Make the Foreign Exchange Report Great Again!!!!!!!!!!!!!!!!

The U.S. Department of the Treasury should transform its foreign currency report so it can be used as a tool to combat currency manipulation. This would be an important step toward a more balanced global economy with fewer persistent deficits and surpluses.

 

Countering currency intervention by foreign governments should be a top priority of U.S. international economic policy. By shifting the prices of imports and exports artificially, currency intervention undermines public faith that trade is fair. Together with other policy changes that raise demand abroad and help export-driven economies grow on their own, a policy of countering currency intervention could help create a global economy with fewer large trade surpluses and deficits.

Currency intervention by foreign governments usually comes when the U.S. economy is weak, since this is when countries that rely on selling to the United States worry about flagging exports. However, such intervention makes it hard for the United States to grow through exports during economic downturns. It also indirectly puts pressure on the U.S. government to support demand and employment by expanding the federal budget deficit, and to embrace regulatory policies that deliver short-term support for growth by ignoring the accumulation of private risk. In the longer term, intervention weakens the U.S. economy by changing the composition of U.S. employment. An artificially strong dollar shifts jobs out of the export sector toward domestic sectors. The U.S. export sector is now modest in size relative to U.S. imports and to the accumulated stock of U.S. external debt. A more balanced economy would be more resilient to future shocks.

How Currency Intervention Affects the Trade Balance

The governments of many large exporting countries have often given their exports an edge by holding down the value of their currency. They do this by selling their own currencies and purchasing dollar bonds or other foreign assets. The result is large holdings of foreign assets in central banks or sovereign wealth funds (SWFs). A government that rapidly accumulates foreign assets while its economy runs a current account surplus is generally regarded as engaging in currency manipulation.  

Currency intervention is currently only a marginal source of the trade deficit. Higher interest rates in the United States than in the other advanced economies have pulled in private funds from Europe and Japan, and private capital is leaving China. This naturally makes for a strong dollar: because the capital flows into the United States largely come from private sources, the U.S. government cannot be said to be manipulating currency.

But at times in the past two decades, currency intervention by central banks and the rising foreign assets of SWFs investing oil surpluses abroad have increased [PDF] the U.S. trade deficit by at least a percentage point of gross domestic product (GDP).

Arguments Against Fighting Currency Manipulation

One argument against a tougher approach toward currency manipulation is that it is impossible to articulate the difference between monetary policy choices that influence the exchange rate and active manipulation. However, monetary policy can be conducted without buying or selling foreign assets. Defining manipulation as intervention in the foreign currency market by countries with large external surpluses and sufficient reserves creates a clear standard that differentiates between countries with weak economies and naturally weak currencies, and countries that are intervening to artificially keep their currencies weak. Intervention for prudential purposes in emerging economies that have external deficits would be explicitly allowed.

Another argument against placing a higher priority on currency manipulation is that it would require confronting many of the United States’ friends and allies, not its geopolitical rivals. It thus could complicate existing alliances, move the focus of negotiations with these countries away from the conventional trade agenda, and potentially undermine any global coalition to push back against Chinese commercial practices.

The goal of a policy shift, though, is not to create conflict with U.S. allies but to manage it. Deterring bad behavior early, before currency manipulation leads to large trade imbalances, makes conflict less inevitable. A security alliance with the United States should not carry with it a free pass to intervene to maintain an undervalued currency. Most countries with large surpluses do not need to rely on exports as heavily as they have in the past, because they have unused capacity to introduce policies that would raise their domestic demand and support their own growth; South Korea, for example, runs an overly tight fiscal policy even as it often intervenes to hold the value of its currency down. Indeed, making it clear that a security alliance does not mean a free pass on currency would be a much less onerous form of burden sharing than proposals that U.S. allies pay the United States for the U.S. contribution to their defense.

Needed Changes to the Treasury’s Foreign Currency Report

A new policy that prioritizes countering excessive currency intervention abroad would require a different kind of foreign exchange report. The Treasury recently took a step in the right direction when it broadened the report’s coverage to all countries with more than $40 billion in bilateral trade. The report previously focused on twelve major trading partners. That was too narrow, as it left out many countries with substantial trade with the United States and large external surpluses, such as Thailand and Vietnam.