Currency misalignment, world trade and the World Trade Report

The World Trade Report 2013 has a large section devoted to currency misalignment and world trade. It goes (p.261)...

The debate on the trade impact of exchange rates has surged again recently in the WTO,56 and is likely to do so each time that it is felt, rightly or wrongly, that the present state of international monetary cooperation does not allow for orderly exchange rate adjustment reflecting balance of payments positions and does allow a particular member, or several members, to enjoy competitive advantages as a result of such a lack of cooperation. While the influence of macroeconomic and structural policies in determining exchange rates is acknowledged (Eichengreen, 2007), the world trading system must regularly “deflect” tensions associated with the perceived trade impact of exchange rates. This has become more frequent in recent years, as growing international inflows and outflows of foreign exchange have the potential to destabilize domestic economic policies and reduce the efficacy of traditional controls (notably restrictions on capital movements).

The question for the WTO is also systemic because exchange rate shifts increase or weaken the desired or perceived level of protection of domestic operators – and thus seem to have a role in the definition of trade policy. At the multilateral level, the erratic movement of exchange rates is frustrating the desired levels of protection that are negotiated by WTO members through long-term commitments – precisely because policies are aimed at setting predictable conditions of access for producers and traders. In turn, members may seek a way to address cyclical development or exchange rate changes in the trade policy toolkit.   

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The need for greater coherence for trade and exchange rate policies was included in the GATT rule book at the outset (see Section E.3(c)). The IMF and GATT were created in response to a lack of coordination of economic policies during the Great Economic Depression – these new institutions aimed at dealing with trade and exchange rate policies as a matter of common interest, with the introduction of disciplines to avoid competitive devaluations, to maintain exchange rate stability, to reduce balance of payments crises and to fight protectionism. From the outset, the international monetary and trading systems were linked by a coherent set of rules aimed at the progressive opening of trade and payments. GATT provisions on coherence reflected two things: the attachment of the trade community to exchange rate stability; and the need for that community to ensure that the trading system was not frustrated by the undisciplined use of exchange restrictions or multiple exchange rates. The institutional set-up remains very much one of coherence – and not of conflict – between the two systems." 

Well, no mention of a possibility of a WTO dispute here. Has that died down? Coherence is the buzzword here. 

Is currency undervaluation the next big protectionist game?

Are we in for some currency wars? Will currency manipulation or undervaluation undermine the delicate balance of international trade? While the subject has not yet made it to the centre stage of world trade negotiations or dispute settlement, the dangers of it becoming increasingly debilitating are increasingly being heard. Is currency undervaluation the next big protectionist game? The IELP blog a couple of years ago did not think it to be a serious trade issue.

Peterson Institute has come out with many papers on this subject. It recently had two interviews by Joseph Gagnon and William Cline that brought to the fore the issue of currency undervaluation but opined that the dangers are not that serious:

1. Is the World on the Binge of Devaluation? Part I

2. Is the World on the Binge of Devaluation? Part II

There is obviously much more to come on this complex topic in trade circles. The complexity of the area is in terms of what constitutes currency undervaluation, the impact it has on trade, the multiple purposes currency undervaluation may have as well as exercise of domestic regulatory space. Added to it is the jurisdictional issue with the IMF. A lot of people think this dispute is not going to knock on WTO's doorstep...

Currency undervaluation - 2013's big trade dispute?

I had recently blogged about a possible currency dispute at the WTO. Does currency undervaluation merit a trade remedy? Is it disguised protectionism? Does it unfairly benefit the exports of the country devaluing it's currency? While many have argued that currency undervaluation does not fall under the domain of the multilateral trade regime (the IMF being the right forum), there is considerable literature emerging that a possible WTO action cannot be totally ruled out. Recent moves by Brazil to raise the issue at the Committees of the WTO also underlies the criticality that members view the issue to be.Nevertheless, others argue that there may not be any credible link between undervalued currency and trade flows at all.

This Bloomberg report highlights the growing disquiet within the EU and Russia on the policy of Japan in managing its currency at a low rate. The murmurs are slowly getting louder. While the Chinese renminbi has been the target of undervaluation normally, this time it is the Japanese yen facing the brunt. The Economist and Voxeu had these comments in recent times.

Irrespective of the desirability of managed exchange rates to further one's domestic macro-economic policy agenda, the criticality of currency undervaluation to trade related issues is here to stay. This may manifest itself in increased opposition at the WTO or at dispute settlement proceedings. 2013 may indeed see the initial impact of those murmurs. The implication this has on domestic policy space, monetary policy independence and interpretation of trade rules (in terms of interpreting what constitutes an actionable or prohibited subsidy - currency undervaluation most likely being labelled as a prohibited subsidy under the ASCM or a violation of other GATT/WTO provisions) are questions which have no easy answers.

A currency dispute at the WTO in 2013?

Currency manipulation/undervaluation/misalignment has not yet attained centrality in WTO disputes or discussions except for a proposal made by Brazil at the WTO to take it seriously. There is abundance of legal literature, however, on the WTO compatibility of currency misalignment and the possible course of action under WTO law.The IELP blog  had a blogpost on it recently here. Does currency manipulation violate Article XV(4) GATT (frustrating the intent of GATT provisions) or is it a prohibited subsidy under the ASCM? I have written a paper on this which I will share soon.

The Peterson Institute for International Economics recently had a Policy Brief that highlighted the seriousness of the problem and recommended that a WTO case be brought against the major manipulators. the Policy brief titled "Currency Manipulation, the US Economy, and the Global Economic Order" gives an exhaustive account of what could constitute currency manipulation and contrary to popular belief that a few countries practice it there seems to be evidence that a large number of countries, both developing and developed, practice it.

 Recommending a WTO case, the brief highlights:

"We nevertheless believe that the status quo produces a gaping hole at the heart of the global economic order, that the bifurcation between the monetary and trading systems must be overcome, that the economic costs of inaction on this issue are extremely high during a prolonged period of slow growth and high unemployment such as the present and possibly the foreseeable future, and that multilateral remedies are highly preferable to unilateral actions. Hence we recommend that the United States and its allies bring WTO cases against the most egregious manipulators as part of a broader action program, all of whose other components would be at least arguably compatible with the existing international rules. If they won the case, it would strengthen their hands enormously in prosecuting all their other remedies and would, in a second WTO step to determine permissible remedial action, add to the arsenal of policy instruments available to them. If they lost, it would dramatize the need for reform of the WTO rules themselves and thus almost instantaneously place the issue on the agenda for either a future round or a stand-alone negotiation. Whatever the outcome, the coalition would have made every effort to use the existing rules and institutions and thus demonstrated its fealty to the international system."

While the legal arguments in favor of a WTO action in case of currency misalignment are not that sound, will 2013 see the first dispute settlement case where an undervalued currency is challenged on the grounds that it is violative of GATT or is a prohibited subsidy under the ASCM? Who will take the plunge?