Sometimes it feels like the globe needs an organizing principle. It used to be the Soviet Bloc versus the West. More recently, we’ve talked about emerging economies and advanced economies—BRICS versus the G7, if you will. But a new paper suggests another way of splitting the global community: Countries that manipulate their currency for an advantage in international markets, versus those that don’t.
We’ve heard, endlessly, about how China’s purchases of foreign reserves have made its exports more competitive, helping drive its growth, although it has relaxed its efforts slightly in recent years. But China is hardly the only economy in the game: Many other Asian countries, including Japan and Korea, keep their currencies down. Oil producing countries do the same to boost their export capabilities. And the largest currency manipulator last year was Switzerland, working to prevent its franc from appreciating against the euro.
All told, about 20 countries are actively manipulating their currencies to the tune of $1 trillion annually, according to research (pdf) by Joseph Gagnon and Fred Bergsten, economists and former US government officials working at the Peterson Institute for International Economics.
The country hurt most by this is the United States, because of the size of its economy and its liberal financial markets. Currency manipulation leads to US trade and current-account deficits, which lead to job losses. Gagnon and Bergsten argue that fully half of America’s current job shortfall is attributable to currency manipulation.
In fact, manipulation even played a role in the 2008 financial crisis. The 2000s-era Federal Reserve kept rates low to counter the effects that those persistent current-account deficits had on employment, and in doing so it inadvertently pumped up the housing bubble. “It’s not the whole story,” Gagnon says. “We had a faulty electrical system, but there was still a surge of electricity that went through it and the circuit breaker didn’t handle it well.”
The problem of persistent trade surpluses
It’s not just the United States that suffers from other states’ attempts to game the free currency system, a point the two authors are at pains to make. That’s because they hope the US will mobilize a global coalition to fight currency manipulation, and, in the process, undo a mistake it made at the Bretton Woods conference in 1947.
Bretton Woods created the International Monetary Fund (IMF), whose job is to smooth out instabilities in the global financial system. Back then, the US was on the other side of the scales from today: running massive trade surpluses, exporting goods to a war-ravaged world. It rejected efforts by John Maynard Keynes and others who wanted the IMF’s rules to constrain the way surplus economies could behave, particularly when a changing global balance requires their currencies to appreciate.
That’s the case today, as rapidly growing export economies in Asia resist the market forces pushing their currencies to rise. Some of the manipulators, particularly Taiwan and Israel, maintain large foreign reserves for political, not economic reasons—they fear being cut off from the international financial system. Switzerland is trying to maintain a stable exchange rate between its franc and its troubled neighbor, the euro, at great cost. But because these countries are defending a significant trade surplus, Gagnon and Bergsten see them as manipulators.
The oil-exporting countries too may have a good claim for holding foreign currency in large amounts, often in sovereign wealth funds. Their national income is based on a non-renewable resource, and they need to save for the future. It’s hard, however, for economists to say at what point saving for the future becomes an effort to play unfairly for now.
All this manipulation has come at the expense of 41 economies considered non-interveners, which include rich countries like the United States and the euro zone, but also developing ones like Mexico. Some 91 other countries, like Brazil and India, practice so-called defensive intervention to maintain parity with more overt currency manipulators, which means they suffer the effects of manipulation less; but that defensive intervention is money down the drain that could go on, say, building roads and bridges.
Gagnon and Bergsten’s proposal is that the US rally as many of the affected countries as possible to push back against the manipulation of eight influential countries: China, Denmark, Hong Kong, Korea, Malaysia, Singapore, Switzerland, and Taiwan.
The currency war toolkit
The US has been accused of fomenting “currency war” because the Fed’s stimulus efforts have made it comparatively more lucrative to invest in emerging markets, leading to upward pressure on their currencies. But calling domestic bond purchases a currency war is a inflammatory when the dollar remains relatively strong and so many other countries are actively intervening in foreign exchange markets.
The goal of Gagnon and Bergstrom’s proposal is to avoid a real currency—or, even worse, a trade—war. This, many observers fear, will be the inevitable consequence of continued imbalances in the global financial system, pitting economies against each other in a race to cheapen their currencies and protect their domestic markets. Instead, Gagnon and Bergsten propose that the US work within the G20 and with other affected countries to counter manipulation.
