American economic strength and dynamism allow the United States to extend its global influence through non-kinetic means, while also accruing additive benefits. The United States, despite its debt and political turmoil, remains attractive for foreign direct investment, immigration, and as a business partner. The United States has a well-earned reputation for a laissez-faire approach to private capital that has made it a global financial hub, sometimes to the chagrin of Congress as it seeks to ban some Chinese companies from listing in US markets.

In the current world order, capital moves across borders with few limitations. Steps taken to slow the flow of capital starve countries of investment and inflict costs on economic growth, employment, tourism, tech transfer, and global opportunities. The same would be true for the United States unless policymakers take economic statecraft seriously. The dollar provides America with a unique competitive advantage that the euro, yen, and yuan have yet to displace. That status is not a given though as domestic polarization (playing on fear) and financial and corporate interests (playing on greed) have the potential to erode USD status.

Policymakers are taking notice.

National Security Advisor Jake Sullivan’s April 27, 2023 speech provided a broad framework for economic statecraft as the avenue for renewal of America’s economic leadership. Unfortunately, it also led to concerns that poorly crafted or blunt-tool economic statecraft are likely to lead to bad policy, which ultimately serve to undermine the greenback and lead to further acceleration of de-dollarization. Concerns about de-dollarization in the near term are overblown, but that does not mean that those concerns shouldn’t be heeded. There are significant dollar shortages in African, South Asian, and South American emerging markets, leading them to trade in non-USD currencies.

Treasury has, at times, taken the lead, but efforts have been scattered across State, Commerce, US trade representatives, and other agencies. Congress and current and future administrations need a strategic perspective when they’re at the trade negotiating table. State is uniquely qualified for this role, but gets overshadowed by traditional conflicts unfolding in Europe, the Middle East, and Asia. Protecting the dollar should be at the center of US foreign policy since it sustains American prosperity and is a key aspect of the US-dominated rules-based order.

The risks to currency dominance are many: shifting balance of power among countries, reshaping the global economy and markets; reduced corporate, institutional, and investor demand for USD over time; heightened exchange rate volatility, especially as over sixty currencies are pegged to the USD; and rewriting the rules of the global financial system, which, under the leadership of the dollar, is guided by US values. If the USD were to lose reserve status, the United States would feel serious negative economic and political repercussions—losing capacity to borrow quickly and cheaply and damaging its ability to fund industrial policy, social welfare programs, and defense.

The US government has at its disposal an array of economic policies to incentivize or punish other countries through tariffs, sanctions, import and export controls, and investment restrictions, among other tools. The biggest threats to the dollar include sanctions and tariffs. Because of USD global dominance and US control over the Society for Worldwide Interbank Financial Telecommunications, sanctions are particularly low-hanging fruit for economic statecraft. They are an extremely important tool, particularly when used by the United States and its allies in multilateral coalitions acting together. But frequent unilateral usage of sanctions and overuse has led to more countries desiring an alternative currency, as countries become wary about being too dependent on the USD. The alliance of the aggrieved seek alternatives to sanctions including positive assistance to the injured party, as compared with reprisals against the aggressor or organizing logistical and financial aid to countries in distress.

Geoeconomic fragmentation and policy-driven reversal of global integration carry potential adverse economic ramifications that could hamper international cooperation and strain the international monetary system and financial safety nets. Unraveling trade links would most adversely impact low-income countries and less well-off consumers in advanced economies, and US sanctions and tariffs can accelerate fragmentation as countries perceive economic interdependence, particularly with the United States, a vulnerability as interdependence is weaponized.

Economic security is national security. Recent commentary on economic statecraft correctly identifies weaknesses in US national economic security priorities, lack of resources, staffing, and organizational design. Deputy National Security Adviser for International Economics, Daleep Singh, one of the primary architects of the Russian sanctions, highlights the necessity for economic statecraft to be grounded in doctrine that enhances global prosperity while safeguarding US national security. Employing economic coercion can be effective, but should be brought to the table with well-defined end goals and long-term ramifications in mind. Currently, there is no whole-of-government effort to counter Chinese and Russian de-dollarization schemes.

Janine Stouse has over twenty-five years of experience in the financial services sector and a Master’s in International Relations with a focus on National Security issues.

To read the analysis as it was published on the Foreign Policy Research Institute webpage, click here.

The post The Use of Economic Statecraft to Achieve Geopolitical Ends appeared first on WITA.

Few topics have generated as much discussion in recent weeks as the evolving role of the U.S. dollar in the global trade and capital regime. The sanctions imposed on Russia by the United States and its allies have demonstrated the immense geopolitical power that control of the global currency system can confer.

These same sanctions also make clear, however, why the governments of other countries that might one day be subject to such penalties are doing all they can to opt out and establish an alternative global currency system—either one they control or one that is unlikely to be controlled by potential adversaries. That is why a vibrant debate has erupted over whether or not countries like China can establish a credible alternative to the dollar.

But while there has been much debate over whether or not the world—or at least part of the world, including countries like China, Iran, Russia, and Venezuela—can live without the dollar, there has been much less attention on an equally important issue: what the trade impact would be of a world less tied to the U.S. dollar. The two issues cannot be separated. The issue of the dollar is part of the debate over global capital flows, but capital flows are just the obverse of trade and current account flows. Savings, after all, can only be expressed as the excess production of goods and services.

