The world's existing level of prosperity is unprecedented. Economists maintain that this outcome could not have been achieved without the possibility of exploiting comparative advantages via international trade. But there are plenty of examples in history showing that the rules of international trade can be violated to gain unfair advantages and that, in turn, can threaten the potential benefits from a well-functioning multilateral trading system.
The likely impact of a country's actions to move the exchange rate – sometimes referred to as ‘currency manipulation’ – with the aim of doing better than its trade competitors in the international markets is an enduring topic of debate in academic and policy circles. In their book, C. Fred Bergsten and Joseph Gagnon, both affiliated to the Peterson Institute for International Economics in Washington, DC, seek to ascertain the significance of currency manipulation in the recent past and do so with a great deal of success.
The book contains six chapters. While chapter 1 provides an introduction to the rest of the book, chapter 2 explains the economics behind the trade balance and policies that can affect its trajectory.
Chapter 3, in turn, discusses what are considered legitimate and illegitimate currency policies. Exchange rate fluctuations other than those generated by cyclical fluctuations can adversely affect an economy. Therefore, it is realistic to expect governmental actions intending to smooth excessive short-run fluctuations in the exchange rate, and can be considered legitimate. The legitimacy of that policy is expected to be endorsed or otherwise by organizations like the International Monetary Fund (IMF), for instance, during periodic assessments of member economies via its Article IV staff missions and subsequent Board reports. In contrast, the authors consider intervention with the aim of affecting a currency's long-run path to be illegitimate.
The debate on the distinction between legitimate and illegitimate currency policies leads to the book's core theme: currency conflict. This conflict is more likely to arise when there is evidence of significant and ongoing currency manipulation, which amounts to unrelenting illegitimate currency policies. The events leading to the Plaza Accord in 1985 are an example of a past currency conflict.
Chapter 4 (page 76) defines currency manipulation as ‘official action to push or maintain a country's current account balance above a reasonable norm … set within a relatively narrow band around zero based on long-term and cyclical factors that are fundamental to each economy and not reflective of inappropriate policy choices’. The authors’ analysis settles on characterizing as reasonable a current account balance within a range of plus or minus 3% of gross domestic product (GDP). Another measure used in determining currency manipulation is a country's official purchases of foreign assets. Bergsten and Gagnon (page 77) also ‘adopt a criterion for currency manipulation that requires net official flows of at least 2 percent of GDP’.
The book employs additional indicators in classifying a country as a currency manipulator: net official flows in relation to oil exports or other non-renewable commodities for countries with substantial exports of natural resources; two other approaches focus on holdings of foreign exchange reserves and other official foreign assets, with one particularly focusing on Greenspan-Guidotti's reserve adequacy rule interpreting as excessive an amount beyond that needed to cover 100% of short-term external debt in all foreign currencies, public and private. The final indicator concerns a country's placement in the World Bank's ranking: only high-income or upper-middle-income countries are considered eligible for the label as a currency manipulator.
Tallying the numbers gathered using the above criteria uncovers 20 economies that intervened during at least one year in the ‘Decade of manipulation’ ranging from 2003 to 2013. Bergsten and Gagnon classify the countries into three groups: manufacturing exporters – Taiwan, China, South Korea, Malaysia, Thailand, Israel, Japan, and Sweden; financial centers – Macao, Singapore, Hong Kong, and Switzerland; and resources exporters – Norway, Algeria, United Arab Emirates, Russia, Libya, Kuwait, Trinidad and Tobago, and Oman. Countries are ordered on the basis of years manipulating the currency: Macao and Norway top the overall list with a total of 11 years of currency manipulation each. But in absolute terms China registers the largest intervention, measured by cumulative net official flows during 2003–2013 adding up to over US$4 trillion. For that reason, and as no other country comes even close to that figure, claims of currency manipulation during this period generally focus on China.
Figure 1 helps illustrate the matter. The graph exhibits monthly data on the United States’ trade balance along with China's real exchange rate. Bergsten and Gagnon's ‘Decade of manipulation’ from 2003 to 2013 is noticeable, even though one should bear in mind that correlation does not imply causation. The worsening in the United States’ trade balance moves in tandem with China's real exchange rate. The latter's lower values denote a more depreciated currency and therefore relatively cheaper exports, ceteris paribus. But subsequently, and particularly from the onset of the Great Depression in the United States in 2008, the co-movement substantially weakens.
