Currency Manipulation and the TPP

In the days since the text of the Trans Pacific Partnership was release, I and many others have been scouring the text looking for what's new? Apart from the scale of the TPP as a regional trade agreement, it doesn't appear to be the case that there's been much dramatic innovation.... with one big exception; a side agreement on currency manipulation.

Currency manipulation has become an important, polarizing, and misunderstood political issue in recent years. In Tuesday night's Fox Business News GOP Debate, for instance, Donald Trump railed against China's alleged manipulation of the Yuan and celebrated the inclusion of currency provisions in connection with the TPP. Senator Rand Paul then pointedly reminded Trump that China wasn't part of the TPP.

But how well does anyone understand what currency manipulation really is, why the issue has become a political football, or what the TPP Side Agreement actually proposes? In this post, I'll try and offer an answer or two, but along the way suggest that one of the reasons for the confusion is that the definition of currency manipulation (for political purposes, especially) is in the eye of the beholder.
1. What is currency manipulation?

Part of the problem with the political debate over currency manipulation is that the definition of "manipulation" is the subject of some debate and, in part, flows from a country's choice of exchange rate regime. Many developed economies, like Canada and the United States, have floating exchange rate regimes, meaning that the values of their currencies fluctuate more or less in terms of global supply and demand. When a country like Canada, for example, experiences a commodities boom, you can expect the value of the Canadian dollar to appreciate relative to other currencies as foreigners demand Loonies to purchase Loonie-denominated assets. Similarly, as the demand for commodities like oil falls (as it has so dramatically in the last year), you can expect the value of the Loonie to fall (depreciate) relative to other currencies.

On the other hand, many other countries have adopted fixed exchange rate regimes, meaning that by the decree of the country's monetary authorities, they will exchange domestic currency for foreign currency at an announced rate. In other words, regardless of levels demand for domestic currency by foreigners, the government will honor the announced rate.

There are decent reasons for adopting either a fixed or floating exchange rate regime that you can read about here (Fix or Float?). However, the point I want to make here is that the choice of exchange rate regime is less about two opposite poles (fix vs. float) and really more of a continuum in which "manipulation" by monetary authorities is more or less explicit. Under fixed regimes-- such as China's-- the authorities are clearly intervening explicitly to tie the Yuan to the U.S. dollar. Those same authorities are allegedly then altering that exchange rate for the purposes of making sure Chinese exports remain relatively cheap for American consumers.

Yet, the monetary authorities in countries with floating exchange rates are constantly "intervening" as well; setting the overnight rate, the purchase/sale of bonds, or, in recent years, the unprecedented monetary expansion known as Quantitative Easing (QE). 

I am a huge fan of the work produced by the Petersen Institute for International Economics. A recent blog post by Fred Bergsten and Jeffrey Schott makes several important distinctions about the fine line between "manipulation" and "intervention." The full post is linked here, but I have pasted the distinctions they make in italics here.

The consultations on macroeconomic policies can and undoubtedly will include monetary policies, such as quantitative easing (QE) as practiced recently by the United States and currently by Japan. Some US officials and members of Congress have expressed concern that other countries might seek to characterize QE as “currency manipulation” by the United States itself, on the ground that QE can lead to a currency depreciation. That is certainly a possibility. But there is widespread international agreement that there are fundamental differences between QE and manipulation: QE pursues domestic economic goals through the use of domestic policy instruments, while manipulation by definition refers to direct intervention in the markets for foreign currencies. In addition, QE increases global as well as domestic demand by increasing the growth of the country involved, while manipulation simply shifts demand from one country to another by reorienting and indeed distorting trade flows. Finally, QE enhances the economies of trade partners while manipulation weakens them. Accordingly, the fear that the new declaration and its consultative group could disrupt the use of legitimate policy instruments by the United States or any other TPP member is groundless.

You can appreciate why one person's "manipulation" might be seen by someone else as mere "intervention?" The main distinction seems to be whether the monetary authorities explicitly intervene in pursuit of a positive export balance (X>M)-- stimulating your economy by artificially making your exports cheaper for foreigners. Good luck getting anyone to admit to that.

