At the Group of 20 Summit in Osaka on 28-29 June, world leaders discussed threats to free, open trade from tariff wars. Underlying their protestations against protectionism were fears about foreign exchange markets. They, along with businesspersons, economists, policy analysts, and lawyers, appreciate that rising, reciprocal trade barriers are linked to the relative strengths of currencies. The pricing of merchandise across borders is determined not only by cost competitiveness that is undermined by trade barriers, but also by central bank policies that, in some cases, are perceived as currency manipulation.
In the United States, there is unprecedented tension between a President and a Chairman of the Federal Reserve. Regularly, President Donald Trump rails against Chairman Jerome Powell about borrowing costs in the U.S. resulting from Fed monetary policy and the of the dollar against other currencies, and openly muses about firing or demoting the Fed chairman. This tension is felt in foreign exchange markets. The Fed may be on a gradual, anti-inflationary monetary policy tightening course, which would lead to higher interest rates and a stronger dollar. That would put the Fed at odds with many other major central banks, which are on a growth-stimulating easing of monetary policy. It also would put the Fed at odds with the President’s policy preference – and his re-election prospects.
So, the near-daily railing by the President against the Fed Chairman about interest rates is also a harangue for a weaker dollar – and that worries the rest of the G-20, including India.
This trajectory differential – between the Fed and President – implicates India. The Reserve Bank of India, under its new governor, Shaktikanta Das, has cut its benchmark interest rates thrice in 2019. The RBI’s actions, slanted in a different direction from that of the Fed, may affect the dollar-rupee rate, and the relative competitiveness of the two economies. And, they may also lead to complaints from President Trump of currency manipulation by India.
To be sure, monetary policy is not supposed to be a weapon in currency matters. Like the Fed and other central banks, the RBI affects the supply of domestic currency using three principal (but not exclusive) techniques: buying and selling government securities in exchange for rupees through open market operations; raising or lowering the repo rate (i.e., the interest rate it charges to commercial and cooperative banks); and raising or lowering the cash reserve ratio (i.e., the fraction of a bank’s deposits that must be held at the RBI). Tight monetary policy reduces liquidity in the banking system, leading to higher interest rates and possibly a stronger rupee (as foreign portfolio investors buy rupees to reap those higher rates). Relaxed monetary policy has the opposite effect.
So, there’s a Gordian Knot: disentangling monetary from foreign exchange policy, when money supply and interest rate conditions have foreseeable effects on forex rates and, in turn, trade balances. The Federal Reserve got tangled up in the knot in its post-2008 global financial crisis ‘Quantitative Easing’.
The Fed QEs were the kind of loose monetary policy that Brazil and many other countries contended was tantamount to currency manipulation, driving down the dollar, promoting American exports and discouraging foreign imports.
If President Trump is unable to persuade the Federal Reserve to change its trajectory, then what legal and quasi-legal concepts and tools are at his disposal? What are the ramifications of putting them into practice? Consider the international and domestic levels, in order.
At The International Level…
International organisations failed to define ‘currency manipulation’. Alas, no universal definition of currency manipulation exists.
Article XV:4 of the General Agreement on Tariffs and Trade mandates that members of the World Trade Organization “shall not, by [foreign] exchange [rate] action, frustrate the intent” of GATT, nor “by trade action, [frustrate] the intent of … the Articles of Agreement of the International Monetary Fund.” Explicitly, this provision links foreign exchange and trade policies, and joins GATT – now the WTO – with the IMF to police behavior that undermines the purposes of the treaties of these international organisations.
Unfortunately, the intent of those treaties is arguable, left to competing inferences from their preambles. Worse yet, “frustration” is undefined, save for a mildly helpful Interpretative Note drafted for the bygone era of fixed exchange rates administered by the IMF, and an inconclusive 1952 GATT Panel Report, Special Import Taxes Instituted by Greece.
It’s worth noting that in the present era of flexible exchange rates, defined as after Aug. 15, 1971, when the U.S. abandoned the gold standard, foreign exchange rates do not invariably and ineluctably matter to a bilateral trade imbalance. Consider China’s large, persistent bilateral trade surplus with America. If Chinese exporters accept rupees (maybe to pay for Indian inputs they need), then a weakened yuan/dollar rate might not blow a big hole in America’s trade deficit with China, though yuan-denominated portfolio investments still would be affected.
At The Domestic Level…
‘Trade balances’ are vital to the American definition of currency manipulation.
In 1988, four decades after GATT and the IMF Articles entered into force, the U.S. Congress – frustrated by multilateral inaction to impart meaning to “intent” and “frustration” – acted. Congress passed the Omnibus Trade and Competitiveness Act, the key provisions of which thereby directed the United States Department of the Treasury to produce an annual report (due Oct. 15), and update it every six months, on forex rates around the world.
Following the OTCA, the Treasury Department checked if any other government pursued an exchange rate policy that undermined free markets by intentionally driving down the of its currency relative to another currency to obtain an advantage in trade. But, the OTCA created no remedy, other than for the U.S. Treasury Department to consult with the relevant foreign government. Efforts in 2004 to launch Section 301 investigations into currency manipulation foundered at the U.S. Trade Representative, which realised the vagaries of GATT Article XV meant a WTO lawsuit could yield an adverse precedent.