USA trade balance (millions of US$) and China's real exchange rate index (2010 = 100) – Bergsten and Gagnon's ‘Decade of manipulation’ ranges from 2003 to 2013
Bergsten and Gagnon discuss two concrete impacts on the United States resulting from exchange rate manipulation: one affecting the financial system and another impinging on the labour market. The narrative on the first impact argues that the financial crisis and the subsequent Great Recession were at least partly triggered by factors originating from currency manipulation. The trade balance surpluses registered by China and other economies returned to the United States in the shape of investments in safe financial assets, mainly Treasuries. The resources contributed to the historically low interest rates observed in the United States – the so-called ‘global savings glut’ hypothesis coined by ex-Federal Reserve Chairman Ben Bernanke- and therefore to sowing the conditions for the sub-prime mortgages predicament to grow and ultimately erupt. And the low interest rate scenario arguably complicated the United States’ Federal Reserve attempt to fight the Great Recession using conventional monetary policy: leaning against the wind by lowering the interest rate.
The other major impact discussed by Bergsten and Gagnon is also part of a research programme identifying the ‘China shock’ producing massive job losses in the United States – see, for example, Autor et al. (2013).Footnote 1 China's export-led growth model had been rather successful starting from the end of the 1970s and building on that momentum after joining the World Trade Organization (WTO) in 2001. Therefore, it is widely accepted that China's growth story would have caused job losses in the United States’ manufacturing sector even in the absence of currency manipulation. But Bergsten and Gagnon argue that currency manipulation significantly magnified the shock to the detriment of the United States and other economies around the world.
Given the evidence on currency manipulation and its impacts, chapter 5 considers a range of policy options. Bergsten and Gagnon bemoan the lack of a comprehensive protocol for addressing currency manipulation. The matter falls in the intersection of open-economy macroeconomics and international trade policy, and therefore in the domain of the IMF (via its Articles of Agreement) and the WTO. Without doubt the global economy would benefit from more effective synergies between the IMF and the WTO in detecting and reacting to instances of currency manipulation.
In trying to bypass the block produced by the prevailing arrangements, Bergsten and Gagnon propose ideas concerning a new strategy for the United States and other countries to discourage currency manipulation in the future. They envisage countervailing currency interventions as a key option in retaliating against currency manipulation. But implementing the policy would be complex, by the United States alone or even in an orchestrated multilateral fashion, say via IMF–WTO linkages. Any other options are deemed to be difficult, such as classifying currency intervention as an export subsidy in WTO rules and therefore triggering applicable sanctions.
The United States is also making progress through other channels. In 2016, the Treasury produced a list with five economies it intended to monitor with respect to currency manipulation: China, Germany, Japan, South Korea, and Taiwan. Furthermore, the United States Congress passed the Trade Facilitation and Trade Enforcement Act of 2015 creating guidelines for reacting to currency manipulation. And the G-7 and the G-20 have also taken steps by adopting formal rules to address the matter. The exposition in this part of the book also contemplates formally incorporating currency commitments in trade agreements.
Chapter 6 concludes and provides recommendations. Currency manipulation is an unfair trade practice and has been observed in the global economy's recent history. In some instances, the practise can even become detrimental for the manipulating economy. For instance, Amador et al.Footnote 2 have previously examined the ‘reverse speculative attack’ affecting Switzerland – a country which appears in Bergsten and Gagnon's list of currency manipulators during 2003–2013 – when in 2015 the Swiss National Bank decided to stop intervening in the foreign exchange market to affect the value of the franc.
Addressing currency manipulation demands tact, and there are various options on the table. Bergsten and Gagnon approach the topic using sound analysis and recommend a workable, but complex agenda for the future. The authors’ call for paying more attention to the potential benefits from developing stronger synergies between the IMF and the WTO is worth heeding. The book is a welcome contribution to the debate on safeguarding a transparent global trading system. It will be a useful reference for academics, and for policy makers in governments and international organizations across the world, working on the intersection of open-economy macroeconomics and trade policy.
