While the information and opinions contained within have
been compiled from sources believed to be reliable, KWR
does not represent that it is accurate or complete and
it should be relied on as such. Accordingly, nothing
in this article shall be construed as offering a guarantee
of the accuracy or completeness of the information contained
herein, or as an offer or solicitation with respect to
the purchase or sale of any security. All opinions and
estimates are subject to change without notice. KWR staff,
consultants and contributors to the KWR International
Advisor may at any time have a long or short position
in any security or option mentioned.
[ Approach ][ Capabilities ][ Staff ][ Clients ][ Press ][ Library ][ Contact ]
"FIXING" CURRENCY MISALIGNMENT: WOULD THE CURE BE WORSE THAN THE SICKNESS?
Russell L. Smith, Willkie Farr & Gallagher LLP
WASHINGTON, DC (KWR) August 20, 2007 --Exchange rate "manipulation" and "misalignment" have been much in the news and much on the minds of many Members of the United States Congress of late. This preoccupation with exchange rates, and even more so the drive to "do something" about them raises some complicated questions.
The primary focus on exchange rate activity is China. China continues to maintain its currency peg, albeit now based on a basket of foreign currencies and adjustable by the Bank of China within a more flexible band. China is the object of strong criticism for substantially undervaluing the "yuan" as an export subsidy, thereby maintaining a low-cost advantage and taking away business not only from U.S. competitors but also from other potential exporters whose currencies freely float against U.S. dollar. In the U.S., this has been reflected in efforts to base claims under the countervailing duty ("CVD") laws on exchange rate manipulation. So far, the U.S. Commerce Department, while accepting CVD cases alleging Chinese export subsidies, has refused to validate exchange rate differentials as a basis for assessing such duties. Similarly, the reluctance of the U.S. Treasury Department officially to label China as a "currency manipulator" has been widely reported and been the object of much frustration among Democrats and Republicans in Congress.
In response to all of these China-based concerns, key Members of Congress have acted. Sen. Max Baucus (D-Montana), the Chairman of the Senate Finance Committee, and Sen. Charles Grassley (R-Iowa), the senior Republican member of the Finance Committee, have joined Sens. Charles Schumer (D-New York) and Lindsey Graham (R-South Carolina) in introducing a bill that would require the identification of countries involved in "currency misalignment," under very vague and open-ended criteria, and especially those that are considered "priority" countries. The Senate Finance Committee recently approved this bill. Priority countries would be singled out for various potential remedies, including denial of certain U.S.-based assistance and especially recalculation of duties in antidumping cases that may be pending to reflect the U.S.-determined undervaluation of currency. Presidential candidates Sen. Hillary Clinton (D-New York) and Barack Obama (D-Illinois) are supporting the Baucus-Grassley bill.
Legislation introduced by Senate Banking Committee Chairman Christopher Dodd (D-Connecticut) and senior Banking Committee Republican Sen. Richard Shelby (R-Alabama) would not go so far as the Baucus-Grassley bill, but would basically require the filing of a WTO case against any country identified that has a misaligned currency, and that has not taken action to "correct" that imbalance. The Senate Banking Committee has approved this bill. Dodd and Shelby have also signaled their willingness to add a provision to their bill that would designate currency misalignment as a basis for a CVD claim.
In the House of Representatives, Rep. Sander Levin (D-Michigan) is preparing to consider legislation that could incorporate a number of these remedies. Levin has said he will base his legislation on bills already introduced by Reps. Timothy Ryan (D-Ohio) and Duncan Hunter (R-California). The latest Ryan-Hunter bill introduced in early July would provide for adjustments in both antidumping and CVD proceedings for "misaligned" currencies.
All of this legislation is premised on the idea that currency misalignment is an adverse condition when it results in a strong dollar and a weak foreign currency. Therefore, action must be taken to "level the playing field" through forced "re-alignment" or trade remedies that will make imports more expensive at levels that correspond to the perceived misalignment. There are a number of obvious problems with such reasoning. First, it substitutes government-dictated judgments as to what constitutes "misalignment" and to what degree it has occurred for normal market forces. Second, it assumes that such a condition is always adverse to the interests of the United States, which is not necessarily the case, particularly given the huge U.S. investment in manufacturing inputs and finished goods in China. Third, it lays the entire blame for misalignment on the foreign country, which most economists would argue fails to recognize factors in the U.S. economy that may also play a role, particularly low U.S. savings rates and continuing government deficit spending that results in large amounts of U.S. government debt available for overseas investors.
Moreover, no thought seems to have been given to the actual consequences of this legislation. What would happen in China, in Asia, and globally, if China suddenly revalued its currency by, for example, 20 percent? Even if such a drastic revaluation took place over the course of a single year, the impact on Chinese businesses and banks, many of which are not financially sound by Western standards, would be devastating. How would other economies in Asia, including Australia and Japan, be impacted, given their very large trade flows with China? What would happen to U.S. consumer prices, given the enormous range of consumer goods that are now imported from China? How would U.S. industries operating on thin margins and trying to keep their production costs low by importing inputs from China be able to cope with such a development? Absent detailed economic analysis of such questions, but simply working with basic principles of monetary policy and history, one could safely speculate that the outcome would be chaotic.
Finally, for all the anti-Chinese rhetoric surrounding them, it is significantly noteworthy that these bills are not China-specific (nor would WTO-rules permit them to be). By making the bills generally applicable, their authors have opened the door to serious potential mischief. One well-publicized example is Japan. The Japanese yen, unlike the Chinese yuan, floats freely against the dollar and the euro. The Bank of Japan has not intervened in currency markets in three and a half years. Most economists who have studied the situation have concluded that interrelated macroeconomic factors in the Japanese economy (exiting deflation, low interest rates and a number of weak business sectors among them) have resulted in the current position of the yen against the dollar and the euro. At the most basic level, this raises the question as to whether these currencies are or are not in truth "misaligned" or simply reflective of the economic conditions in each country.
More significantly, only one U.S. industry, the auto industry, is complaining about the yen. Yet if any of the currency legislation now pending in the U.S. Congress became law, this single industry would be free to demand of the U.S. government a variety of assistance to force the yen to be re-valued to the unique advantage of that industry. The legislation would permit, and even encourage such classic economic "rent-seeking," again to the potential detriment of both economies and consumers in the United States.
It is helpful that each of the major bills now being considered by the U.S. Congress raises serious questions of WTO consistency. However, as most in the trade community well understand, WTO members including the United States have shown no reservations about implementing measures that the WTO, after years of dispute resolution processes, has declared to be rules violations. With no recourse for any costs or damages suffered from such violations, the claim of WTO inconsistency provides cold comfort.
It can only be hoped that if there can be thoughtful debate and consideration of these currency initiatives, cooler heads will prevail, and those with concerns will turn to both bilateral efforts and initiatives within the International Monetary Fund to address perceived currency imbalances.