2. Why is "manipulation" a political football?

Allegations of currency "manipulation" run straight into the nasty politics of trade liberalization I have written about in previous blog posts (for example). If you are accused of currency manipulation, you are actually being accused of artificially pumping up your exports while, in effect, making imports from your trading partner more expensive at home. It's a form of protectionism in trade through the use of monetary intervention. If China is keeping the Yuan artificially pegged below its "normal" value (depreciated) relative to the U.S. dollar or the Euro, then Chinese products are more attractive to U.S. and European consumers relative to domestic goods. Similarly, American or European products are consistently more expensive for Chinese consumers because of the comparatively high (manipulated) value of the dollar and the Euro.

For many, this kind of activity is a neo-mercantilism that requires countervailing actions similar to those you'd find in the WTO for dealing with unfair subsidies. Yet, like subsidies in trade relations, proving manipulation is a process fraught with a near-bottomless pit of ambiguities.

Interestingly, the monitoring of currency manipulation has been the task of the U.S. Treasury Department since it was mandated by Congress in Section 3004 of the 1988 Omnibus Trade and Competitiveness Act. Treasury is required to produce a Semiannual Report on International Economic and Exchange Rate Policies. In recent years, Treasury's report has garnered considerable interest and been the target of political pressure from Congress, many Members of which have expected Treasury to slap some "manipulator" labels on countries like China.

They've been regularly disappointed. In fact, recent Treasury reports have side-stepped such language, instead describing currencies as "undervalued," "significantly undervalued," or "below appropriate valuation." Moreover, Treasury's toughest language on currency valuations is actually reserved for key U.S. allies such as South Korea and Japan, not China. The international politics of being labelled a "manipulator" likely narrows the bargaining space at home and abroad for actually addressing the issue at all. Treasury's reluctance might also be linked to the definitional ambiguities noted above about what "manipulation" actually is.

However, the most important reason for not labeling countries like China as currency "manipulators" is that (as depicted in the cartoon above), despite the populist rhetoric to the contrary, international monetary relations are not one sided affairs. The details here probably merit a separate post on this blog, but the short story in my mind is that fixing the Yuan has served both China and the U.S., in the short run at least. First, the fixed Yuan has contributed mightily to China's mercantilist, export-led growth model. The flipside is that the fix has prolonged America's consumption through both low-priced Chinese manufactures (Yuan fixed below dollar) and the recycling of low-interest finance back into the United States. Two major worries linked to this include growing and unsustainable macro-imbalances that can be the source of significant financial crises and the threat of competitive devaluations (beggar-thy-neighbor) among countries-- a kind of fruitless, tit-for-tat currency war that helps no one.
 
3. What does the TPP Side Agreement actually propose?

So, what's in the Side Agreement (The Joint Declaration of the Macroeconomic Policy Authorities of Trans-Pacific Partnership Countries)? Far and away the most important thing to note here is that there is a side agreement at all. In fact, while not formally part of the TPP text, the side agreement is the first formal connection between trade policy and broader macroeconomic management and coordination among FTA members-- possibly a good thing to monitor the onset of beggar-thy-neighbor policies. Previous to the TPP, trade liberalization efforts were loathe to link the two; indeed a kind of fire-wall between these areas of economic policy was in place.

However, this side agreement has a number of parallels with the NAFTA Side Agreements (labor and environment) the Clinton Administration negotiated in 1993 as a condition of his support for the broader agreement. Like currencies prior to the TPP, Labor and Environmental issues were studiously avoided by trade negotiators prior to the NAFTA. There were many who saw obvious linkages between trade, labor, and environmental issues, but many negotiators worried about this kind of linkage endangering the success of the negotiations. Most importantly, the NAFTA Side Agreements permanently linked those issues to the trade liberalization agenda. The genie was out of the bottle. That may now be the case with currency valuation as well.

The other similarity between the NAFTA Side Agreements and the currency side agreement of the TPP is the voluntary and coordinative nature of what has been agreed to (see Treasury Fact Sheet). Trans-Pacific Partnership countries have agreed to additional transparency measures in their macro-policy decision-making, including the sharing of data upon which those decisions are being made. Institutionally, again like the NAFTA Side Agreements, there are no binding, supranational institutional mechanisms that could investigate macro policy divergences or initiate remedial action in the event of the emergence of imbalances. Instead, the currency agreement establishes an annual meeting of a "Group of TPP Macroeconomic Officials."

We'll see in the years ahead if the Macro Policy Group evolves similarly to the NAFTA's Commission on Environmental Cooperation. In that instance, the absence of supranational institutions has not prevented the CEC from becoming a voice on trilateral environmental matters far more influential than what was envisioned in 1994.