The campaign to include enforceable obligations on currency manipulation in U.S. trade agreements is gaining momentum. On January 9th, the American Automobile Policy Council (APPC) unveiled its proposal for a currency manipulation clause for the Trans-Pacific Partnership (TPP) trade agreement, making its support for this key trade initiative contingent on the adoption of such enforceable provisions. The following day, leaders of the Congressional committees with jurisdiction over international trade finally introduced the draft of a trade promotion authority bill with the novel addition of currency manipulation as a main negotiation objective. Congressman Sander Levin, ranking member of the House Ways and Means Committee, withheld his support of this bill, noting among his objections that it did not go far enough on currency intervention issues. And on January 14th, Fred Bergsten of the Peterson Institute released his recommendation for a currency manipulation chapter in U.S. trade agreements, building on his previous work with Joe Gagnon, which has so influenced Congressional views and informs as well the AAPC currency manipulation proposal.
As I have argued before, at first glance the logic for using trade sanctions to penalize foreign governments who in mercantilistic fashion intervene in foreign exchange markets appears irresistible: if exchange rates have a powerful impact on trade flows, if some governments deliberately intervene to depreciate their currency and boost their exports, and if the IMF has been remiss in rooting out this practice, why shouldn’t we use the enforcement arm of trade agreements to punish cheaters? However, closer scrutiny of these recent proposals, reveals why attaching enforceable currency manipulation rules in the TPP is an ill-advised move.
Let me start by noting a major improvement in the AAPC’s position: with its current proposal it has dropped the double standard of accusing Japan of currency manipulation through its monetary policy of quantitative easing, while failing to acknowledge that the Federal Reserve has in fact practiced the same policy. It is commendable that the AAPC has now stated unequivocally that countries retain autonomy in their domestic monetary policy, and that only direct intervention in foreign exchange markets will be covered by the proposed disciplines.
But this improvement does not make for a sound proposal on enforceable currency provisions in the TPP. The core of the AAPC proposal is a simple three-step test to determine whether governments have intervened in currency markets to obtain unfair competitive advantage: 1) did the TPP country have a current account surplus in the six-month period in question? 2) did it add to its foreign exchange reserves during this period?, and 3) does it have more than sufficient foreign exchange reserves (greater than the amount needed to cover three months of normal imports)? Through an expedited dispute settlement mechanism, countries that fail this test would have their tariff benefits revoked for at least one year.
The key problem with the APPC proposal is that it does not faithfully translate the IMF principles against currency manipulation into workable operational guidelines that can be subject to enforcement, as it claims to do. The IMF forbids members from manipulating their currency to obtain unfair advantage and uses the following criteria in its surveillance of compliance with this rule: large-scale intervention in one direction in the exchange market, excessive and prolonged official or quasi-official accumulation of foreign assets, and large and prolonged current account deficits or surpluses. Moreover, in a 2007 Executive Board Decision on Bilateral Surveillance (retained in a later decision of July 2012 that included multilateral surveillance), the IMF further clarified that members manipulating their currency are only acting inconsistently with Article IV principles, if they do it for the purpose of gaining unfair competitive advantage which requires the Fund to establish that the objective of the policies in question is to undervalue the currency to increase net exports. Hence as explained in a briefing of the IMF’s legal department, “determination of intent is required” to be in breach of Article IV.
The gaps between the IMF’s Article IV principles and the proposed currency clause in FTAs begin to come into view. Advocates of enforceable currency rules in trade agreements argue that the determination of intent is a major loophole in IMF disciplines, as countries can always explain away their actions. Hence their proposals take intent out of the equation. Objective criteria (as in the three-step test of the AAPC proposal) are said to be a superior alternative to murky determinations of intent. But even if this is the case (and there are problems with the criteria as discussed below), the essential point is that the proposals for currency manipulation disciplines in trade agreements deviate from established IMF doctrine in one very significant way. Should a twelve nation trade pact become the vehicle to change a major point of doctrine for the multilateral body with direct jurisdiction over exchange rates? Can these twelve countries agree to this supposed operationalization of IMF principles, which in fact erodes an important principle in the multilateral regime on exchange rate surveillance?
The IMF principles are clear in that only protracted and large scale interventions in exchange markets count, and only for countries that have for extended periods recoded sizable current account imbalances. However, none of this is captured in the current AAPC proposal. It simply asks whether a country has a current account surplus in a six month period (step 1 of the test). Hence, there is no distinction on the magnitude of the current account surplus (from modest to vast) or on the duration of such surplus (recent or long-standing). And it asks whether there was any addition to foreign exchange reserves in a six month period beyond what is necessary to cover the import bill for three months (step 2). Therefore, moderate or substantial acquisition of reserves will both count in the proof of currency manipulation.
But the real can of worms is establishing what constitutes excessive reserves (step 3), and this circles back to the critical question of intent. Current proposals on a currency manipulation clause in trade agreements rely on traditional measures: three months of normal imports (which could be extended to six) or short-term foreign debt. And they also make allowances for exporters of non-renewable resources to accumulate “rainy day” funds. Importantly, these proposals are out of step with the more recent work in the IMF on reserve adequacy metrics. In fact, a recent IMF report concluded that the traditional metrics listed above “are by their very nature arbitrary, focus on a particular aspect of vulnerability, and give disparate results.” The IMF work on reserve adequacy is based on three central insights: countries maintain reserves not only for liquidity reasons but for precautionary purposes; the types of shocks that countries are hedging against with reserve accumulation go beyond trade shocks to include capital account phenomena such as sudden stops of capital or currency crises; and the adequacy of the reserves hinges not only on the types of shocks a country faces, but also on the available resources – in addition to reserves – to address these crises. The complexity of establishing the reserve adequacy ratio for each country underscores the limits of using the “one-size-fits-all” indicator of the AAPC proposal which chooses a single aspect of vulnerability. More fundamentally, it underscores the impossibility of enforceable currency manipulation rules, when there is little international consensus on what constitutes an adequate level of reserves.
For the many reasons highlighted above, TPP countries are unlikely to agree that the current proposals in the United States on currency manipulation are a faithful interpretation of the IMF principles to which they already subscribe. Demanding that American trade negotiators introduce such a chapter at this critical stage in the negotiation process is akin to throwing a wrench in the works of the single most important trade initiative under way: one that will determine whether the United States is a key actor in shaping an Asian regional economic architecture or not, and one that will also affect the fate of negotiations with Europe. It would also mean that the United States is prepared to forego the possibility of a future Chinese entry into the TPP and give up the sizable benefits of promoting greater market reform, regulatory transparency, and compliance with intellectual property rules, to name just a few. All of this, for the sake of an unworkable proposal on currency manipulation.