The US Treasury Department has just named Switzerland and Vietnam currency manipulators. While its latest foreign exchange report (FXR) includes valuable analysis about responses to Covid-19, its mechanistic application of ‘enhanced analysis’ criteria leads to missteps in assessing harmful currency practices. The Yellen Treasury should modify this approach.
Under the Bush and Obama administrations, FXRs didn’t label any country a currency manipulator, even as China ran massive surpluses and foreign exchange interventions. Treasury secretaries negotiated fiercely with China but felt a designation might set back behind-the-scenes efforts that were helping pressure the renminbi higher. This changed though when Congress, frustrated by the lack of designations, constrained the FXR, basing it on ‘enhanced analysis’ criteria: a country’s bilateral balance with America, global current account/gross domestic product and intervention.
Switzerland and Vietnam met these three criteria. Others, including China, who only met one or two were placed on a monitoring list. The mechanism for carrying out this analysis results, however, in somewhat off target conclusions.
Switzerland is a difficult case, clearly breaching all three principles. Yet, the franc is a haven currency in a European sea of instability. Switzerland is a small, open economy and currency appreciation can reinforce deflation. It has highly negative interest rates, a small domestic capital market due to low government debt and does not sterilise its foreign exchange operations.
The FXR struggles with these realities. It ultimately argues for more ‘domestic’ quantitative easing and fiscal stimulus, though Switzerland has already provided Covid-19 support worth 11% of its GDP. The FXR could have better discussed the debate surrounding the franc’s valuation. Switzerland is designated for preventing effective balance of payments adjustment, but not for seeking competitive trade advantage. Mitigating circumstances could well argue against designation. But it appears the Treasury decided three strikes and you’re out. Perhaps for evenhandedness with Vietnam?
The administration’s focus on Vietnamese currency practices over the past year is shown by the Department of Commerce launching countervailing duties on tyres and the rushed US trade representative’s section 301 currency undervaluation investigation.
When economists suspect currency manipulation, they look at whether a country has a large current account surplus and intervenes to keep its currency undervalued. The Treasury’s current account surplus threshold was 3% of GDP, but the Trump administration cut that to 2%. Vietnam’s surplus was virtually flat through 2017, but well exceeded the threshold in 2019. However, it’s estimated to be under 2% for 2020. The FXR acknowledges Vietnam’s trade surplus is inflated by Chinese goods passing through the country and the relocation of foreign enterprises out of China into Vietnam. While reserve growth is significant, reserves have gone above some thresholds only in the last year.
The Treasury is right to encourage greater dong appreciation. But apart from Vietnam tripping the three criteria, it may have felt compelled to designate it because of broader administration pressures reflected in the CVD and currency undervaluation cases.
The chart below shows that apart from Switzerland, the persistent standouts are Taiwan and Thailand, not Vietnam and China.
Thailand and Taiwan have long records of massive surpluses, intervention and opaque foreign exchange practices. Whether or not their intervention is below the thresholds right now, they have often exceeded them in the past. Taiwan, in particular, hid its interventions, as shown in outstanding work by Brad Setser of the Council on Foreign Relations. Their intervention and massive surpluses are persistent, multiples of Vietnam’s. Korean surpluses and intervention also are a longstanding matter. These countries are far bigger and more developed than Vietnam.
They warrant more scrutiny for harmful currency practices than Vietnam, yet the Treasury concentrates on the latter.
With Janet Yellen soon leading the Treasury, what FXR modifications might be useful?
- Administrations have struggled to properly balance quantitative and qualitative considerations. If the Bush and Obama Administration relied too heavily on qualitative judgments to avoid designations, one can argue that mechanistic reliance on enhanced analysis criteria ignores mitigating factors. The Treasury should better balance qualitative and quantitative analysis.
- Economists dismiss bilateral balances. If Japan produces no oil, should it worry about a deficit with Saudi Arabia? Yet, bilateral balances are weighted equally with other FXR criteria. The Treasury should down play the bilateral balance criteria, though this may be difficult given China’s surpluses.
- The Treasury should consider reverting to its prior 3% current account threshold.
- Currency movements do not occur in isolation. If US interest rates rise, if there is an imbalanced fiscal and policy mix due to tax and spending measures, if there is a risk-off event or if American threatens trade retaliation, the dollar tends to rise. That is not because others are undervaluing their currency. The FXR could acknowledge these realities and build them into currency assessments.
- There is reason to think that recent administration CVD and 301 actions on Vietnam have affected the Treasury’s handling of Vietnam. But foreign exchange movements are affected by macroeconomic policies and capital flows, not just trade. US current account deficits persist, despite the copious trade restrictions of recent years. The Treasury should exclusively control US foreign exchange policy.
- Finally, it should focus more on financial diplomacy and less on labelling.
Mark Sobel is US Chairman of OMFIF.