Treasury's Foreign Exchange Report: Another Missed Opportunity to Address Trade Imbalances

April 18, 2018

President Trump has made reducing the large US trade deficit a priority. However, he has delegated responsibility on this objective to officials who lack any useful tools to affect the trade balance. Meanwhile, the agency that has traditionally been responsible for trade imbalances—the Treasury Department—just issued another semiannual report(link is external) that bemoans the problem without giving any hint of what the United States could do to fix it. In reality, the US government has all the tools it needs to achieve balanced trade without risking a trade war. Unfortunately, a key tool—fiscal policy—is moving rapidly in the wrong direction.

[Joseph E. Gagnon | April 17, 2018 | PIIE]


The administration incorrectly blames the trade deficit on barriers to US exports. The US officials charged with obtaining fair treatment of US exporters—the Secretary of Commerce and the US Trade Representative—have announced tariffs in retaliation for perceived bad behavior in various foreign countries. Undoubtedly, many US exporters do receive unfair treatment by foreign governments. My colleague, Chad Bown, has written extensively on the trade cases against different countries and the advantages and disadvantages of the administration’s strategy for dealing with them. However, as explained in my testimony last year, foreign trade barriers and US tariffs have essentially no impact on the overall US balance of trade.


The policies that matter for the overall trade balance are fiscal policy (the federal budget deficit) and exchange rate policy (foreign exchange intervention and regulation/taxation of foreign capital). Because the trade balance reflects transactions with other countries, fiscal policies and exchange rate policies in other countries also have a profound influence on the US trade deficit. Treasury’s foreign exchange report focuses entirely on how other countries’ policies affect their trade imbalances, and, by implication, the US imbalance.

The best aspect of the Treasury report is the analysis of how the pattern of global trade imbalances largely reflects inadequate domestic spending in surplus countries, most notably China and Germany. Improved social safety nets in China and Korea and infrastructure spending in Germany would meet internal needs and rebalance global trade at the same time. During the long period of weak global economic growth, the large US fiscal deficit provided a net benefit to the world while at the same time it contributed significantly to the US trade deficit. Treasury’s report is strangely silent on the role of the US fiscal deficit in the trade imbalances. This role is poised to become much larger with the tax cut and spending increases passed since December 2017.


In its discussion of foreign exchange rate policies, Treasury declined to classify any country as a currency manipulator. Treasury limits its analysis to “major trading partners” of the United States. To be named a manipulator a country must meet three criteria: (1) have a current account surplus of at least 3 percent of GDP; (2) have foreign exchange intervention of at least 2 percent of GDP; and (3) have a bilateral trade surplus with the United States of at least $20 billion.[1] This third criterion is not an appropriate metric for currency manipulation because currency purchases that push up the dollar cause US imports to rise from all countries.

In a recent blog post, Tessa Morrison and I identify eight countries as currency manipulators in 2017 using the criteria developed in my book with Fred Bergsten[2]: Hong Kong, Israel, Macao, Norway, Singapore, Switzerland, Taiwan, and Thailand. Except for Thailand, these countries did not meet Treasury’s bilateral trade surplus requirement.[3] Thailand did not meet Treasury’s definition of being a “major trading partner” of the United States, although it had the 20th largest bilateral exports plus imports of goods (and 15th largest if the euro area is counted as a single trading partner).

It appears that Treasury interpreted its statutory mandate in a way designed to avoid finding any country guilty of currency manipulation. If the bilateral surplus criterion were lowered to $10 billion, intervention were measured on a flow basis, and “major trading partner” were defined to include the top 20 trading partners, Treasury could have found Switzerland, Taiwan, and Thailand to be currency manipulators.[4]However, the combined foreign currency purchases of these three plus the other five manipulators that Morrison and I identified were $299 billion in 2017, contributing perhaps $100 billion to the US trade (current account) deficit of $466 billion.[5] Currency manipulation remains an important issue, but it is not responsible for most of the US trade deficit.

Treasury maintains a monitoring list of six major trading partners that it feels deserve continued scrutiny. Five countries on the list exceed two of Treasury’s three criteria: Germany, India, Japan, Korea, and Switzerland. China is included because its bilateral surplus is exceptionally large. A more appropriate monitoring list would focus on major trading partners that have a current account surplus and a history of substantial foreign exchange intervention: China, Hong Kong, Japan, Korea, Singapore, Switzerland, Taiwan, and Thailand.[6] India does not belong on the monitoring list because it has a current account deficit and its intervention is aimed at reducing its imbalance, not increasing it. Germany does not belong on the list because it does not intervene. Although Germany is an important contributor to global trade imbalances, other policies are responsible for its trade surplus, including fiscal policy.


By far the largest omission in Treasury’s report is the lack of any acknowledgment that the United States possesses the policy tools it needs to reduce the trade deficit on its own. Foreign exchange intervention to widen or support excessive trade surpluses is harmful and deserves opprobrium. But intervention to reduce a large trade deficit is beneficial and fully in accord with international rules. It is long past time to replace the strong dollar policy with a balanced dollar policy aimed at minimizing global imbalances. Such a policy would include stabilizing foreign exchange intervention and possibly taxing foreign capital inflows to minimize swings in the dollar’s exchange value that give rise to unsustainable trade imbalances.

At present, however, the most urgent priority is reversing the disastrously timed US fiscal expansion. If corrective steps are not taken soon, the US economy will overheat to a degree not seen in decades. The booming economy will suck in more imports, widening the trade deficit further. Policies aimed at weakening the dollar would exacerbate the overheating and should be avoided or minimized for the time being.

Follow @GagnonMacro(link is external) on Twitter.


1. The requirement of a bilateral surplus with the United States is part of the statute that mandates the report, but the cutoff amount is set by Treasury.

2. The criteria include the first two used by Treasury. We exclude low-income countries and countries with inadequate levels of foreign exchange reserves. We allow nonrenewable resource exporters to save a considerable fraction of their resource exports through foreign asset purchases. We identify 20 countries that manipulated their currencies in at least one year from 2003 through 2013.

3. Brad Setser’s blog(link is external) recently discussed Thailand’s rising bilateral surplus and its potential to meet Treasury’s criteria.

4. Based on Treasury’s estimates of outright currency purchases, Taiwan was slightly below the cutoff of 2 percent of GDP. However, Taiwan’s reported official currency flows, which include interest payments but not valuation changes, were modestly above 2 percent of GDP, as shown in my blog post with Morrison.

5. Current account data are from the US Bureau of Economic Analysis. For a discussion of the effect of foreign currency intervention on the US trade balance, see my recent working paper.

6. Here major trading partners are the top 20 in bilateral exports plus imports of goods based on data from the US Bureau of Economic Analysis (Exhibit 14 for 2017).

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