The Need to Address Currency Manipulation in TPP, and Why U.S. Monetary Policy Is Not at Risk

The IMF Guidelines demonstrate that the United States is not manipulating its currency and would not be at risk of losing a dispute. The far greater risk is that more middle class jobs will be lost in the United States as a result of foreign governments' currency manipulation. We need strong and enforceable disciplines in TPP to help prevent that from happening.
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Over the past decade, currency manipulation by foreign governments has resulted in an increase in unfairly traded imports into the United States and has made it more difficult for U.S. exporters to compete in foreign markets. The practice has cost U.S. workers between one million and five million jobs -- and is responsible for as much as half of excess unemployment in the United States. It has contributed to stagnant wages and to inequality in the United States. And it contributed to the global financial crisis.*

Bipartisan majorities in the House and the Senate have urged the Administration to include strong and enforceable currency obligations in the Trans-Pacific Partnership (TPP), which includes a number of former currency manipulators, such as Japan. Other countries interested in joining TPP in the future -- such as China, Korea, and Taiwan -- are also current or former currency manipulators.

The IMF already prohibits currency manipulation and has developed guidelines to define when it occurs. The problem is that the IMF lacks an enforcement mechanism.

I have proposed taking the existing IMF guidelines, building upon them, and establishing an enforcement mechanism through the TPP. Other groups and economists, such as the American Automotive Policy Council (AAPC) and Fred Bergsten of the Peterson Institute, have tabled similar proposals. Economists on the right and left support including currency disciplines in TPP. And the Commission on Inclusive Prosperity recently stated: "New trade agreements should explicitly include enforceable disciplines against currency manipulation that appropriately tie mutual trade preferences to mutual recognition that exchange rates should not be allowed to subsidize one party's exports at the expense of others." Currency manipulation must become a subject in the TPP negotiations.

A chief concern about including strong and enforceable currency disciplines in TPP is that U.S. monetary policy could be successfully challenged by our trading partners, given that our expansionary monetary policy (in the form of 'quantitative easing') may have had the secondary effect of weakening the dollar. What follows is a factual response to that concern.

Again, my proposal is to take the IMF guidelines and make them enforceable. Under the IMF guidelines, currency manipulation is about government interventions in the foreign exchange markets, not about other policies that may have a secondary impact on foreign exchange rates. The IMF guidelines clearly distinguish between currency manipulation -- government intervention in foreign exchange markets -- and monetary policy.

Article IV of the IMF's Articles of Agreement states that "each member shall...avoid manipulating exchange rates... to gain an unfair competitive advantage over other members." The IMF has gone on to provide seven factors in its Guidelines to determine whether a country is manipulating its currency. The following review of each factor identified in those guidelines demonstrates that U.S. monetary policy, including quantitative easing, cannot be described as a form of currency manipulation.

Factor 1: Protracted Large-Scale Intervention, in One Direction, in Currency Markets.

The United States intervenes in the currency market less than almost any other country in the world. The United States has only intervened in the currency markets a total of three days since the late 1990s: June 17, 1998 (during the Asian exchange rate/financial crisis); September 22, 2000 (after the euro was introduced and concerns grew over the euro's significant depreciation against the dollar); and March 18, 2011 (in connection with a Japanese earthquake and tsunami). These three interventions over nearly 20 years cannot be described as "protracted" interventions. Compare this record with, for example, China's interventions over the past decade, which have occurred almost daily, and almost always in the same direction, to weaken their currency.

The circumstances surrounding these three interventions are consistent with the Federal Reserve's Foreign Currency Directive: interventions "shall generally be directed at countering disorderly market conditions." They are therefore not consistent with the objective of "gaining an unfair competitive advantage" over its trading partners, which is what currency manipulation is about. In fact, the IMF recommends and encourages members to intervene "to counter disorderly conditions." It is also worth noting that in these three instances, the United States coordinated its intervention with the other countries involved, again demonstrating that the action was not taken to gain a competitive advantage. Indeed, in all three cases the other country requested the intervention of the United States.

While the United States has a flexible exchange rate (i.e., it lets the market determine its value), it is also important to note that the IMF Guidelines do not prevent other countries from establishing a fixed or managed exchange rate. The Guidelines only provide that the rate cannot be set at a consistently artificially low level (i.e., countries may engage in "protracted, large scale" interventions, so long as all of these interventions are not all in the same "direction").

Factor 2: Excessive Accumulation of Foreign Exchange Reserves.

Despite the fact that the United States has the largest or second largest economy in the world, the United States holds fewer foreign exchange reserves than Thailand, Algeria, and Saudi Arabia, among others. Further, China has 25 times as many foreign exchange reserves (nearly $4 trillion) as the United States ($126 billion).

