In a little noticed countervailing duty case involving Vietnamese tyres, the US Treasury may have set off tremors for the international monetary system, concluding for the first time that currency undervaluation potentially warrants a Commerce Department subsidy finding.
Given the administration pushed a rule to allow currency undervaluation CVDs, rejecting views held under Presidents George W. Bush and Barack Obama, Treasury’s decision is hardly surprising.
Its action raises nettlesome questions on three counts – the model, Vietnam’s circumstances, and international financial considerations. I have repeatedly raised concerns about the Treasury/Commerce action.
Model results reflect a range of assumptions. There is no precise way to measure undervaluation multilaterally and especially bilaterally. Treasury’s model, drawing on the International Monetary Fund’s external balance approach, reflects sophistication and merits praise.
But despite the model’s publication, transparency could be enhanced significantly. The model is multilaterally consistent. Since global current accounts in principle must add up to zero, one country’s norm impacts others. Current account norms are impacted by numerous variables – demographics, institutions and policies, among others (see chart below). In the IMF’s EBA, the US norm is pulled down 2% of GDP by the dollar’s reserve status. If the US norm were not impacted as much by the reserve variable, surplus nations’ norms could not be as large, making undervaluation findings more feasible.1
Treasury’s model deviates from the Fund’s reserve variable and introduces haven and other considerations. It appears the ‘reserve’ role attributed to others – Switzerland, Japan and probably Germany – increases, thus reducing the size of the dollar’s reserve role in the US current account norm relative to EBA. Unlike the IMF, Treasury assumes foreign exchange intervention by countries with open capital accounts generates a larger current account position.
Treasury may have solid intellectual grounds for so doing. But the effect of these assumptions perhaps biases the model toward finding undervaluation, at least relative to EBA. The impact of other variables isn’t shown. Hence, more transparency is needed and Treasury should provide its analogue to the Fund’s chart.
External balance assessment current account norm, 2018 (% of GDP)
I use the 2018 figure since the Fund hasn’t published the 2019 version. Unhelpfully, the chart combines oil market positions with reserve currency status. Regardless, the dollar’s reserve currency status pulls the US current account norm down roughly 2% of GDP.
The model raises difficult questions for Treasury’s semi-annual foreign exchange report – will Treasury be pressured to publish model results for major trading partners; will its discretion on finding ‘manipulation’ be constrained?
Interpretation should reflect Vietnamese considerations, while avoiding excess discretion. Vietnam’s current account bounces around – it was negative or flat relative to GDP between 2015-17; nearly 2% in 2018; it then jumped to 4% in 2019, which appears to be the chosen year for analysis. The IMF last projected a 2020 current account surplus under 1% of GDP; the Asian Development Bank foresees a flat outcome.
When analysts examine currency undervaluation, generally uppermost in their minds is that a country might be intervening to seek unfair trade and current account advantage. But currencies can be driven by capital accounts, not just current accounts. Vietnam receives large foreign direct investment inflows, swamping its current account surplus. It did intervene considerably in 2019, but its reserves to import ratio barely exceeded three months – a standard minimum adequacy measure. Building a minimal reserve buffer should not be equated with excess reserve accumulation.
Commerce will undoubtedly use Treasury’s work to slap the first ever currency CVD on a country. This will be problematic for the international monetary system.
When I first joined Treasury in the foreign exchange office, my supervisor regaled me with stories about former Federal Reserve Chair Paul Volcker. One was about Volcker saying that he didn’t know what the right exchange rate was, but he knew a wrong one when he saw it.
Emerging market currency swings are a well-known phenomenon. They can be amplified by reactions to global monetary policies, including Fed actions. It is unclear how such forces are accounted for.
Yet, Treasury provides a pinpoint 2019 equilibrium dong/dollar rate. This action suffers from the fallacy of false precision, especially given that a 4.5% deviation may not be that large considering the exercise’s uncertainties. Further, since it is now known Treasury can generate such data, it may be asked what is the ‘right’ exchange rate for the euro, renminbi or yen, unleashing more CVD cases. One only needs to think back to the active efforts by US-based automobile makers on the yen.
The 1930s saw a surge in beggar-thy-neighbour currency policies and trade protectionism. During and after the 2008 financial crisis, the G20 committed to refrain from competitive devaluations, not target exchange rates for competitive purposes and resist protectionism. The world now faces the potential for more currency CVD cases, copycat legislation and trade retaliation.
The US is fully justified in its vigilance against harmful currency practices. But currency undervaluation CVDs could ultimately harm multilateralism and the international monetary system. Treasury may rue the day.
Mark Sobel is US Chairman of OMFIF.
1 Assume there is a large deficit country with a negative norm. Assume also a surplus country with a 2% of GDP positive norm but an actual 5% surplus; the 3% gap would yield a given ‘undervaluation’. If the model is then refined and the deficit country norm is substantially reduced, that would lower the surplus country norm, let’s say to 1%. The gap would then be 4% of GDP and yield a larger ‘undervaluation’.