The Trump administration’s decision last week to punt on labeling China a currency manipulator disappointed some of his supporters, but should not have surprised anyone paying attention to the policy details. Indeed, it’s a culmination of decades of a hyper-legalistic approach to economic strategy.
Before delving into the details, let’s look at the basic economics.
The China currency issue and the dollar’s value are intimately connected. China is one of the U.S.’s major trading partners. If the value of the yuan rose relative to the dollar (or if U.S. policymakers took action to do the same), the U.S. would export more to China and thereby lower the trade deficit. Indeed, manufacturing advocates cite the “strong” dollar as one of the top problems they face.
As Ezra Klein has pointed out, adjectives like “strong” or “weak” aren’t particularly clarifying. A “strong” dollar means that one greenback can be exchanged for lots of foreign currency. That’s great if you’re shopping at Walmart, where the cash in your wallet will get you more of the goods, from clothes to patio furniture, which are routinely imported from abroad. However, the flipside is that stuff that’s “Made in America” is relatively more expensive in foreign markets. Pushing or talking down the value of the dollar would boost exports and tamp down imports. Or, as Justin Wolfers put it on Twitter: “A strong dollar makes foreign stuff cheap (yay!), and stuff we make expensive for foreigners (boo!). Depends on what you want.”
Is the dollar overvalued, and relative to what? The Economist Big Mac index (which measures the divergence between the cost of a McDonald’s Big Mac across borders) finds that the dollar is over 50 percent higher against the Chinese yuan than it should be if introductory economics textbooks (e.g. the law of one price) held. The International Monetary Fund finds a much smaller estimate of overvaluation (as does the Peterson Institute), but still significant. So the dollar still has room to appreciate.
The problem with all of this is the “how.” With flexible exchange rates, the adjustment back to balance can come through changes in prices of traded goods. For example, an appreciation of the Chinese currency would make their exports more expensive, eventually lowering their current account surplus. Yet we live in a world where the U.S. has a flexible exchange rate, and China effectively manages its exchange rate.
The tools we have for addressing currency manipulation in this bifurcated environment are weak. The International Monetary Fund supposedly prohibits such policies, but has never sanctioned the dozens of countries that have used them. The World Trade Organization has some tools that might be used to sanction currency manipulators, but countries have been loath to test them. The U.S.’s 1988 Trade Act leaves much to the discretion of the executive branch, which hasn’t labeled any country a currency manipulator in over two decades.
What happened last week, and why it matters
Under U.S. law, the Treasury Department assesses three criteria before it will even consider beginning the process of labeling a country a currency manipulator. First, does the country’s U.S. bilateral trade deficit top $20 billion? Second, does its global trade deficit top 3 percent of national income? Finally, do its foreign currency purchases in the last year top 2 percent of GDP? These requirements are cumulative, so while China, Japan, Korea, Taiwan, Germany, and Switzerland each meet at least one of the requirements, none meet all three.
So despite Trump’s campaign pledge to declare China a currency manipulator on day one, as trade analyst Ed Gerwin told Politico, “At the end of the day, Trump can’t decree that up is down. The numbers are the numbers.” And this isn’t some unique Trumpian flub: Hillary Clinton would have been in the same boat with her labor supporters if she were in the White House now.
A big question is why this particular formula—an issue focus on currency, and an activity focus on manipulation—came to dominate the policy conversation. After all, the variable that should be most directly of interest to U.S. policymakers is the wellbeing of U.S. workers. International economic exchange is one channel by which livelihoods are affected. If the current trade surplus countries stimulated their economies and boosted the purchasing power of their citizens, this would put upward pressure on their exchange rates. The result: Their consumers would substitute some U.S.-made goods for domestic goods, and the inverse would happen here. This outcome would be a win for their consumers and our workers.
There are many reasons that currency adjustment may fail to take place: Currency manipulation is one, but so is sitting on excess reserves (as does China), or suppressing manufacturing wage growth (as does Germany). Picking instruments to track is like a distracting game of whack-a-mole.
At a more fundamental level, the difficulty in resolving these persistent imbalances is a result of a breakdown in norms at multiple levels that have yet to be replaced. Under the gold standard (1870s-1914) and the gold window (1940s-1971), there were established international expectations that domestic policymakers would help restore balance for their trading partners. Moreover, presidents throughout most of the 20th Century shared basic orientations that made currency collaboration possible. In 1936, leaders in deficit country France benefited from a shared social democratic outlook with their counterparts in the (then) surplus country U.S., which led to international currency agreement (although too late to head off the rise of fascism). Even after Nixon’s closing of the gold window in 1971, he and subsequent U.S. presidents through Ronald Reagan negotiated temporary currency fixes with foreign leaders that could remember the benefits of the Bretton Woods era.
Today, a norm favoring balance doesn’t exist. For example, China’s growth model makes a lot of money for the global and local manufacturing companies that have bought into it, who are a force against change. Not only do surplus country policymakers now resist such adjustments, but their voters do as well. Research at the University of Geneva finds, for instance, that German citizens see their 8.3 percent surplus as a sign of moral rectitude—a factor that makes policy motion that much harder. (As Dean Baker noted in a post today, this “virtue” could come back to haunt Germans.)
The lack of public consensus finds a counterpart among academics. Reviewing a few decades of literature, economist Thomas Palley identifies at least nine schools of thought that discount the seemingly simple proposition that tradable sectors in deficit countries would benefit if surplus countries bought more of their stuff. He argues that this is the intellectual corollary to a trading system built less on comparative advantage than it is on locking in low social costs for corporations.
Yet at the very time when these norms have deteriorated, the demand for them is highest. During the gold standard era, there was the possibility that governments could use instruments like selective tariff increases to buy off and divide manufacturing interests away from agrarian populists demanding currency-based solutions to competitiveness problems. Today, such targeted approaches are largely off the table due to U.S. commitments to the World Trade Organization and other trade pacts. Deviating from these obligations requires jumping through legal thickets that make the currency criteria look like a cakewalk. And years after Democrats even seriously attempted to pass labor law reform, what benefits can politicians credibly promise manufacturing unions to redirect their attention away from China?
Re-establishing norms isn’t easy. But an important first step is to wean the public debate off of a focus on specific policy instruments. In a recent report for the Roosevelt Institute, I lay out a domestic deal (support for unionization and trade reparations) that could bolster support for globalization at home. Meanwhile, an international deal could rebalance global trade in exchange for enhanced U.S. cooperation on tax, financial stability, and monopolies. These moves would benefit U.S. workers and our trading partners alike, and contribute to making trade and currency relations less of a heads-I-win/tails-you-lose proposition.
Also published on Medium.