Sunday, January 19, 2014

Currency Manipulation

When you read literature on free trade, you are bound to come upon the topic of currency manipulation. Like with many other topics in economics, you have fairly respectable economists with different views on the topic. There are ardent free marketers who believe that the price is always right, i.e, the exchange rate of a currency is exactly what it should be, irrespective of the trade surplus or deficit of that country. Among the people mentioned in the links listed below, Don Boudreaux and Russ Roberts are good examples of those who think this way. In this podcast on EconTalk, Russ Roberts raises, what seems to me, a good point: How do you decide that a currency is over or undervalued? It seems equivalent to the question of whether a stock is over or under priced.

Then, there are people with a greater interest in labor issues, especially in the manufacturing industry. It is in these industries that workers have felt most strongly the whiplash of globalization. Job losses in better-paid, skilled manufacturing jobs in the US are well-documented. The source for these job losses is tougher to identify. It must be a combination of globalization, technology, free trade, and...currency manipulation. Depending on your perspective, you tend to apportion different percentages to these factors. There was a  coalition, known as the China Currency Coalition, which was active during the Bush years (2005) and blamed the currency manipulation for a big portion of the trade deficit. I'm not sure what it says about the issue that the coalition seems to be defunct now. (There were some good points made by Peter Morici, Professor of Business at University of Maryland, about how the trade deficit and China's policies were supporting the housing bubble in US. Remember, this is a press conference from 2005). Especially with China, there is the whole issue of geo-politics and a clash-of-ideas - their version of capitalism vs ours. Peter Morici fears that by not branding China a currency manipulator, and allowing them to dictate trade on their terms, they are exporting their version of capitalism to many parts of the world.

Anyway, here is a list of articles that I found interesting. Big disclaimer: I did not read all of them in entirety. My goal is to get a reasonable understanding of this topic, not to do FX trading tomorrow!
  1. Brian Palmer explains currency manipulation: If Currency Manipulation Is So Great for Exports, Why Don’t We Do It? 
  2. Fred Bergsten in Financial Times: Our chance to slash the high costs of currency manipulation 
  3. Don Boudreaux and Russ Roberts at EconTalk: China, Currency Manipulation, and Trade Deficits (audio)
  4. Simon Johnson at Economix blog: Preventing Currency Manipulation 
  5. Jerry Jasinowski at HuffPost: The Debilitating Currency War 
  6. Gilbert Kaplan at HuffPost: The Anti-Manufacturing Forces in Washington 
  7. Scott Paul at HuffPost: While Treasury Sleeps, Congress Stirs on China's Currency  
  8. China Currency Coalition press conference: Chinese Currency Control 
  9. Alan Tonelson at The Case for Coddling Currency Manipulation CollapsesWhy Obama Must Deal with Currency Manipulation in his Trans-Pacific Partnership

On most topics in economics, in which my expertise hovers imperceptibly above zero, I find it difficult to figure out what is reasonable and closer to truth. You cannot take ardent free marketers at their word if they try to preach their belief that currency manipulation is of no consequence, or that it is in fact good for us (non manipulators). On the other hand, when people with an interest in labor issues bring up this issue, it almost takes on shades of protectionism. So, it helps when economists from think-tanks that usually trumpet the virtues of free trade actually highlight this issue as a problem. In this case, I am referring in particular to Fred Bergsten and Joseph Gagnon from Peterson Institute for International Economics, which by no means can be accused of having anything but free trade  running through their veins. Essentially, they highlight in a report that currency manipulation has been a problem and continues to be one, though not as bad as a few years ago. However, Joe Gagnon cautions that it could become worse in the future, if no steps are taken to stem it. Finally, a few excerpts from Joseph Gagnon and Fred Bergsten's lengthy report on
By finally redressing the imbalance between deficit and surplus countries and forging effective linkages between monetary and trade policy, after almost 70 years of failure to do so, they could lead to the most fundamental changes in the international monetary system since the widespread adoption of flexible exchange rates in the 1970s.

Fortunately, such prioritization is justified by the very high costs of the status quo and the very high payoff from effective promulgation of the proposed strategy.

In particular, is it ready to take the risk that the manipulating countries that hold large dollar reserves, especially China but several of the other target countries as well, would respond by selling dollars, i.e., can the United States afford to take on its banker(s)?

Is it ready to acknowledge more broadly that the reserve currency role of the dollar is no longer an unmitigated blessing, and perhaps has even become a net cost for the United States

The budget deficit will obviously have to be trimmed substantially over the coming years, hopefully at a pace that will avoid throwing the economy into one or more recessions. The new Dodd-Frank regulations on financial institutions will need to be enforced aggressively and comprehensively.

The United States must also accept that, even if it is successful in attracting a number of allies to its cause, it will be the inevitable and essential leader of the effort. Hence it could jeopardize some of its other economic policy goals, and indeed broader foreign policy goals, vis-à-vis several key global players. For example, the United States will continue to seek help from China on other key economic issues, such as trade negotiations and climate change, as well as central foreign policy issues such as North Korea and Iran.....(Such) have led to US hesitation in recent years to confront China over the currency issue and especially to label it a manipulator.

The point here is simply that the United States (and its allies) should not be reluctant to push for substantial currency realignments that would produce an implied further depreciation of the dollar. From the standpoint of the global role of the currency, it would in fact be far superior to do so by insisting on an end to currency manipulation that produced artificially undervalued currencies, and thus an artificially overvalued dollar, than by overtly pushing the dollar down through explicit actions by the United States itself.
By the way, China is not the only currency manipulator. There are many others but they don't appear as major threats because they are not as big in size. According to Bergsten and Gagnon, China, Denmark, Hong Kong, Korea, Malaysia, Singapore, Switzerland, and Taiwan are the eight most egregious manipulators. Some others would add Japan to the list too. Many would also say that Japan and Korea manipulate their currencies in response to China.

Anyway, good luck in trying to make more sense of it. My basic questions still remain unanswered: (1) If currency manipulation were eliminated, how would it alter the trade deficit? (2) How will the unemployment situation in the US, and other countries, be affected by elimination of currency manipulation, (3) What will the effect on China and other currency manipulator nations be? Actually, I am so illiterate on this topic, I dont even know how to formulate my questions!

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