The Trans-Pacific Partnership will have three signatory nations (Japan, Malaysia, and Singapore) that are flagrant currency manipulators, yet that trade agreement completely fails to address the issue. In 2013 the United States had a current account deficit of $400 billion (U.S. Department of Commerce, 2015). Of that total, $183 billion of the deficit was with China (The World Bank). The current account is the difference between the goods and services that the U.S. imports and those that we export, plus the difference between investment income paid to people in the U.S. from foreign countries and that paid to people in other countries from the U.S., plus miscellaneous other transfers, such as taxes paid across the border. The deficit with China is most obviously manifested in all the manufactured products on American store shelves “Made in China.” In 2014, the trade deficit with China in goods (excluding the other elements of the current account), was $343 billion. The goods deficit with China has exceeded $200 billion since 2005 (U.S. Census Bureau).
Current account deficits and surpluses between nations are not supposed to be large or persistent.
If the U.S. imports more from Japan, for instance, than we export to Japan (to simplify to only that element of the current account), the Japanese exporters sell more dollars to buy yen (to pay workers, suppliers, creditors, taxes) than U.S. exporters sell yen to buy dollars. Because the value of dollars offered for sale exceeds the value of yen offered for sale the exchange can only occur by the value of the yen rising relative to the dollar (equalizing the value of the two volumes of currencies to be exchanged). Because the value of the yen rises, Japanese exports become more expensive to Americans, while American exports become cheaper to the Japanese. The value of imports and exports equalizes over time and the trade imbalance is erased.
Of course, demand for currency doesn’t result only from purchases of goods and services and the other transfers included in the current account. To a lesser degree, legitimate capital flows also produce buying and selling of currencies. If the Japanese buy movie studios and office buildings in the U.S. that will require selling yen and buying dollars, which, like purchasing American products, would reduce the value of the yen relative to the dollar. All of these private transactions involving goods, services, capital investments and payments of investment income are entirely legitimate. Currency manipulation is something else again.
In currency manipulation, the central bank of a nation creates money in its native currency and sells it to buy the currency of another nation, thereby driving down the value of its currency relative to the value of the other nation’s currency. China can maintain a $200 billion per year current account surplus with the U.S. year after year by creating and selling enough yuan to buy dollars keep the value of the yuan from rising relative to the dollar and thereby eliminating the surplus. By doing this, the Chinese, Japanese, and other currency manipulators provide manufacturing jobs for their citizens and render American manufacturing workers unemployed.
Is there any economic restraint to this predatory behavior? Not really. A central bank can create arbitrary amounts of its own nation’s currency and add it to the central bank’s account by typing an integer followed by lots of zeros on a keyboard. It can then spend the money any way it wishes. Of course, if the Chinese central bank creates and sells yuan for dollars that increases the supply of yuan, which will be spent in China. The resulting increase in money supply in China, a very large increase given the scale of Chinese currency manipulation, could cause inflation if the economy is operating at near capacity. In that case, the central bank can simply create bonds and sell them, thereby removing the excess money from the economy. This process of “sanitizing” the currency creation removes the economic restriction on the currency manipulation.
What are the consequences for the U.S. of the current account surplus with the U.S. that China maintains by currency manipulation? The $183 billion current account deficit with China is the equivalent of 3.7 million, $50,000/yr. U.S. manufacturing jobs. Of course it isn’t quite that simple. If Chinese currency manipulation stopped, some manufacturing would move to other low-wage countries. However, Scott (2/4/2015) reports that eliminating currency manipulation by 20 countries would reduce our trade deficit by $200 to $500 billion/yr. and create 2.3 to 5.8 million jobs in our country. We have totally lost many manufacturing industries to trade deficits caused by currency manipulation. In the high tech industries of the future we have lost not only manufacturing capacity, but manufacturing expertise. And since the design of a new product includes the manufacturing process and technology to produce it, the design advantage for things like electronics is shifting to East Asia.
