Forbes Opinion: Currency Manipulation And Its Impact On Free Trade


As my good friend James Carville is apt to remind, “It’s the economy, stupid!” Leaders of the new Republican majority should heed that advice at every turn as they craft their agenda for the next session of Congress.

[Reposted from Forbes Opinion online  |  Art Laffer  |  January 20, 2015]

A prosperous economy is created by good economic policy—and then getting out of the way to let America’s companies and citizens work, produce and invest. The perfect pro-growth agenda includes: a low rate flat tax, spending restraint, sound money, minimal regulation, and free trade. While there isn’t much agreement between Republicans and Democrats on these policies today, the two parties should still work together where they can. One such area would be to give President Obama trade promotion authority in order to complete the negotiation and passage of the Trans-Pacific Partnership and the Transatlantic Trade and Investment Partnership, free trade agreements with most of the nations around the Pacific Ocean and the European Union, respectively.

Gains from trade come from our differences, not our similarities

Just as Minnesota is better off engaging in trade with Hawaii to bring bananas to its citizens, rather than building elaborate greenhouses on the frozen tundra, the same is true of trade between countries. The gains from trade come from our differences, not our similarities; and the greater the differences, the larger the potential gains. When a trading country is no longer constrained to making products and services to only match domestic demand, both consumers and producers win.

This is an idea that goes back to Adam Smith, one of the earliest advocates for free and unrestricted trade. As such, Smith was an ardent foe of mercantilism, a system under which the goal of a state was to stockpile gold by exporting as many goods as possible and importing as little as possible. Smith argued that such a policy deprived citizens of benefiting from the skills and abilities found in other nations. Instead, all nations benefit from free and open, not managed, trade.

The benefits of free trade have become a core, basic tenet of every Econ 1 course across the globe. Foreigners make some things better than we do, and we make some things better than they do—we would both be foolish to avoid taking advantage of those different capabilities and the resultant gains.

Currency manipulation used for trade advantage

Smith’s core beliefs remain true, but the complexity of today’s interconnected global markets sometimes creates challenges for supporters of his market-based approach. International commerce has evolved significantly since Smith made his discoveries over two centuries ago, but his understandings of how mercantilist practices used by nation states distort free market principles remain relevant. Today, currency manipulation is a potent tool of mercantilists, tempting nations to increase their trade balances and export domestic unemployment to the countries that are not devaluing, a “beggar-thy-neighbor” approach to international economics.

The negative impacts are well documented: The Peterson Institute for International Economics has found that more than 20 nations have utilized currency manipulation policies that keep “the currencies of the interveners substantially undervalued, thus boosting their international competitiveness and trade surpluses.” The effects aren’t insignificant—especially for the U.S. Peterson Institute experts estimate that “the United States has lost 1 million to 5 million jobs due to currency manipulation.”

Japan is one of the biggest interventionists

Surprisingly, given our close strategic ties, one of the biggest interventionists on the global stage is Japan. Experts have understood for decades that Japan intervenes in currency markets to devalue the yen and boost exports. But in recent years, they have only become more aggressive. According to a Wall Street Journal report, the Bank of Japan’s data shows that when adjusted for inflation and the weight of Japanese trade, the yen’s rate is now the lowest since 1982.

Some will argue that Japan’s monetary policy merely mimics the quantitative easing program that recently ended in the U.S. However, there are significant differences between the two programs. First, the Japanese have refused to restructure their economy or utilize any fiscal policies that actually stimulate their economy. Second, the Japanese quantitative easing is massive when compared to the U.S. It is nearly four times as large relative to the size of their economy and thus a far larger expansion of their monetary base. It has led to an enormous devaluation of the yen, designed to provide Japan with a trade advantage at the expense of the U.S. and other trading partners who then suffer higher unemployment rates and slower growth.

A three-part test to address currency manipulation in future trade agreements

Global institutions understand that currency manipulation is a relic of the 20th century and needs to end. Both the World Trade Organization and International Monetary Foundation have supported bans on nations using such policies in order to gain a trade advantage, but their guidance is vague and has never been effectively enforced. The IMF has published what it sees as indicators of manipulation that demonstrate when a country is not keeping its commitments. Using those indicators, others have proposed a three-part test that would be an effective way to address currency manipulation in future free trade agreements. The test asks:

  • Did the nation have a current account surplus over the six-month period in question?
  • Did it add to its foreign exchange reserves over that same six-month period?
  • Are its foreign exchange reserves more than sufficient (i.e., greater than three months normal imports)?

By including this test in future trade agreements such as the Trans-Pacific Partnership and the Transatlantic Trade and Investment Partnership, global leaders can adopt trade norms that lead to an even playing field for all member nations, and compel the IMF and WTO to adopt similar practices.

Since the days of Adam Smith, when European nations tried to undermine each other’s economies, mercantilist practices like currency have been all too common. As we begin a new session of Congress and our leaders strive to work together to promote wide-spread economic prosperity, such policies must become history.

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