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Can trade agreements stop currency manipulation?

It is impossible to deny that trade and exchange rates are closely linked. But does that mean that international trade agreements should include provisions governing national policies that affect currency values?

Some economists certainly think so. Simon Johnson, for example, recently argued that mega-regional agreements like the Trans-Pacific Partnership should be used to discourage countries from intervening in the currency market to prevent exchange-rate appreciation; Fred Bergsten has made a similar argument. But the United States Treasury and the Office of the US Trade Representative continue to argue that macroeconomic issues should be kept separate from trade negotiations.

As it stands, the relevant international institutions — the World Trade Organization and the International Monetary Fund — are not organized to respond effectively to possible currency manipulation on their own. Incorporating macroeconomic policies affecting exchange rates into trade negotiations would require either that the WTO acquire the technical capacity (and mandate) to analyze and adjudicate relevant national policies or that the IMF join the dispute-settlement mechanisms that accompany trade treaties.

To be sure, since 2007, the IMF has prohibited “large-scale intervention in one direction in the exchange market,” in a decision on “bilateral surveillance” that also identifies “large and prolonged” current-account imbalances as a reason for review. But neither that decision nor later IMF policy papers on multilateral surveillance provide specific and comparative quantitative indicators that would eliminate the need for case-by-case judgment.

The situation is complicated by the multitude of mechanisms whereby treasuries and central banks can drive down their exchange rates to gain a competitive trade advantage. The most direct method is purchases of foreign assets. But, in a world of large short-term capital flows, central-banks’ policy interest rates – or even just announcements about likely future rates — also have a major impact. Moreover, quantitative easing affects exchange rates and trade, even if central banks purchase only domestic assets, as demonstrated by recent movements in the exchange rates of the dollar, the euro, and the yen.

One could go even further. An income-tax hike will reduce private demand (unless one believes in perfect Ricardian equivalence), including demand for other countries’ exports. Other macroeconomic policies of all kinds influence the current-account balance.

In short, for “policies affecting the exchange rate” to become part of trade agreements, monetary and fiscal policies would have to become part of trade agreements. In that case, there would be no trade agreements at all.

Consider the problem that would be posed by the eurozone — an economy that faces major challenges in reconciling its members’ divergent monetary, fiscal, and exchange-rate needs. Germany’s current-account surplus has stood near 7% of GDP — bigger than China’s — for two years, and is likely to grow even larger, owing to the euro’s recent depreciation. Meanwhile, most other eurozone countries have lately been forced to tighten fiscal policy, thereby reducing or eliminating their current-account deficits.

As a result, the total eurozone trade surplus is now massive. Because individual eurozone members have no monetary-policy tools at their disposal, the only way that Germany can reduce its surplus while remaining in the eurozone is to conduct expansionary fiscal policy. The economist Stefan Kawalec has explicitly referred to the current policy mix in the eurozone as “currency manipulation.”

Trade negotiations are hard enough to conclude. The need to wrestle with macroeconomic-policy issues could easily cause talks to bog down — and give protectionist lobbies the political ammunition they need. That is why the Trade Representative is wisely trying not to add macroeconomic policy into the bargaining, despite demands from powerful voices in the US Congress.

None of this means that macroeconomic policies that affect exchange rates are not problematic. They are. But trade negotiations are not the right forum for discussing the causes and consequences of current-account imbalances and reaching agreements on macroeconomic-policy coordination; that is what the IMF and the G-20 are for. In fact, the issue of large actual or potential discrepancies between aggregate savings and investment in countries or monetary zones, reflected in current-account imbalances, is at the heart of the IMF’s emerging multilateral surveillance role; it has been a focus of the G-20 as well.

The G-20 “mutual assessment process” — established to analyze national economic policies’ effects on other countries and on global growth, with the goal of formulating individual adjustment commitments – has highlighted the difficulty of reaching agreement on macroeconomic policies with significant spillover effects. Indeed, it is even more difficult than reaching trade agreements, which must cover issues like tariffs, quotas, quality standards, regulatory regimes for particular sectors, and relevant microeconomic issues. Merging all of these challenging topics into a single negotiation process is a recipe for deadlock.

A better approach would include strengthening the IMF’s multilateral surveillance role. Doing so would broaden discussions of macroeconomic policy to include employment issues — specifically, the potential impact of large foreign-trade surpluses on domestic jobs. And it would give trade negotiations a chance to succeed.


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