Currency manipulation and the NAFTA renegotiation: with manipulation in remission, now is the time to add currency provisions to the agreement.

• Author: Bergsten, C. Fred
• Position: Report

U.S. Trade Representative Robert Lighthizer has indicated that the Trump administration will seek to include the currency issue in a renegotiated NAFTA (and in any other trade agreements it might pursue). U.S. Secretary of Commerce Wilbur Ross has reiterated the Administration's focus on bilateral trade balances on many occasions, and has specifically called for appraisal of the impact of currency misalignments, "whether or not due to manipulation," in assessing the causes of U.S. deficits.

The Trump administration would be misguided to try to use trade agreements to reduce the overall U.S. external deficit, which is a macroeconomic problem that requires macroeconomic solutions. It would be doubly misguided to focus on bilateral trade imbalances, whose reduction would do little or nothing to correct the global U.S. deficit, especially with countries such as Mexico and Canada that are running large global deficits themselves. But currency manipulation is an unfair trade practice that can have huge effects on trade flows and trade balances, and it is thus quite appropriate for the administration to address it in their trade negotiations.

A currency chapter in the new NAFTA and other trade agreements could accomplish four things. It should commit the members to avoid manipulation or competitive depreciation. It should encompass a simple definition of manipulation to identify violators of that commitment as incorporated in currency legislation passed by Congress a year ago: substantial intervention in the currency markets by countries with sizable surpluses to block or limit significant appreciation of their exchange rates. It should subject these commitments to the dispute settlement mechanism of the overall trade agreement. Most critically, it should provide effective sanctions against violators in order to deter future manipulation, including a "snapback" of the trade advantages that the violators had gained under the agreement.

Currency manipulation is the use of intervention in the foreign exchange markets by countries to avoid or limit appreciation of their exchange rates. Largely because of massive intervention by China during 2003-2013, along with more isolated but sometimes sizable intervention by Japan, manipulation came to be viewed as an unfair trade practice and was widely criticized as such throughout the Congressional debate over trade policy during the current decade and in the political campaigns in 2016. In my new book with Joseph Gagnon, Currency Conflict and Trade Policy, we analyze the issue in depth and conclude that it was quite significant: about twenty countries were active during the "decade of manipulation," their excessive intervention averaged over $600 billion per year, and the result was a shift of more than $300 billion of annual current account balances. The U.S. current account deficit increased by $150-$200 billion annually as a result and the United States lost more than a million jobs during the Great Recession and the tepid recovery from it.

A large number of members of Congress rejected the responses of both the George W. Bush and Obama administrations to the problem as grossly inadequate, and urged the inclusion of "enforceable currency disciplines" in the Trans-Pacific Partnership. Congress included the issue as a major U.S. negotiating objective in the Trade Promotion Authority legislation in 2015 and passed new currency legislation as part of the Trade Enforcement and Trade Facilitation Act of 2015 (the "customs bill") that adopted objective criteria for identifying manipulation (see below) and required presidential response under some circumstances. The Obama administration, in an effort to deflect Congressional pressure without jeopardizing the TPP, negotiated a side agreement to it that reiterated the commitments of the member countries (from the IMF Articles of Agreement) to avoid manipulation and to enhance the transparency of their related international financial activities, but included no dispute settlement mechanism or enforcement provisions. It also created a TPP Macroeconomic Group that was somewhat analogous to the consultative North American Financial Group that was created at the outset of NAFTA but was not active for very long. But many members of Congress remained dissatisfied with the policy response and the issue was thus cited widely, in the Congressional debate on TPP and the election campaigns in 2016, as a reason to oppose any new trade agreements and indeed globalization more broadly.

Both Canada and Mexico maintain floating exchange rates that are largely "clean," that is, conducted without intervention. Neither has been accused of manipulation in recent decades. Mexico in fact recently sold modest amounts of dollars to counter depreciation of the peso.

Furthermore, unlike China or Japan, both Canada and Mexico now run sizable global current account deficits (despite Mexico's bilateral surplus with the United States) on the order of 2.5 percent to 3 percent of their GDPs. For both these reasons, the practical impact of adding currency issues to NAFTA would be modest or even non-existent at present. However, the combination of domestic political pressure in the United States and the Administration's desire to set a precedent for other trade agreements where currency might be more relevant (for example, Japan, a revived TPP) suggest such an effort. The blueprint suggested below outlines how such a chapter could be fashioned and incorporated in a revised NAFTA (or bilateral agreement with Mexico).

HISTORICAL BACKGROUND

Trade agreements have traditionally avoided trade imbalances and the currency issue for two reasons. First, such agreements aim primarily at expanding the level of trade, and...