The authors hope that a coalition of nations, backed by an effective plan to fight manipulation, could convince the eight manipulators to join in a Plaza-style accord to set limits on their foreign purchases. To bolster this, they want the IMF to remedy the mistake at Bretton Woods by adopting a change to its charter, making clear that macroeconomic sanctions against manipulators are lawful and that the IMF will supervise them.
The most important of these tools is countervailing currency intervention, where the central bank of the “victim” country buys the manipulator’s currency to nullify its impact on exchange rates. Other strategies will be necessary to deal with countries like China, which limits the sale of its currency abroad: The US and its allies could tax the earnings on their US assets or restrict further purchases. The program also includes trade-focused measures, like including currency manipulation in trade subsidy calculations and bringing cases against manipulators in the World Trade Organization.
While many other countries already have policies like these—Brazil, notably, taxes certain capital inflows—none are comprehensively targeted. For America to adopt them would be a big change. “There’s nothing here that’s at all revolutionary,” Gagnon says. “It’s only that we would ask the US to do them that’s revolutionary. If we tell them that they can’t buy our bonds, it’s no difference from them telling us we can’t buy their bonds.”
It’s revolutionary because the US would be relinquishing, at least partially, the dollar’s position as the world’s currency. But that’s already happening, thanks to the rise of the euro (despite its recent troubles) and the renminbi, and the growing economic power of multiple financial centers around the globe.
That’s why it’s important that the US make this a global concern, not a single-handed crusade. It helps that the IMF has recently relaxed its stance on capital controls for countries trying to manage heavy capital inflows. “The IMF was thinking more of developing economies when it wrote that,” Gagnon notes, “and nothing in it is limited—it’s a general prescription, and, oh, the US actually qualifies, too.”
The hope is that these policies won’t have to be implemented, or at least not for long—that, faced with a credible threat of sanctions from a multilateral coalition, the big eight manipulators will start to rebalance. Especially if they’re offered a carrot as well as a stick. That means helping them find ways to stimulate domestic economic growth rather than exports; the authors suggest that a G-20 scheme for infrastructure investment in developing economies could be a good way to do this.
This has been the limited pattern of the United States relationship with China since the financial crisis, but the US has declined to put much real pressure on China’s economic policymakers, relying on something of a good cop, bad cop strategy, with populist US legislators demanding harsh sanctions and President Obama taking a more measured stance. This new scheme would significantly intensive that approach—and its risks.
The will to change the world
To gain support for an overhaul of global financial flows, the US needs the powerful emerging economies such as India and Brazil to believe that the actions of the manipulators are more harmful to their interests than America’s efforts to goose its own growth.
Gagnon is confident that they, as fellow sufferers, can be brought around, and that economists who still doubt that artificial current-account surpluses are such a bad thing will find the data hard to dispute. He has informally presented his research to IMF officials in an effort to convince the institution to do more against manipulation, and believes he is making headway. “I never thought I’d be saying the things I’m saying now, but the data forced me to,” he says.
But the biggest obstacles aren’t economic; they’re political. The Obama administration’s big foreign-policy initiative has been its “pivot to Asia,” and six of the eight big manipulators are large Asian countries. While it’s true that two of them are China and Hong Kong, and the rest are largely keeping up, a showdown between an EU-US alliance and Asia’s most powerful economies doesn’t look great. And the US needs China’s support on global problems like Iranian and North Korean nukes, the Syrian civil war, and climate change. But then again, part of the point of the pivot to Asia is to empower China’s neighbors too, and leveling the currency playing field would do just that.
In its own interests, China could learn from the United States’ mistake at Bretton Woods, and think about where it might be 50 years from now. If imbalances lead to a real trade war, it could shut down the global marketplace that enabled China’s economic boom. The US, meanwhile, has a chance to craft international norms that will create more stability as its economic dominance of the world wanes, and bump up its own economic growth in the meantime, perhaps by as much as 1.5% annually.