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Opinion: The Trans-Pacific Partnership Must Address Currency Manipulation

April 14, 2015

Currently, one of the few mutual priorities of the Obama administration and establishment Republicans is over the passage of a proposed Trans-Pacific Partnership free trade agreement between the United States and eleven countries in Asia and the South Pacific, including the US’s massively important trade partner Japan. The agreement, which has not yet been finalized, has nonetheless inspired massive lobbying both in support and opposition. However, one topic has been largely absent from the debate, despite having substantial implications for international trade: currency manipulation.

What is the Trans-Pacific Partnership?

As mentioned above, the TPP is a free trade agreement between the United States and a group of countries in Asia and the South Pacific. It’s a massive group, economically speaking: the countries in the agreement account for 40% of US trade flows, as well as 40% of the entire global GDP.

(Image: Countries involved in the TPP and their trade balances with the United States. Source: Federation of American Scientists)

What are the goals of the TPP?

Nominally, free trade agreements focus on lowering tariffs and other barriers to trade, under the economic assumption that trade allows countries to specialize in producing the goods in which they have a comparative advantage, increasing output and GDP for both parties to the trade. In theory, the TPP is focused on reducing those barriers to trade.

However, the US has a number of other official goals in the TPP, including:

  • Expanding and strengthening intellectual property rights

  • Binding participating countries to enact labor and environmental standards, as well as stronger international regulatory systems

  • Providing new mechanisms of dispute settlement in an international context

Just as important, however, are some of the US’s unofficial goals. One important, if implicit, objective is to combat the rise of China. Over the past few years, China has begun to exert increasing economic dominance in the region, and as it liberalizes its own trade markets, the Obama administration believes it to be critical to creating a strong economic foothold in the region, to prevent countries from neglecting trade with the US and entering China’s fold.

What is the opposition to the TPP?

With the TPP, the Obama administration has seemingly picked a massive fight with its own liberal allies. Unions are furious about the deal, largely because of a phenomenon called factor price equalization. It’s the theory that if firms can freely move between countries, they will want to produce where factor costs (such as the cost of labor) are lowest. This exerts downward pressure on the wages of laborers in countries with strong labor standards as producers in those countries struggle to compete with low labor costs in countries with weak regulations. This downward pressure on wages could exacerbate income inequality in countries like the US.

US Income Inequality 


(Image: The Gini Coefficient of US Household Income, a popular measure of income inequality in which a higher number indicates higher levels of inequality, plotted against KOF’s annual economic globalization score – a higher number again means fewer trade barriers – since 1973. The Gini coefficient and KOF Index score have a 0.91 correlation, which statistically speaking is very high; 1 is considered a perfect correlation. Source: Chart compiled by Shane Murphy; Gini coefficient data from US Census Bureau)

There are other arguments against the TPP as well. Some groups object to what they view as an unnecessary focus on intellectual property rights, which if taken too far can stifle competition. Labor and environmental groups argue that the standards outlined in the agreement are too weak, or voluntary. Additionally, Congressional liberals such as Senator Elizabeth Warren (D-MA) have objected to the inclusion of an Investor State Dispute Settlement (ISDS) mechanism, which allows companies to sue countries directly, outside of their own court system. Warren and her contemporaries allege that this violates state sovereignty and would allow corporations to sue the US to weaken its labor and environmental standards.

What impact will the TPP have?

Ironically, probably not much. Tariffs between the US and the countries involved are already very low, so trade flows probably will not increase very much as a result of the deal, and relative labor costs will be minimally affected. Intellectual property rights are important, but will likely not have a major economic impact either way. Concerns about ISDS are arguably overblown. Even the Obama administration’s geopolitical arguments about China are not especially convincing.

So why has the agreement sparked such a heated debate? And why is the Obama administration devoting so much political capital towards passing an agreement its allies hate?

The best explanation is that the TPP is not important for what it is, but rather for what it represents. Arguably, the TPP is the Obama administration’s proposed template for future trade agreements – and that’s why it’s so important. If the provisions of the TPP constitute the outline the US indicates it’s willing to accept in trade agreements, then it will likely serve as the model for all future trade negotiations. The TPP is the Obama administration’s attempt to get free trade agreements “right” for the future.

In light of this understanding, it’s easier to comprehend the opposition. If the US is perceived as weak on labor or environmental standards, or supportive of ISDS and onerous intellectual property rights in the TPP, those same shortcomings are likely to be features of all major trade agreements going forward – potentially disastrous for groups concerned about these issues.

The Obama administration clearly thinks it has the right template; many progressives and trade groups disagree. There are compelling arguments for both sides, but there is one thing both are neglecting to focus on: the absence of restrictions on currency manipulation.

  Why is it important to include currency manipulation restrictions in the TPP?

First, recall central banks’ ability to manipulate currency from our monetary policy primer. To summarize: in the absence of controls or laws governing exchange rates, central banks can artificially devalue their currency relative to other currencies (for example the US dollar). When these currencies are devalued, countries’ exports become cheaper and imports become more expensive, encouraging domestic production at the expense of fair competition. And this idea is more than an abstraction. The reality is that ever since the abandonment of the Bretton Woods system of fixed exchange rates in 1971, some countries – especially in Asia and the South Pacific, where the TPP is primarily focused – have artificially devalued their currency relative to the dollar, and it is causing serious economic problems for the United States. One important country perpetually accused of currency manipulation is China.