Economists generally use four benchmarks, cited by Treasury in 2006 and 2014 reports, to determine whether a country's reserves are excessive. U.S. reserves are well below each benchmark:

  • Benchmark #1 -- Reserves may be excessive if they exceed 100% of short-term external debt (commonly referred to as the "Guidotti-Greenspan Rule"). U.S. reserves are equal to 2% of its short-term external debt (1.2 trillion). If only taking into account debt denominated in foreign currencies, U.S. reserves would equal 38% of short-term debt. Note, however, that this benchmark was designed with emerging markets in mind, not the U.S. economy.

By way of comparison, China's reserves are about 700% (i.e., seven times greater than) its short-term external debt.

  • Benchmark #2 -- Reserves are excessive if they exceed 5 - 20% of money supply, commonly referred to as M2. U.S. reserves are 1.1% of U.S. M2 (11.7 trillion). China's reserves are 43% of its M2.
  • Benchmark #3 -- Reserves are excessive if they exceed 20% of GDP. U.S. reserves are less than 1% of U.S. GDP (around 17 trillion). China's reserves are 42% of its GDP.
  • Benchmark #4 -- Reserves are excessive if they exceed 3-4 months of imports. U.S. reserves equal less than a single month of U.S. imports (about200 billion). China's reserves equal 23 months of its imports.

Factor 3: Restrictions on / Incentives for Transactions or Capital Flows for Balance of Payments Purposes.

The United States has one of the least restrictive regulatory structures in the world concerning the free flow of capital. In fact, the World Economic Forum ranks the United States first in the world in terms of capital account liberalization and second in the world under a more general 'financial development' index.

Factor 4: Encouragement of Capital Flows through Monetary Policy for Balance of Payments Purposes.

This is the only guideline that even mentions monetary policy. And while the United States -- and every other country in the world -- does have a monetary policy, the purpose of U.S. monetary policy is neither to encourage capital flows nor to achieve a balance in payments. The goals of U.S. monetary policy are spelled out in the Federal Reserve Act, which specifies that the Board of Governors and the Federal Open Market Committee should seek "to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates."

Indeed, the IMF has explicitly supported U.S. monetary policy (including each round of quantitative easing since the "Great Recession"). As the IMF said in its most recent report, "[IMF] Directors agreed that the current highly accommodative stance of monetary policy is appropriate, consistent with the Federal Reserve's objectives of maximum employment and price stability." The IMF has also noted that U.S. monetary policy has been good for other nations ('positive spillover effects') because it has helped to sustain global growth. Similarly, the G-20 (which includes China, Japan, Korea, the United States, and three other TPP countries) has distinguished between monetary policy and exchange rate policy -- and has recognized "the support that has been provided to the global economy in recent years from accommodative monetary policies, including unconventional monetary policies."

Factor 5: Fundamental Exchange Rate Misalignment.

If anything, the U.S. dollar is properly valued or even overvalued, not undervalued, according to the most recent IMF data and estimates. Further, given the continued weakening of the yen and euro, many expect the dollar to further strengthen in value in 2015.

Factor 6: Long and Sustained Current Account Surpluses.

The United States has had just one current account surplus since 1981. In fact, the United States has been running large current account and trade deficits for almost four decades. Indeed, those imbalances are a major cause of concern to many economists -- and currency manipulation by other countries has contributed substantially to the U.S. trade deficits in recent years.

Factor 7: Large External Sector Vulnerabilities from Private Capital Flows.

While the United States does have external sector vulnerabilities (i.e., private and public sector debt owed to foreigners), as reflected in the large current account deficit, much of those vulnerabilities stem from purchases of U.S. debt by foreign governments -- not private capital flows. And much of those purchases by foreign governments are the result of foreign government intervention in the currency markets that result in the accumulation of foreign reserves. Thus, if anything, this factor, like Factor 6, tends to suggest that the United States is a casualty of other governments' currency manipulation, not that it is manipulating itself.


The IMF Guidelines demonstrate that the United States is not manipulating its currency and would not be at risk of losing a dispute. The far greater risk is that more middle class jobs will be lost in the United States as a result of foreign governments' currency manipulation. We need strong and enforceable disciplines in TPP to help prevent that from happening.

This and my other proposals that serve as a guide to a "Path Forward to an Effective Agreement" can be found here.

* China's currency manipulation "is arguably the most important cause of the financial crisis. Starting around the middle of this decade, China's cheap currency led it to run a massive trade surplus. The earnings from that surplus poured into the United States. The result was the mortgage bubble." Sebastian Mallaby, "What OPEC Teaches China," Washington Post op-ed (Jan. 2009). The Bush Administration White House also drew the connection: "the President highlighted a factor that economists agree on: that the most significant factor leading to the housing crisis was cheap money flowing into the U.S. from the rest of the world, so that there was no natural restraint on flush lenders to push loans on Americans in risky ways. This flow of funds into the U.S. was unprecedented." Statement by White House Press Secretary Dana Perino (Dec. 2008). Most of the cheap money flowing into the United States came from foreign governments (not the private sector) accumulating foreign exchange reserves and other official assets. See Joseph E. Gagnon, "Global Imbalances and Foreign Asset Expansion by Developing-Economy Central Banks," Peterson Institute for International Economics (Mar. 2012).

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