignment of responsibility in that instance was for the IMF to determine whether a country did in fact have a BOP problem, and then the WTO took over to appropriately regulate the restrictions. Indeed, two important disputes in the WTO—quantitative restrictions on beef imports by Korea (late 1980s) and on consumer goods by India (late 1990s)—involved such restrictions, which eventually had to be eliminated after dispute settlement panels found them to violate GATT/WTO rules. In the Korea beef case, the IMF determination was made in the context of the Fund’s Balance-of-Payments Committee deliberations. But in the dispute involving India, the Fund’s involvement resulted from the dispute settlement panel, in deference to Article XV requiring Fund input on these matters, posing specific questions to the Fund. Responses to these questions were treated as factual inputs, which the panel went on to interpret and use to adjudicate the case.

We envisage a procedure very similar to Fund-WTO relations on restrictions for BOP reasons. Just as in these cases, where the Fund determines whether there is a BOP problem facing countries, it would be essential for WTO panels to seek the IMF’s assessment on whether the member’s exchange rate was misaligned and whether it was a consequence of clear government action. So rather than take on the political risks of what might be very one-off and controversial pronouncements, the IMF would respond to the WTO’s request by making a more technical determination (based possibly on the results of the IMF research department’s multilateral model (CGER) for determining equilibrium exchange rates). To be sure, this determination would have to be made and approved at some high level (either the Fund’s management or the Board), but it could still be less controversial than the issue being raised within the Fund itself.

It's important to note that the authors are not concerned with all currency undervaluation, but only that which is caused by government action.  In this way, their proposal for a greater WTO role is somewhat limited in scope.

I do have a question about their proposal, though, in relation to its scope.  The authors seem to have a broad conception of the types of government actions that may cause undervaluation ("fiscal and monetary policies, policies related to capital flows, taxes and subsidies, and intervention in foreign exchange markets").  But are there non-protectionist reasons to take such actions?  With such a wide range of policies mentioned, it seems likely the answer is yes.  If that is the case, would it be a mistake to condemn all government-caused undervaluation?  Do we need to look at the intent behind the particular government actions at issue?  Or will governments be held liable for the impact of their policies, even if they did not intend to lessen the value of their currency?

AD/CVD and Currency Manipulation

Chris Padilla, Under Secretary of Commerce for International Trade, says that using AD/CVD duties to fight currency manipulation is not a good idea:

The Chinese currency has received particular legislative attention. I will leave it to my colleagues at the Treasury to discuss currency policy. Instead, I will address the challenges of requiring the Commerce Department to include an assessment of China’s currency value in antidumping (AD) or countervailing (CVD) duty margins. This is problematic for at least four different reasons.

First, keep in mind that the central purpose of inserting currency judgments into trade remedy cases is to drive up the price of imports from China. China is the single-largest supplier of inexpensive products purchased by American consumers. In this time of economic uncertainty, as Congress and the Administration work together to stimulate growth, it would be very unwise to pass legislation that could inflate consumer prices.

Second, there are serious questions about how the Commerce Department would administer a trade-remedy regime that turns on currency valuation. The staff of Commerce’s Import Administration works hard to measure prices and subsidies in a transparent, objective manner. But I could pick up the phone today and call five economists who would give me five different opinions about the value of the renminbi. Some say it is undervalued by 40 percent.  Others say twenty-five. Last July, The Economist’s famous Big Mac index found a 58 percent undervaluation of the RMB based on input prices for a hamburger. But even that tongue-incheek method of valuing currencies depends heavily on the prices of local inputs which are not easily arbitraged across borders.

There are other such operational problems. The bills require that the Commerce Department consider only how currency affects the final price of products assembled in China, discounting that a low currency simultaneously increases the price China pays to import components that go into those final products. And currency valuation is to be considered on a one-way basis – only when there is alleged foreign undervaluation, with no offsetting effect when the dollar is relatively weak compared to overseas currencies. I can only imagine what would happen the first time a petitioner appeals to the U.S. Court of International Trade, arguing that the currency valuation used in a trade remedy case was wrong. Do we really want judges to arbitrate the fair market value of the dollar against foreign currencies?

