Nafta Currency Rules Portend Tough U.S., South Korea Trade Fight

June 20, 2017

U.S. government signals that it will push for a ban on currency manipulation in the North American Free Trade Agreement have attracted little attention, as Mexico and Canada are rarely accused of gaming the foreign-exchange market. The strategy is likely to prove more contentious when the Trump administration turns its attention to South Korea.

[Randy Woods & Jiyeun Lee] June 15th, 2017 [Bloomberg]

The East Asian nation has long been in Uncle Sam’s crosshairs over charges it artificially depresses the won, and the Treasury Department said in April the country meets two of the three criteria of a full-fledged currency manipulator.

Any currency provision agreed to in the Nafta negotiations could serve as a template for a revamping of the 2012 U.S.-Korea Free Trade Agreement that President Donald Trump has pressed for. Talks are likely to occur later this year or next, and the FTA will probably come up during South Korean President Moon Jae-in’s visit to the White House later this month.

South Korean policy makers deny any accusation of currency manipulation, saying they only step into the foreign-exchange market to ensure financial stability. They say they act to calm extreme movements in the currency’s value by preventing it from dropping or rising abruptly, while rejecting arguments that the government seeks to weaken the won to benefit exporters.

Former Treasury official Brad Setser, now a senior fellow at the Council on Foreign Relations, disagreed and said years of interventions have left the currency undervalued by at least 10 percent.

The Treasury argues that South Korea frequently intervenes in its currency market without publicizing its actions. The department noted in its April report that South Korea continues to stockpile foreign reserves, which tends to weaken the local currency. It called for more transparency in South Korea, adding that the nation “should limit currency intervention to only exceptional circumstances.”

A weaker currency makes Korean exports more competitive and imports into the country dear, exacerbating its trade surplus with the U.S., according to the Treasury. Ma Tieying, an economist at DBS Bank in Singapore, says there are other factors behind the imbalance, including South Korea’s reduced demand for imports since the end of the global financial crisis. She also notes that South Korea’s intervention in the currency market in recent years has been to smooth out sharp declines as well as gains.

Whatever the cause of the trade gap, it undoubtedly has attracted the ire of Trump, who in April threatened to scrap rather than renegotiate the bilateral pact.

Trade experts such as Wendy Cutler, who was the chief U.S. negotiator of the FTA, say there’s no easy solution on the currency question, as it’s difficult to design and agree on a provision that either side could enforce when rules are broken.

Negotiators could get tripped up simply defining currency manipulation, considering many policy tools that are designed to stimulate or stabilize an economy also impact the exchange rate, according to Troy Stangarone, a senior director at the Korea Economic Institute in Washington. South Korea probably wouldn’t want to hamstring its central bank with a currency provision that limits its ability to act in a crisis, both Stangarone and Cutler said.

All that makes it unlikely the two sides will agree on a strong currency provision, according to Scott Bradford, an economics professor at Brigham Young University in Utah who has written about the FTA.

It’s unclear whether an impasse on the matter would be a deal-breaker, especially given the importance of preserving bilateral ties amid rising tensions with North Korea. But a breakdown is always a possibility that would make U.S. exporters the unwitting victim rather than intended beneficiary of the trade talks.

“Scrapping this agreement could drive the won down, which contributes to this perceived problem of the U.S. deficit being too large,” Bradford said. “To scrap this agreement, which has political as well as economic implications, is probably not thinking things through well enough.”

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