May 29th 2015

The Currency Manipulation Charade

by Stephen S. Roach

Stephen S. Roach, a faculty member at Yale University and former Chairman of Morgan Stanley Asia, is the author of a new book Unbalanced: The Codependency of America and China.

NEW HAVEN – As the US Congress grapples with the ever-contentious Trans-Pacific Partnership – President Barack Obama’s signature trade legislation – a major stumbling block looms. On May 22, the Senate avoided it, by narrowly defeating – 51 to 48 – a proposed “currency manipulation” amendment to a bill that gives Obama so-called “fast-track” authority to negotiate the TPP. But the issue could be resurrected as the debate shifts to the House of Representatives, where support is strong for “enforceable currency rules.”

For at least a decade, Congress has been focusing on currency manipulation – a charge leveled at countries that purportedly intervene in foreign-exchange markets in order to suppress their currencies’ value, thereby subsidizing exports. In 2005, Senators Charles Schumer, a liberal Democrat from New York, and Lindsey Graham, a conservative Republican from South Carolina, formed an unlikely alliance to defend beleaguered middle-class US workers from supposedly unfair competitive practices. Stop the currency manipulation, went the argument, and America’s gaping trade deficit would narrow – providing lasting and meaningful benefits to hard-pressed workers.

A decade ago, the original Schumer-Graham proposal was a thinly veiled anti-China initiative. The ire that motivated that proposal remains today, with China accounting for 47% of America’s still outsize merchandise trade deficit in 2014. Never mind that the Chinese renminbi has risen some 33% against the US dollar since mid-1995 to a level that the International Monetary Fund no longer considers undervalued, or that China’s current-account surplus has shrunk from 10% of GDP in 2007 to an estimated 2% in 2014. China remains in the crosshairs of US politicians who believe that American workers are the victims of its unfair trading practices.

While this argument has great emotional and political appeal, it is deeply flawed, because the United States has an insidious saving problem. America’s net national saving rate – the sum total of household, business, and government saving (adjusted for the depreciation of aging capacity) – currently stands at 2.5% of national income. While that is better than the negative saving rates of 2008-2011, it remains well short of the 6.3% average of the final three decades of the twentieth century.

Lacking in saving and wanting to grow, America must import surplus savings from abroad. And to attract that foreign capital, it has no choice but to run equally large balance-of-payments deficits.

So it is no coincidence that the US economy has a chronic current-account deficit. While this shortfall has narrowed from a peak of 5.8% of GDP in 2006 to 2.4% in 2014, it still leaves the US heavily dependent on surplus foreign savings in order to grow.

This is where the trade deficit comes into play. The US does not just pluck surplus foreign savings out of thin air. To attract the capital it needs, America must send dollars overseas through foreign trade.

And it is here that the currency manipulation argument falls apart. In 2014, the US ran trade deficits with some 95 countries. In other words, America does not suffer from a small number of bilateral trade deficits that can be tied to charges of currency manipulation by countries like China, Japan, Malaysia, or Singapore. Rather, the US suffers from a multilateral trade imbalance with many countries, and this cannot be remedied through the imposition of bilateral penalties such as tariffs.

Without fixing its savings problem, restricting trade with a few so-called currency manipulators would simply redistribute the US trade deficit to its other trading partners. In effect, America’s trade balance is like a water balloon – applying pressure on one spot would simply cause the water to slosh elsewhere.

Moreover, this approach could easily backfire. For example, assuming that there is no increase in domestic US saving, penalizing a low-cost producer like China for currency manipulation would most likely cause the Chinese piece of America’s trade deficit to be reallocated to higher-cost producers. That would be the functional equivalent of a tax hike on middle-class families – precisely the constituency that so concerns Congress. Further complications would arise from putting the verdict on currency manipulation – presumably dependent on some type of “fair value” metric – in the hands of politicians.

This is also the twist that underscores the ultimate congressional hypocrisy. The charge of currency manipulation is nothing but a foil for the US to duck responsibility for fixing America’s saving problem. Lacking any semblance of a strategy to boost savings – not just a long-term fix to the federal government’s budget deficit, but also meaningful incentives for personal saving – US politicians have turned to yet another quick fix.

In the end, there is no way around it: If Congress does not like trade deficits, it needs to address America’s saving problem and stop fixating on misplaced concerns over currency manipulation.

None of this is to argue that the US should ignore unfair trading practices. As a member of the World Trade Organization, the US has ample opportunity to use that body’s dispute-resolution mechanism to adjudicate major problems with its trading partners. And it has enjoyed success with this approach. What Congress cannot do is pretend that wrong-footed trade policy is the answer to its inability or unwillingness to refocus its domestic policy agenda.

Of course, it is always easier to blame others than to look in the mirror. But history has not been kind to major trade blunders. Just as the Smoot-Hawley Tariff Act of 1930 sparked a global trade war that may well have put the “great” in the Great Depression, Congressional enactment of enforceable currency rules today could spark retaliatory actions that might devastate the free flow of trade that a sluggish global economy desperately needs.

The US Senate was wise in rejecting this dangerous option. We can only hope that similar wisdom prevails in the House of Representatives. Currency manipulation legislation is one tragedy that can and should be avoided.


Stephen S. Roach, a faculty member at Yale University and former Chairman of Morgan Stanley Asia, is the author of Unbalanced: The Codependency of America and China.

Copyright: Project Syndicate, 2015.
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