Third, inserting relative currency values into trade remedy cases could open a Pandora’s Box of never-ending trade retaliation. The United States is already the third-largest victim of antidumping cases in the world. If we insert our own judgments on the value of foreign currencies into trade remedy cases, we would have to expect that similarly subjective countermeasures would be directed against our exports. It is not hard to imagine foreign trade bureaucrats using the relative value of the dollar as an easy excuse to erect new trade barriers. This would be particularly worrisome at a time when surging exports have been an important counterweight to the downturn in our domestic housing market. And there is a risk of multilateral retaliation as well. As Secretaries Gutierrez, Paulson, and Ambassador Schwab pointed out in a letter to Congress last summer, certain provisions of the pending China bills appear to raise serious concerns under international trade rules and could invite multilateral, WTO-sanctioned retaliation against U.S. goods and services.

Finally, there is no evidence that the proposed bills would reduce the bilateral trade deficit. Consider just two simple facts: According to the Treasury Department, the RMB has appreciated approximately 15% against the dollar since the peg was abandoned in July 2005. Yet over the same period, the Commerce Department reports that the bilateral trade deficit with China has increased by approximately 30%. The deficit is driven by many complex factors, including relative growth and interest rates, relative savings rates, and many others. Passing currency legislation won’t make the trade deficit go away.

A Rising Yuan?

The Economist reports:

IN 2005 two American senators introduced a bill into Congress that threatened to slap a tariff of 27.5% on all Chinese imports unless the yuan was revalued by the same amount (their estimate of how much the currency was undervalued). That legislation was dropped, but several other China-bashing bills are still working their way through Congress and accusations about “unfair” Chinese competition will surely play a big role in this year's presidential election. Many American politicians and economists talk as if the yuan was still fixed against the dollar. Yet on current trends, by the time the next president enters the White House the yuan could be within spitting distance of the magic figure demanded in 2005.

Since the beginning of October the yuan has climbed at an annual rate of 13% against the dollar—its fastest pace since China stopped pegging to the dollar in July 2005 .... Since 2005 it has appreciated by a total of 14%. The offshore forward market is pricing in another 8% increase over the next 12 months; several economists are betting on a rise of 10% or more.

So does this mean the U.S.-China currency dispute is close to being over?  Probably not, they say:

The yuan's rise is unlikely to silence flag-waving American Congressmen or economists. The slide in the dollar since 2005 means the yuan has risen by only 5% in trade-weighted terms, according to the Bank for International Settlements. China's current-account surplus has risen from 4% of GDP in 2004 to 11% last year, so any gauge that defines the equilibrium exchange rate as the rate that would eliminate the surplus would suggest the yuan is now even more undervalued. In 2005 Morris Goldstein and Nicholas Lardy at the Peterson Institute for International Economics estimated the yuan was 20-25% undervalued. By late 2007 they thought it was at least 30-40% undervalued despite its gain over the previous two years.

More at the link.

Some Support for a WTO Agreement on Currency Manipulation

I've said before on this blog (see, e.g. here) that WTO rules on exchange rate manipulation would be useful.  I didn't have any detailed proposal in mind; it was my gut instinct plus some very basic arguments.  Well, now I can cite to some top-notch economists who support the idea.  In an op-ed piece, Arvind Subramanian writes:

India could work toward multilateralising the exchange rate issue. And here’s the punch line: this multilateralisation should be in the context of the WTO rather than the IMF. In a new paper, Aaditya Mattoo of the World Bank and I offer suggestions on how the exchange rate can be made into a multilateral trade issue. The WTO is the obvious alternative to the IMF since undervalued exchange rates have large and direct trade consequences. What is needed is a new rule in the WTO proscribing undervalued exchange rates, which are in effect a combination of export subsidies and tariffs, each of which is currently disciplined by the WTO.

I haven't seen the paper online yet, but I'll look for it, because it would be nice to have some support for my off-the-cuff blog post views.  I agree with them in principle and I think something along these lines can be achieved.  No doubt the details will be very tricky, though.  I'm curious to see what they have to say in this regard.