Members of Congress and interested observers have advocated adding a chapter to the Trans Pacific Partnership trade deal (TPP) that takes action against trading partners who manage their currencies to subsidize their exports to us and tax our exports to them. An often heard argument against this idea is that it would put our own Federal Reserve Bank in the cross hairs.
In order to lower the cost of borrowing and stimulate demand in weak economies, the Fed lowers the short-term interest rate or engages in “quantitative easing” to lower longer term rates. One side-effect of such actions is to lower the value of the dollar. But that doesn’t imply currency management by a long shot.
In fact, there are at least two ways to distinguish between domestic demand management or currency management: one, is the central bank loading up on foreign currencies, and two, is the country running a persistent and large current account surplus?
Obviously, the fact that we’ve run trade deficits averaging -2.5 percent of GDP since the mid-1970s insulates us from the second criteria.
But not only do we very rarely intervene in currency markets, the fact that we own the world’s main reserve currency (we don’t buy dollars…we print them) and maintain flexible exchange rates makes it extremely unlikely that we would be designated a manipulator by any sensible rule.
As Rep. Sandy Levin recently stressed in a detailed piece covering many of these points, the US currently holds about $126 billion in foreign exchange compared to China’s almost $4 trillion. Thailand, Taiwan, and Singapore, tiny economies compared to ours, all hold more reserves than we do.
In fact, the real challenge in crafting effective currency rules is not protecting our central bank. No plausible set of rules would implicate our Fed. The challenge is keeping other countries’ central banks from being labeled manipulators when their exchange rates are reasonably aligned. Most analysts, for example, believe that even while China holds trillions of dollars in reserves and still has a large current account surplus, its exchange rate is about where it should be (note: China is not a TPP country).
Thus, the rule needs to consider not just stocks (trade surpluses, reserve holdings) but also flows (are surpluses or reserves growing?) as well as established metrics such as those of the IMF (see Levin link above) that look for large scale, one directional purchases of reserves, reserve holdings that are numerous multiples of foreign debts, and more. Bill Cline, of IIE, has long estimated currency alignments (see his figure 2 here) based on how much exchange rates would have to change in order to bring current account imbalances within ±3 percent of GDP (where + is of course the relevant sign in identifying manipulation). Such rules, I believe, could handily discern demand management from currency management.
The problem with the anti-currency-chapter argument is that it essentially says: we can have an active Federal Reserve Bank or we can have a clear policy against currency managers. We can’t have both. Which, one layer down reads: sorry, to spare the Fed from international scrutiny we’ve got to live with large, persistent trade deficits. Another layer down: if we want a Fed that can manage the macro-economy, then we have to accept mis-aligned exchange rates such that our exporters must compete on a playing field that’s often sharply tilted against them.
Also, note that this position doesn’t just say we can’t have a currency chapter in the TPP. It implies we can never take action beyond quiet diplomacy—urging our trading partners not to manipulate exchange rates—without compromising our Fed’s independence.
I understand that Treasury and other TPP’ers emphasize the impact of their quiet diplomacy. But most analysts agree that while helpful, that approach alone is insufficient. And our record of persistent current account deficits shows this to be the case.
I, for one, have been careful in my writings not to outright oppose a TPP. I’m sympathetic to the notion that since we already have lower tariffs than our trading partners, there are gains to be made on this front. But if the negotiators are truly saying we simply cannot have a trade deal that blocks currency managers, then maybe we shouldn’t have a trade deal.