Currency manipulation has been hollowing out American industry for a long time. The Japanese used it to gain a foothold in our auto and electronics industries, and South Korea and Taiwan followed the same export driven development strategy enabled by intensive currency manipulation. It’s useful to examine the financial magnitude of the practice.
TABLE 1 Foreign currency assets and reserves held by governments
Country Official foreign assets Foreign reserves Foreign reserves
($billion) as % of GDP in months of imports
China 4,065 37.5 23.13
Japan 1,239 25.2 14.53
South Korea 349 24.5 6.50
Malaysia 138 34.7 6.11
Thailand 162 40.2 6.78
Singapore 543 85.8 6.38
Hong Kong 311 107.8 6.42
Switzerland 498 71.2 21.95
United State 0.3 0.20
Canada 3.4 1.25
United Kingdom 2.8 1.15
Table 1 (statistics, generally for 2013, presented by Laffer from various sources) shows foreign assets held by the governments of selected countries in the first column, the foreign assets as a percentage of GDP in the second column, and the assets in months of imports in the third column. It is sometimes maintained that a nation can reasonable hold foreign assets equal to three months of import. Even that is unnecessary if a country has any reasonable level of political stability (generally true of the countries in Table 1), and if the country allows its currency to float, rather than manipulating its exchange rate. That is clear from the examples of the United States, Canada, and the United Kingdom, the only countries in Table 1 that do not manipulate their currencies to steal jobs from the citizens of their trading partners.
Foreign assets as a percentage of GDP indicates the magnitude and long-term nature of currency manipulation. At first glance it might seem that acquiring all those foreign T-bills, bonds, and sometimes common stocks as well, must be a financial burden for those countries, some of which are quite poor. But, recall that it actually costs them nothing. They simply create the currency out of nothing, exchange it for other currencies in order to drive down its value, then buy financial assets in the target currency. As an added bonus they collect investment income on the assets purchased. It is the perfect crime as long as it goes unpunished.
Gagnon (2013) estimated that a country’s current account balance increases between 60 and 100 cents for each dollar spent on foreign currency assets in that year (Scott, 2/4/2015). Given that this can be accomplished at no cost to the manipulator it is hard to resist the temptation to buy $1 billion of U.S. Treasury bonds to add $0.6 to $1.0 billion to the profits of Chinese firms and the wages of Chinese workers by taking the same amount from the bottom line of U.S. firms, and workers who end up unemployed.
Currency manipulators buy $1.5 trillion of foreign assets each year (Laffer) in order to keep their currencies artificially low and to take jobs from the countries they victimize. Fully 60% of those predatory purchases are in U.S. dollars (Laffer). They do it to us because we let them. To me, understanding why we allow this is rather akin to understanding why people believe in God, clearly an irrational thing.
In the case of the earlier, but still continuing, currency manipulation by Japan, South Korea and Taiwan, I suspect that the U.S. government was pursuing foreign policy goals, at the expense of American workers. The idea was to build up Japan, South Korea, Taiwan, and later Malaysia and Thailand, as a bulwark against the communism of the Soviet Union, North Korea, China and North Vietnam. It was easy. Our government achieved its foreign policy objective at the expense of millions of Americans by looking the other way in the face of flagrant currency manipulation. A quid pro quo eventually also emerged. Japan allowed us to use their country as a forward staging area for the Vietnam War, and even to fly B-52 missions from Okinawa, which the Japanese very conveniently allowed to remain under U.S. control until 1972. Korea sent a division of combat troops to Vietnam to fight alongside U.S. forces. And they were highly effective. The Viet Cong and North Vietnamese were afraid of the Koreans.
