Trade protectionism masquerading as currency policy is harmful

Mark Sobel is US chair of OMFIF and former deputy assistant secretary for International Monetary and Financial Policy at the US Treasury.

Team Trump wants a weaker dollar. But it seems confused on how to get it. Tariffs and expansionary fiscal policy are a recipe for a stronger, not weaker, dollar. 

Nor is both demanding a dollar devaluation and threatening taxes on countries shunning dollars a way to fulfil the Republican promise to protect the dollar’s global dominance. It would jack up US government borrowing costs and undermine the use of the dollar as a lever for financial sanctions. It flies in the face of the old dictum — you can’t devalue your way to prosperity. 

Calls for an “Mar-a-Lago Accord” also seem chimerical. The 1985 Plaza Accord traded US fiscal consolidation for other countries boosting domestic demand, not only actions to weaken the dollar. Today, US fiscal policy is heading in the wrong direction; major central banks are independent and target inflation; and other countries can’t readily boost domestic demand given their own fiscal woes.

However, the dollar pundit class seems to have forgotten that there’s another Trumpian way to skin the cat if tariffs and “devaluation” are infeasible or don’t get the job done — resurrecting countervailing duties (CVDs) for currency undervaluation. 

CVDs are typically punitive tariffs slapped on subsidised, artificially cheap foreign goods that are harming US industry, but they can also be deployed for “indirect” subsidies, as spelled out by the Tariff Act of 1930 (often better known as the Smoot-Hawley Act)

If—

(1) the administering authority determines that the government of a country or any public entity within the territory of a country is providing, directly or indirectly, a countervailable subsidy with respect to the manufacture, production, or export of a class or kind of merchandise imported, or sold (or likely to be sold) for importation, into the United States, and

(2) in the case of merchandise imported from a Subsidies Agreement country, the Commission determines that—

(A) an industry in the United States—

(i) is materially injured, or

(ii) is threatened with material injury, or

(B) the establishment of an industry in the United States is materially retarded, by reason of imports of that merchandise or by reason of sales (or the likelihood of sales) of that merchandise for importation,

then there shall be imposed upon such merchandise a countervailing duty, in addition to any other duty imposed, equal to the amount of the net countervailable subsidy.

CVDs are undoubtedly on the minds of Trump’s emerging trade team. The measure was introduced by Team Trump 1.0 in late 2020 to punish Vietnamese tire production, but too late to hit China as the administration was fading away into the sunset. They have now already been internally mooted in the new Trump team taking shape.

Unfortunately, they are dumb tool that should be strongly resisted. Why are currency undervaluation CVDs so dangerous and wrong-headed? Let us count the ways.

There’s no accepted, precise or scientific way to measure currency undervaluation

To gauge undervaluation, you first have to estimate an equilibrium exchange rate and then deviations from it. To do so, you have to make some heroic assumptions, which can wildly skew the results. 

Typically, economists use estimates of a current account norm expressed as a percentage of that country’s GDP. And to the extent actual current account positions deviate from the norm, they gauge the amount of currency movement needed to get back to equilibrium. 

To calculate the norm, economists look at underlying saving and investment trends, which then get into estimates of the impact of demographic, net foreign asset positions, desirable fiscal and other policies etc. But, for example, what would a “desirable” US fiscal policy be, according to the Trump team’s inputs? Should the US current account norm be in deficit, as is the case in IMF estimates, or would Team Trump set it at balance? 

Such guesstimates look at a currency’s trade-weighted misalignment. Under currency CVDs, however, one must devise a bilateral exchange rate misalignment. That adds layers of improbable assumptions and complexity.

For example, a renminbi undervaluation estimate might rest on an assumption of what the proper US bilateral trade deficit with China should be. But should it be zero, $100bn, $200bn?

The idea that a hardly-unbiased US government would claim to know – let alone with precision – how far off a currency is from the “right” exchange rate smacks of arrogance and folly.

Exchange rates reflect macroeconomic developments — forces much broader than trade flows

Exchange rates are determined by the entire gamut of financial flows through the balance of payments, not only trade or current account flows. In fact, gross capital flows responding to shifts in interest differentials and central bank monetary policies and other macroeconomic policies swamp current account flows.

Think back to the early 1980s, when the Reagan administration cut taxes and increased military spending, stoking the economy at the same time as Paul Volcker’s Fed was sharply tightening monetary policy to wring inflation out of the economy. The result was predictable — traders bought dollars like crazy, generating huge protectionist pressure.

The dollar was the messenger, not the cause, but sometimes the messenger gets shot.

Undervaluation may just be the flip side of dollar strength

Under Trump 1.0, fiscal expansion and tariffs pushed the dollar higher. Under the Biden Administration, fiscal expansion and Fed tightening pushed the dollar even higher. In other words, in recent years the dollar’s strength has first and foremost been a dollar story.

Yes, other countries often haven’t performed as well as the US, but that doesn’t change the fact that dollar strength has been mainly made in the USA and the dollar is almost across-the-board viewed as overvalued.

Imagine a two-country/currency world — the US and Ruritania. The US implements unbalanced policies which cause the dollar to become overvalued. If the dollar is overvalued, then Ruritania’s currency must by definition be undervalued. A currency CVD would hit Ruritania for no fault of its own. It certainly won’t fix the US imbalance.

The who and how of administering currency CVDs

The Treasury is responsible for US foreign exchange policy. But exchange rates are heavily influenced by monetary policy and the Fed. In practice, Treasury and the Fed therefore work hand-in-hand on FX policy.   

The Commerce Department administers CVDs, but it has zero mandate and expertise on foreign exchange and monetary policy. Under the first Trump administration’s currency CVD proposals, Commerce was to work with the Treasury Department in gauging undervaluation, but it could then adjust as it saw fit.

Handing a chunk of foreign exchange policy to Commerce — a department often seen as unquestioningly parroting the interests of US industry — makes no sense. 

Currency CVDs are likely WTO-inconsistent (not that Team Trump would care)

Under the WTO, subsidies should be seen as specific and providing a direct financial contribution. Many trade lawyers have come to the conclusion that it is doubtful that exchange rates, which apply economy-wide, meet those standards.

Of course, Team Trump might not care a jot what the WTO thinks about this issue. But other countries around the world do, and could use it to justify their own retaliatory measures.

It’s true that the world has for too long relied on US economic resilience. Other countries have pursued export-led growth strategies and even harmful currency practices, taking advantage of strong US domestic demand. That needs to be rectified.

But let’s be clear — injecting protectionist trade practices into foreign exchange market developments, blaming others for Americas unbalanced macroeconomic policies, and resurrecting the spectre of beggar-thy-neighbour currency feuds is a recipe for harming the international monetary system and economic damage. Other countries surely will not sit by idly. 

Trump 2.0 might still resurrect the bad idea of currency undervaluation CVDs. Any self-respecting Treasury secretary should fight such proposals tooth and nail.