Rethinking Currency Manipulation

Interest groups in the United States have focused on the possibility of including provisions in trade agreements with the intent of countering currency manipulation.  The concern is that another country may choose to reduce the value of its currency relative to the U.S. dollar in order to encourage its businesses to export more goods to the United States.   Such currency realignment also would tend to make it more expensive for the devaluing nation to import products from this country.

It’s true that an adjustment in currency exchange rates – regardless of the reason for the adjustment – can have an effect on trade flows.  U.S. industries that export to foreign customers, or compete with imported goods in the domestic marketplace, understandably would prefer that currency relationships not become skewed against their commercial interests.  Currency stability improves the business climate by making it easier to build long-term relationships with customers and suppliers. 

However, currency exchange rates have fluctuated throughout recorded history.  Sometimes those changes may be driven by a government’s conscious desire to devalue its currency.  More often the variability in exchange rates reflects fundamental economic realities.  Economies that experience growing productivity and rising prosperity should not be surprised to find that market pressures cause their currencies to strengthen.  The reverse is true for countries that are growing slowly or not at all. 

A shift in exchange rates changes a country’s “terms of trade,” which is a term  used by economists to describe the ratio of a country’s export prices to its import prices.  From a U.S. perspective, if another country sets its currency at an artificially low level relative to the dollar, the U.S. terms of trade will improve.  The United States will be able to obtain a greater value of imports for the same value of exports.  Exporting the same number of airplanes and soybeans as before will pay for the importation of larger quantities of shoes, coffee, and automobiles. 

The country that chooses to undervalue its currency will be placing an artificially low value on the output created by workers and capital in its domestic economy.  It will, in effect, be selling its exports for less than their true economic worth, thus transferring wealth to the United States.  People in this country experience meaningful increases in their standards of living at the expense of the country that has devalued.

Yes, most buyers like to get a good deal.  An increase in affordable imports generally doesn’t strike consumers as a bad thing.  Assuming those imports don’t compete too directly with goods and services produced widely in the United States (think of coffee, bananas, shoes, clothing, diamonds, rare earth metals, etc.), they tend to be well accepted even by people with mercantilist tendencies.   Some imports that do compete directly with U.S. products – such as crude oil or cars – also may not raise strong political objections, either because domestic demand is larger than can be served solely by domestic supplies, or because consumers desire a variety of choices.

The politics of affordable imports become more complicated when those products compete directly with goods and services produced in the importing country.  Competition always is a challenge, whether it comes from other domestic firms or from overseas.  Firms often struggle to deal with forces as diverse as changing technology or changing consumer tastes and preferences.  Not all firms survive forever.  Rather, the process of creative destruction keeps the economy in an ongoing state of reinvigoration and renewal.  There’s no doubt, though, that an increase in imports can create adjustment headaches for import-competing U.S. companies and their workers.

The good news is that the United States already has a policy framework with which to address unfairly priced imports, regardless of whether those imports relate to currency undervaluation.  U.S. trade remedy laws allow industries to seek antidumping or countervailing duty (AD/CVD) protection against imports that may be injuring domestic producers.  From a free-trade perspective, it’s important to understand that U.S. trade remedy laws leave a lot to be desired.  They generally are seen to be relatively protectionist – slanted in favor domestic industries over imports. 

However, trade remedies are a better policy response (even though suboptimal) to currency manipulation than would be the case for special provisions in trade agreements.  Trade remedies are relatively selective.  They are applied only to unfairly priced imports that are troublesome to U.S. industries, and only after those producers have demonstrated that they’ve been injured.  On the other hand, currency provisions included in trade agreements would apply to all imports from the offending country.  American consumers would end up paying more even for tea and T-shirts, for which there is little or no U.S. production.  Given the broad negative implications of using trade agreement provisions to counteract currency manipulation, U.S consumers would be much better off dealing with the narrower negative consequences of AD/CVD measures.

A concluding thought:  Since currency undervaluation by other countries serves to transfer wealth to the United States, should we consider finding some diplomatic way to thank them?  Such a gesture likely would do far more good than including misguided currency provisions in trade agreements.  It might help prompt policymakers around the world to rethink the plusses and minuses of allowing currencies to get out of alignment.

(For more detail on issues surrounding currency manipulation, see this article from by my colleague, Dan Ikenson.)