So why do we allow the Chinese to do the same thing to us? They are obviously our principle political adversary and must be regarded as our only serious military adversary, yet we allow them to build their economy (using their new wealth to fund a frightening military buildup) while destroying our technological and industrial base and depriving millions of Americans of good, high paying jobs. In this case the motivation is even more sinister and it lies in the profound corruption of our political system. The principal beneficiaries of Chinese currency manipulation are Chinese companies and workers, but quite a few large American companies have benefited by moving the manufacturing of products that they sell in the United States to China. They are picking up the crumbs that the Chinese leave on the table. These are the large companies than can afford to employ lobbyists and make large political contributions, both openly and secretly to PACs that can make or break a member of Congress. American workers and manufacturing companies that compete with Chinese companies are not the only victims of this. Large, often profoundly inefficient, backward companies with manufacturing in China can use the resulting low labor cost to compete successfully with small, new companies with better technology and products that cannot afford the very large fixed cost of setting up a manufacturing operation in China. So acquiescence in currency manipulation doesn’t just hurt American workers, it also makes our economy less efficient and less competitive.
Are things really as simple as I have portrayed them to be? Yes, but in the controversy surrounding the issue there are exaggerations that cloud the issue, and where there is corruption there are also lies. I will first address the exaggerations, then the lies. There are 22 countries (Scott, 5/12/2015) that have been identified as currency manipulators (China, Hong Kong, Japan, South Korea, Malaysia, Singapore, Taiwan, Thailand, Algeria, Angola, Azerbaijan, Kazakhstan, Kuwait, Libya, Norway, Qatar, Russia, Saudi Arabia, United Arab Emirates, Denmark, Israel, Switzerland). Many of them deserve the label, but some do not. Governments such as those of Kuwait, the United Arab Emirates, and Norway have oil income that far exceeds what could be spent on current expenditures. It would be lunacy to buy enough imports to balance their oil exports. It would also be impossible to find enough productive investments in those small nations to put the revenues to productive use. So, their sovereign wealth funds make large foreign portfolio investments in order to maximize returns and provide income for their people when the oil runs out. Those investments certainly depress the value of their currencies, but I think it inappropriate to term the actions of those governments currency manipulation. And, they are not printing money to buy dollars, they are investing royalties. Their non-oil exports to the U.S. are, in any case, infinitesimal.
Then there are the lies about currency manipulation, told by those who have been bought off, and often repeated by the ignorant. The first lies suggest that our current account deficit is our fault. This is based on an accounting identity in the calculation of GDP that arises from the obvious observation that people don’t put large sums of money under their mattresses; they invest it. So, if the U.S. has a $400 billion dollar current account deficit that means that $400 billion more dollars left our country in payments for goods, services, etc. than entered. Those foreigners who are in receipt of that excess of dollars invest them in dollar-denominated financial assets, which then represent a capital flow into the U.S.
The accounting identity states that the current account deficit is the difference between investment in the U.S. and savings in the U.S. (money saved is invested by Americans, just as the excess dollars of the current account deficit are invested in dollar denominated securities). The resulting, completely fatuous claim is that the current account deficit and the trade deficit that is the principal part of it, occur because Americans don’t save enough. The assertion is that our lack of thrift causes the current account deficit. Consider the truth. China, Japan, and other nations, create money, use it to buy dollars, driving down the value of their currencies, then they buy assets (mostly Treasury obligations) with the dollars. With every dollar they add one dollar to the difference between “investment” in the U.S. and U.S. savings. Would the current account deficit go away if Americans saved more? Of course not. The Chinese, Japanese and other miscreants would still be buying dollars and “investing” them in Treasury obligations. The current account deficit caused by currency manipulation would not diminish at all.
Another nonsensical claim, which is an aggravated elaboration of the above, is that we run a current account deficit with China because the virtuous Chinese have a very high savings rate and we profligate Americans have a very low savings rate. Let me first address the invidious value judgment in that assertion. The current, very high savings rate in China is the result of rapidly rising income in China. Sensible people don’t immediately raise their standard of living to match an increase in income, they save, so China has a high savings rate. Ordinary Americans, those who work in factories, as secretaries, or construction workers, have lower real income now than they had four decades ago. They fail to save money because they are struggling to provide their children, and sometimes even their grandchildren, with the advantages their parents were able to give them. Savings rates have nothing to do with current account deficits. Chinese currency manipulation does not involve thrifty Chinese citizens buying U.S. Treasury obligations or U.S. common stocks with their savings. Indeed, the heavy-handed capital restrictions of the Chinese government make it very difficult for Chinese citizens to invest money outside China. Currency manipulations in China and elsewhere, and the resulting current account imbalances, are central government stratagems that are completely independent of the savings rate here, there, or anywhere.
