Its report on ‘currency manipulators’ overlooks the destabilising impact of capital flows on exchange rates
As per this Act, the Secretary must consider whether countries “manipulate the rate of exchange between their currency and the United States dollar for purposes of preventing effective balance of payments adjustments or gaining unfair competitive advantage in international trade.”
The recent report, covering the period July 2019 through June 2020, was released on December 16, 2020.
This report reviewed and highlighted 20 major trading partners of the US as per the following three key criteria: bilateral merchandise trade surplus (at least $20 billion over a 12-month period); current account surplus (at least 2 per cent of GDP over a 12-month period); and persistent and one-sided intervention in the forex market (net purchases of foreign currency in at least six out of 12 months, and at least 2 per cent of an economy’s GDP over a 12-month period).
If a country becomes qualified as per all the three criteria, then as per the report, it can be inferred that, “potentially unfair currency practices or excessive external imbalances that could weigh on US growth or harm US workers and businesses…” in that country.
Stripped of political niceties, effectively the country is seen as a currency manipulator by the US.
This year’s report focuses its attention specifically on two countries — Vietnam and Switzerland — which qualify in all the three criteria (Table). Although the contexts are different, both the countries have intervened substantially in their foreign exchange market to defend their currency.
Second, China is off the key monitoring list as it satisfies only one of the three criteria. In some sense, this shows the extent of rebalancing in China over the last few years.
Admittedly, opinions may differ regarding the underlying causes. In particular, explanations may swing between the extremes of: (a) it is due to the initiation of the trade war on behalf of the US, and (b) it reflects some sort of internal rebalancing of China that is happening during the last few years.
Third, India seemed to have had a close shave. After all, India qualifies in two out of the three criteria. Our low current account surplus seems to have saved us from being included in the league of currency manipulators!
Massive capital flows
However, the economic rationale behind the report seems to be rather weak. In this day and age, when massive capital flows, arising out of flood of liquidity from the taps of developed country central banks, are increasingly dictating exchange rate, complete overlooking of capital flows can hardly be justified.
The rise of such destabilising capital flows has made intervention by the central banks in the foreign exchange markets a legitimate and essential element of the toolkit of central banks in developing countries.
Ironically, for the period mentioned in the report, these interventions were needed because policies adopted by the US Fed drove down the value of dollar internationally.
Service trade ignored
Secondly, the report only talks about merchandise trade and not directly about trade in services. This is possibly because the US is a service-led economy and runs trade surplus in services vis-à-vis many countries. However, it is losing competitiveness in trade in goods over the years. Therefore, focussing only on merchandise trade balance perhaps allows the US to paint more countries as currency manipulators.
The third flaw in the report is much more fundamental. There was a time when balance of trade used to dominate determination of exchange rate and when a persistent trade surplus was seen as an evil in a mercantilist tradition.
In the post-1991 era of globalisation, the capital account is playing equally or sometimes more important role than the trade balance. The benchmarks used in this report completely ignores the volatility associated with the capital account. It only focusses on current account indicators with an emphasis on merchandise trade.
Overall, the indicators used in the report are ad-hoc, biased and insensitive. It fails to distinguish between competitive countries and currency manipulators. While it highlights the inability of the US to produce goods at a competitive price, it stays silent on the supremacy of US in export of services, its dominance in intellectual property rights or finance, all of which do not find a place in the set of metrics in the report.
Also, it totally ignores that some foreign exchange interventions by central banks of developing countries are a hand forced by the US Fed. These make the analysis of the report smacking of Voodoo Economics!
The writers are Professors of Economics at IIM Calcutta