The WSJ reports today that a day after the Democrats in the Senate repudiated Mr. Obama, the Senate agreed to allow a vote on Trade Promotion Authority (TPA), once the Republican leadership agreed to allow a vote to force the administration to punish “unfair” trade in the form of currency manipulation.
The concern have over currency manipulation is that some nations–Asian nations in particular–have artificially lowered the value of their currencies to make their exports more competitive, which has cost American jobs. The idea is we need to fight back; historically administrations don’t like to get into public trade wars, and likewise members of congress get very bellicose on behalf of their exporting constituents. This issue is likely getting even more momentum than usual with the dollar’s strong appreciation over the last 10 months or so. Rather than tackle the unfolding political process on TPA, I’d like to offer a few ideas on “currency manipulation.” In the interest of full disclosure, I’m pretty close to the Milton Friedman idea that even if every other country does stupid protectionist policies, its still best for the U.S. to practice free trade.
First, I think there is ALWAYS currency manipulation by every nation. Every country that engages in monetary policy is affecting the value of their currency for the benefit of the domestic economy in some respect, its only a question of how much of its economy is in exports and imports. So currency manipulation is a matter of degree, rather than kind. It’s especially hypocritical of politicians that cheered QE1-QE3 to talk about currency manipulation, when the purpose of QE was to juice the economy including our exports. It’s good to remember Jesus admonition here, “You hypocrite, first take the log out of your own eye, and then you will see clearly to take the speck out of your brother’s eye.” Likewise, I hear little of currency manipulation by the EU or Japan with their current monstrous infusions of QE liquidity. Is this just China bashing?
Second, China is just doing what we told them to do! For many countries, their primary monetary problem historically was too loose a policy, with high inflation. We encouraged emerging economies (which China was not too many years back) to just end an independent monetary policy. They should dollarize (actually use U.S. dollars as currency) or have a currency board that treated the U.S. dollar as if it were gold (the country would have to pledge to keep a certain amount of dollars for each of the domestic currency units). In both of these cases, the U.S. got seigniorage from additional $$ spent by the U.S. and effectively taken out of circulation. Alternatively, the country could just peg the value of their currency to the dollar, which would effectively force them to follow U.S. monetary policy. For China, they had had very high rates of inflation in the 70s and the 80s; ultimately they did what we recommended and pegged their currency to the U.S. dollar. The problem is that when we started inflating to rev up a slowing economy, China did the same thing to keep the peg, and that resulted in depreciating their currency making their economy grow even faster. This means they started exporting even more to us and our current account deficit grew larger and larger. And unfortunately for us, they didn’t buy our goods, they bought T-bills and mortgage backed securities (MBS). So they made it easier for Washington to run deficits and helped fuel the mortgage bubble. So for the politicians complaining about China and currency manipulation, I have a solution. Stop running deficits. Stop promoting MBS. If you do this, they will have to buy something else, and ultimately either our exports will rise to offset or the value of our currency will fall correspondingly.
So if our politicians would “first do no harm,” then we wouldn’t have a big problem with currency manipulation. In the short run, financial flows determine currency valuations. But in the long run, trade flows will determine the value of a nation’s currency. If the politicians end the deficits which allow financial flows to dominate the value of our currency, then trade will take care of itself.
EDIT UPDATE: 5/22/15
Don Boudreaux has a gem of logic over on Cafe Hayek to answer the critics of TPA on the left who argue that secret trade negotiations will just benefit big corporations: just immediately complete and open free trade! Eliminate ALL U.S. trade restrictions. That will solve the problem.