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  January 15th, 2018 | Written by

Anti-Manipulation or Currency Alignment?

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  • It is not clear that US objectives in NAFTA talks are limited to remedying currency manipulation.
  • It is more straightforward to identify currency manipulation than to define optimal currency relationships.
  • The analysis of currency manipulation involves reviewing specific practices and determining their immediate effects.
  • The analysis of currency misalignment is an economic modeling exercise.

The Trump administration has indicated that it is seeking a currency provision in a revised NAFTA agreement. In itself, this is not particularly controversial. The three NAFTA countries maintain floating exchange rates that are not subject to significant intervention, and all of them run sizable current account deficits. They may well wish to use NAFTA to establish a model currency provision that can be used in agreements with other countries.

The devil, however, is in the details. A simple agreement to refrain from currency manipulation, which establishes a mechanism for remedying such manipulation, would represent an important step forward in the battle against trade-distortive practices.

The background here is China’s massive intervention to devalue its currency on global markets from 2003 to 2013. The Peterson Institute for International Economics has estimated that excessive intervention during that period averaged over $600 billion per year. This had a very substantial impact on trade, and consequently on jobs, just as the United States and other countries with current account deficits were struggling to emerge from the Great Recession.

More than one million US jobs were lost, and we know from recent academic studies that communities were disrupted as well. Especially when demand is slack in the overall economy, there is little reason not to think of massive devaluation as a zero-sum game—there are clear winners and losers. Even when overall demand is not slack, such devaluation by a US trading partner can impose substantial costs on import-sensitive industries in the United States.

China is not devaluing its currency at present, but it is prudent for the NAFTA countries to take a proactive approach to address any use of devaluation to obtain a competitive advantage, whether by China or other trading partners. The Mexican Economy Minister indicated recently that Mexico has no objection to a pledge with its NAFTA partners aimed at preventing currency manipulation, provided that it does not affect monetary policy.

It is not clear, however, that US objectives with regard to currency are limited to establishing a mechanism for identifying and remedying currency manipulation. The administration may be looking for currency misalignment to be taken into account in trade agreements regardless of whether it is due to manipulation. If that is indeed the goal, consensus with Canada and Mexico would be more difficult to achieve.

It is true that an undervalued currency promotes exports and inhibits imports, thus affording the country with such a currency a trade advantage. But how would one measure currency misalignment in situations where there is no indication of currency manipulation? Would one first determine “equilibrium” capital flows and then derive benchmark currency values from those flows? The very first step in that process would likely get bogged down in debates about the role of the dollar in the international political economy as well as whether capital flows in the past have, or have not, been in equilibrium.

It is far more straightforward to identify currency manipulation, and its impact, than it is to define optimal currency relationships. The analysis of currency manipulation is less an economic modeling exercise than it is one of reviewing specific practices and determining their immediate effects. The analysis of currency misalignment where there is no manipulation, on the other hand, is essentially an economic modeling exercise, and there would likely be extensive, ongoing debate about the assumptions to be employed in generating appropriate models.

Moreover, to the extent that a currency misalignment provision would cause monetary policy to be subjected to greater scrutiny as a potential cause of trade frictions, the stakes would be raised and the circle of affected stakeholders enlarged, making negotiations significantly more complex. Given the recent statement by the Mexican Economy Minister cited above, as well as the fact that the United States itself resorted to unconventional, and expansive, monetary policy in the aftermath of the Great Recession, one would think US trade negotiators would seek to avoid getting entangled in those kinds of issues.

By maintaining a focus on addressing currency manipulation, the administration would make the US position less susceptible to the argument that its underlying objective is managed trade. One can imagine a scenario in which a trade imbalance is treated under a currency provision as a per se indication that there is currency misalignment; such a provision would be, in effect, an agreement to eliminate trade imbalances. A proposal along those lines would provoke vigorous debate among US trading partners.

Assuming the policy objective is simply to target currency manipulation, it seems a way forward can be found. A renegotiated NAFTA might include: (1) a ban on specific currency interventions known to have been used historically in the global trading system to obtain trade advantage, with quantitative thresholds to ensure that only massive interventions are prohibited; (2) a formula for determining the trade impact of each banned intervention; and (3) an expeditious dispute resolution mechanism, that would be triggered by substantiated allegations that a banned intervention has occurred and which would include provisions specifying the remedies that could be imposed to offset the trade impact of the intervention. Such a mechanism could even be embedded within existing procedures used to address foreign unfair trade practices.

The steps I have outlined are admittedly not intended to address the overall US trade deficit. They would, however, represent a measured approach to a problem that has bedeviled US trade policy in the past and could reemerge as countries seek to adjust to changing conditions in the international economic system. And they have the advantage that they are not likely to provoke sharp disagreement among the United States, Canada, and Mexico as they renegotiate NAFTA.

Dean A. Pinkert is a partner in the Washington, D.C., office of Hughes Hubbard & Reed LLP and a former commissioner and vice chairman at the US International Trade Commission. The opinions expressed are those of the author and do not necessarily reflect the views of the firm or its clients. This article is for general information purposes and is not intended to be and should not be taken as legal advice.