The Treasury Department branded China a currency manipulator five times between May 1992 and July 1994, and the U.S. talked with China. And talked. And talked.
Enter, again, a frustrated Congress. In 2015, Congress passed another awkwardly titled statute, the Trade Facilitation and Trade Enforcement Act. Helpfully, the TFTEA set three questions for the Treasury Department to define “currency manipulation.” Does the foreign country:
- Have a large absolute bilateral trade surplus with the U.S., namely, over $20 billion?
- Have a large (that is, ‘material’) overall current account surplus as a percentage of that country’s gross domestic product, namely, over 3 percent?
- Aggressively engage in one-sided intervention in currency markets, specifically, devaluing its currency by purchasing foreign assets equal or exceeding 2 percent of its GDP?
As of its May 2019 updated report, the Treasury Department made it easier to say ‘yes’, by dropping the second threshold to 2 percent of GDP. The Treasury Department puts any country satisfying two of the three criteria on a Watch List. Three strikes, and you’re a currency manipulator.
India had two strikes in two of the last three reports. But because India had just one strike in May, the Treasury Department struck India from the list in that update.
Eight other countries were not so lucky. With two strikes, Japan, Korea, Germany, Italy, Ireland, Singapore, Malaysia, and Vietnam are on the list. A ninth country – China – is cited for its disproportionate share of America’s overall bilateral trade deficit.
To combat accusations of currency undervaluation, central banks like the Fed and RBI can work collaboratively to engineer a politically-driven deal about appropriate forex s. That’s what happened via the 1985 Plaza Accord, when Japan conceded to American, British, French, and German demands to lower the relative of the yen against their currencies and thereby reduce Japan’s bilateral trade surpluses. The fact is, if a foreign exchange rate is negotiated, then it ain’t currency manipulation.
Indo-American collaboration on that scale is foreseeable. But, don’t expect similar Chinese-American collaboration that would produce a yuan/dollar peace deal. The Chinese Communist Party likens the Plaza Accord to the 1842 Treaty of Nanking: an Asian country kowtowed to western imperialists, and was all the worse off.
American Remedies For Currency Manipulation Are Modest
The TFTEA orders the U.S. president to “enhance engagement” with a foreign country that the Treasury Department determines practices a “persistent one-sided intervention in the foreign exchange market.” That’s enhanced interrogation for foreign central bank and finance ministry officials. If they don’t break, then they may be punished.
The punishments are modest. Firms from that country may be barred from U.S. government procurement contracts. But, ‘Buy American’ preferences may do so already. The Overseas Private Investment Corporation may be barred from financing new projects in which those firms were involved. But, they can sign up for China’s BRI.
But, America might fight underd currencies with countervailing duties.
Modest, until now.
The U.S. Department of Commerce is poised to finalise the two most dramatic changes to international trade rules on subsidies since the birth of the WTO on Jan. 1, 1995.
On May 28, the Commerce Department proposed a regulation to allow it to impose countervailing duties against all merchandise exported by a country that the Treasury Department declares a currency manipulator.
First, the Commerce Department would group together all producer-exporters from that country to satisfy the ‘specificity test’ in CVD law. They would not have to trade in the same ‘like’ product, such as automobile speedometers from India to the U.S., to constitute an identifiable industry. Rather, coffee powder from Coorg and car parts from Faridabad would comprise the specific enterprise – exports – at which the Commerce Department might fire CVDs.
Second, an underd currency would count as an illegal export subsidy. If the Treasury Department says India engages in currency manipulation, notwithstanding any RBI protests about its monetary policy, then the Commerce Department will order Customs and Border protection to collect CVDs on Indian merchandise.
Untidiness
The situation is untidy. Monetary policy should not be used to cause currency wars, nor to create or prolong artificial competitive advantages in trade. There should not be a race to the bottom in defining key finance and trade concepts. Already, trade aficionados realise the unilateral American CVD changes would go beyond the WTO Agreement on Subsidies and Countervailing Measures.
In the 1930s, with no international organisations to stop them, countries abandoned the gold standard and competitively ded their currencies. Their actions were not constructive, exacerbating the Great Depression. Today, in searching for ways to catalyse quantitative and qualitative growth, there is a lesson from this dark history. The failure of post-Depression Era international organisations to define ‘currency manipulation’ is inviting unilateral action to correct trade imbalances allegedly due to underd currencies, by weakening forex rates in ways veiled as uneven monetary policy, and by imposing CVDs. ‘Beggar-thy-neighbour’ yesterday – and tomorrow?
Raj Bhala is the inaugural Brenneisen Distinguished Professor, The University of Kansas, School of Law, and Senior Advisor to Dentons U.S. LLP. The views expressed here are his and do not necessarily represent the views of the State of Kansas or University, or Dentons or any of its clients, and do not constitute legal advice.
The views expressed here are those of the author, and do not necessarily represent the views of BloombergQuint or its Editorial team.
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