(Image: China’s exports as a percentage of its total GDP, indexed to 1981=100, plotted along side the yuan/US dollar exchange rate, also indexed to 1981=100. The values are indexed so that they can both be plotted on the same graph. Notice how the yuan is massively devalued over the course of the 1980’s and 1990’s, losing nearly six times its exchange value relative to the dollar. This devaluation was likely of an artificial nature. Source: Federal Reserve Economic Data)

(Image: Another visualization of the same data above, this time plotting Chinese exports relative to GDP, again indexed to 1981=100, as a function of the exchange rate, which is not indexed on this graph. As one can see, the correlation between the two is extremely high. Source: Compiled by Shane Murphy, data from Federal Reserve Economic Data)

What economic consequences does currency devaluation have?

First, the United States’ net exports (exports produced by the US minus imports to the US from foreign countries) have cratered since the 1970’s.

(Image: United States net exports since 1960. Source: Federal Reserve Economic Data)

Net exports crashing is a bad sign for the economy as a whole. Economic health is usually measured by the total amount produced by an economy, such as Gross Domestic Product. When a good is exported, it contributes to GDP, but when an import is consumed in the United States, it does not contribute to GDP (because it’s not produced here). Additionally, think of opportunity cost: if a consumer buys an imported good, in many cases they are forgoing the purchase of a competing domestically produced good. This hampers production potential.

Currency devaluation also has other consequences, such as lowering factor costs in countries with devalued currencies. When workers in China are paid in yuan, and the yuan is devalued relative to the dollar, it is much less expensive to move workers to China and pay them in yuan.

(Image: US Manufacturing employment since 1960. A caveat: It is highly unlikely that all the employment losses were due to lower factor costs in other countries. Much manufacturing employment has been replaced by machines as well. Source: CreditWriteDowns.com)

And it’s not just China. Many countries engage in currency manipulation, including many of the countries in the TPP such as Malaysia and Singapore. That is why it is so crucial that the agreement provide some sort of framework for currency dispute settlement.

So why isn’t currency devaluation in the TPP?

It is important to begin with the caveat, of course, that the TPP is not yet finalized and we have not been privy to the internal negotiations that have produced it. However, there are probably two main reasons that currency rules are unlikely to make the final deal.

The first is that currency manipulation is a crucial tool for many of the countries involved in the deal – so much so that combating it may well be a dealbreaker. The Obama administration may have made the calculated decision not to include restrictions on manipulation in the service of the greater good: getting the deal passed.

The second is that the United States itself has been accused of being a currency manipulator. In the aftermath of the financial crisis, the Federal Reserve engaged in fairly aggressive monetary stimulus, largely in the form of quantitative easing. This stimulus – intentionally or not – almost certainly devalued the US dollar.

Was the Fed purposefully trying to artificially manipulate the dollar with quantitative easing? Perhaps, though the Fed’s efforts were likely primarily motivated by the need for monetary stimulus – currency devaluation was likely more of a (fortunate) side effect. However, the effects on the value of the dollar were and are hard to ignore. Thus, any agreement over currency manipulation may hamstring the Fed’s ability to conduct expansionary monetary policy. The Obama administration (justifiably so!) is probably highly unwilling to restrict the Fed’s policy autonomy.

What are the implications of the TPP ignoring currency manipulation?

Of course the United States should never accept a deal that severely hampers the independence and sovereignty of its own central bank, but that does not mean there is no possibility of restricting currency manipulation. Free trade agreements generally create a number of dispute settlement bodies, and there is no reason the TPP could not authorize the creation of an independent body of economists and financial experts who could evaluate claims of currency manipulation and render judgments in the form of sanctions or other economic consequences.

A crucial feature of such a policy would obviously be lenience in times of economic hardship. When a central bank determines that an economy requires monetary stimulus, it should be able to conduct that stimulus without interference from the entities enforcing the TPP. But when the central banks’ monetary actions are clearly intended primarily to artificially devalue currency, they should not be allowed to continue ad nauseum.

How would this policy take shape, exactly? It is impossible to say. Countries would have to negotiate, compromise, and iron out a complex system meant to deal with this problem. The Obama administration would have to expend significant negotiating capital and political pressure on the other countries who are part of the deal. The problem is that none of this is happening, and no side has shown a meaningful desire to change that.

The Obama administration’s negotiators and their contemporaries in the TPP governments are content to simply allow the harmful and economically dangerous status quo. This is especially disturbing when one considers the actual purpose of the TPP: to establish a blueprint for all future trade agreements. If currency manipulation is ignored now, it will likely be ignored in perpetuity.

That is an extraordinary shame.


Student Blog Disclaimer
  • The views expressed on the Student Blog are the author’s opinions and don’t necessarily represent the Wharton Public Policy Initiative’s strategies, recommendations, or opinions.


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