Another bit of disingenuous nonsense is that we need the Chinese to buy T-bills and Treasury bonds to finance our federal budget deficit. What would happen if the Chinese stopped buying U.S. federal debt? Other than appreciation of the Chinese currency relative to the U.S. dollar with a short-term increase in the cost of imports and massive long-term job creation in the U.S., nothing would happen. Any shortfall in demand for U.S. Treasury securities would be met by purchases by the Federal Reserve. Like other central banks, the Fed creates money at will and spends it as seems desirable. During the recent severe recession the Fed bought trillions of dollars worth of various Treasuries, and other securities as well.
What can be done? First, the congressional corruption that allows a handful of large US. Corporations to benefit at the expense of millions of American workers must be overcome. Where there is no will to do good, no good will be done. An amendment was proposed in the Senate to the recently passed Fast Track legislation requiring that currency manipulation be forbidden in trade treaties. The corrupt, corporatist Obama administration and its corrupt, corporatist allies in Congress easily defeated the amendment. Institutionally, currency manipulation is tacitly accepted. Although it is the most destruction remaining barrier to beneficial free trade, the WTO (World Trade Organization) chooses to ignore this new mercantilism, although it officially forbids it. On matters of currency manipulation it defers to the IMF (International Monetary Fund). The IMF has standards for identifying currency manipulation, and also forbids it, but it has absolutely no enforcement powers. It can inform a country that it has found it to be a currency manipulator and ask it to stop, but the perpetrator can just say, no thanks.
In the U.S., the Omnibus Foreign Trade and Competitiveness Act of 1988 requires the Treasury Secretary to make semiannual reports on economic and exchange rate policies. Under this authority, Taiwan, South Korea, and China were cited, but with no apparent long-term effect. When the U.S. joined the WTO in 1994 we lost our effective tools for enforcement actions against currency manipulators, and no nations have been cited by the Treasury Secretary since that year. In this environment of flagrant violations of fair trade that have cost the jobs of millions of Americans, Congress should act. Crippling tariffs should be imposed on nations that manipulate the exchange rate with the dollar, in defiance of the WTO, if necessary. Would that precipitate a trade war with China? Does it matter? China could accede to our reasonable demand that it quit buying dollars and effectively float its currency with respect to the dollar. That would quickly eliminate their current account surplus with the U.S., and manufacturing jobs would move back to the U.S. Or, they could refuse, triggering our tariffs and respond with tariffs of their own. The Chinese trade surplus would be eliminated and manufacturing jobs would move back to the U.S. Either way we win and their predatory trade practice ends.
REFERENCES
U.S. Department of Commerce, 2015. News Release: U.S. International Transactions. U.S. Department of Commerce. Bureau of Economic Analysis. http://www.bea.gov/...
The World Bank. Current account balance (BoP, current US$) http://data.worldbank.org/...
U.S. Census Bureau. U.S. Trade in Goods by Country. U.S. Census Bureau. https://www.census.gov/...
Laffer, Arthur B., Currency Manipulation and its Distortion of Free Trade. The Laffer Center, Pacific Research Institute. http://www.laffercenter.com/...
Gagnon, Joseph E. 2013. The Elephant Hiding in the Room: Currency Intervention and Trade Balances. Peterson Institute for International, Economics Working Paper 13-2. http://piie.com/...
Scott, Robert E., 2/4/2015. Currency Manipulation and the 896,000 U.S. Jobs Lost Due to the U.S.-Japan Trade Deficit. Economic Policy Institute. http://www.epi.org/...
Scott, Robert E., 5/12/2015. Stop Currency Manipulation in the T4rans-Pacific Partnership. Economic Policy Institute. http://www.epi.org/...