This essay makes three related points. First, it would be extremely difficult, if not impossible, for countries like China and Russia to upend the dominance of the U.S. dollar. Most sophisticated economic policy advisers in China and Russia know this, even if they have to express this knowledge cautiously.

Second, for the U.S. dollar to stop being the world’s dominant currency would mostly require specific action by U.S. policymakers to limit the ability of foreigners to use U.S. financial markets as the absorber of last resort of global savings imbalances. While most analysts still believe that the United States will never willingly take the necessary steps to end U.S. dollar dominance, there is a growing awareness of the costs of playing this role to the U.S. economy. Although any move to limit the international use of the dollar would be opposed by parts of Wall Street and the foreign affairs and military establishments, as the costs rise, this outcome will become increasingly likely.

And third, a global economy without the U.S. dollar—or some unlikely alternative—as the currency lingua franca also would be a global economy in which large, persistent trade and savings imbalances are impossible. This is probably a good thing for the global economy overall, but with so many major economies locked into structural domestic demand deficiencies, any policy that forces an elimination or sharp reduction of global trade imbalances also would force deep institutional changes in the global economy—changes which also would likely be politically disruptive for many countries. This is especially the case for countries whose economies have grown around persistent trade surpluses.

CAN THE WORLD FIND AN ALTERNATIVE TO THE U.S. DOLLAR?

The dollar is the most widely used currency in international trade not just because of network effects, but also for other reasons that are hard for other countries, especially countries like China, to replicate. The world uses the dollar because the United States has the deepest and most flexible financial markets, the clearest and most transparent corporate governance, and (in spite of recent sanctions) the least amount of discrimination between domestic residents and foreigners.

This means that, for example, for China’s renminbi to compete with the U.S. dollar, Beijing would have to be willing to present the same benefits to foreigners. This includes giving up control of its current and capital accounts and substantially reducing its ability to control credit growth and the liabilities of its financial system.

All of these measures, at least for the foreseeable future, are extremely unlikely. In fact, not only has Beijing shown no inclination in recent years to accept any of these changes, but it has been moving in the opposite direction, especially with the centralization of bureaucratic and political power and the expansion of the state sector that China has undertaken in the past several years.

There is another, more important reason for the widespread use of the dollar. The global trading system is terribly unbalanced, with several large economies—including China, Germany, Japan, and Russia—locked into unbalanced income distributions that reduce domestic consumption and force up their savings rates. Because weak consumption, along with weak investment from private businesses who depend mainly on local consumers to buy the goods they produce, leads to weak domestic demand, these economies require large, persistent trade surpluses to resolve the excess production that drives their economies.

But surplus economies must acquire foreign assets in exchange for their surpluses. This is where the United States—and other Anglophone economies with similar markets and governance, like the UK—play their most important role. A country can only import net foreign savings by exporting ownership of assets, and the United States and other similar economies are the only stable, mature economies that are both willing and able to allow foreigners unfettered access to the acquisition of local assets. To put it another way, they are the only major economies both willing and able to run the permanent trade deficits that accommodate the needs of foreign surplus-running countries to acquire foreign assets. No other major economy can accept, or is willing to accept, this burden.1

It helps to consider the alternative assets surplus countries can accumulate to see why, in spite of decades of complaints in the international community, the U.S. dollar remains the dominant currency. In principle, surplus-running economies can accumulate small amounts of assets in other advanced economies, but with the exception of the European Union (EU) and perhaps Japan, none is big enough to balance more than a tiny share of the world’s accumulated trade surpluses. More importantly, Japan and the EU, along with most advanced, non-Anglophone economies, run persistent surpluses themselves, so they cannot accommodate the surpluses of countries like China and Russia. I will explain later why giving up these surpluses would be so difficult.

Some analysts have argued that surplus-running countries can instead invest their excess savings in the developing world, and while much of the developing world would welcome small persistent capital inflows, the problems with relying on them are fairly obvious. Their economies are far too small to absorb a reasonable share of global excess savings without causing significant domestic dislocations that would make repayment impossibly difficult. In fact, China has in the past six or seven years significantly reduced its already limited exports of capital to developing countries as the risks have become increasingly obvious, while Russia doesn’t invest much in the developing world.

WILL ACQUIRING COMMODITY RESERVES PROVIDE AN ALTERNATIVE?

In recent weeks, some analysts have argued that, as a consequence of the sanctions imposed on Russia, the world is likely to see a shift in global reserve accumulation toward commodities. This, too, is unlikely. Countries like Russia, Iran, and Venezuela are all primarily commodity exporters, which makes the arithmetic of reserve accumulation very tricky. They would have to buy most aggressively when prices are high and their surpluses are large, and they would most likely have to monetize their reserves when prices are low and their economies are struggling. Not only would their reserve accumulation process thus exacerbate the volatility of commodity prices, which would be damaging for their economies, but, more worryingly, their reserves would be most valuable when they needed them least and least valuable when they needed them most. This is the opposite of what countries want from reserves.

China, of course, is the world’s largest commodity importer, so at first it might seem to be in the opposite position of commodity-exporting countries like Russia, in which case accumulating commodity reserves instead of foreign assets might seem to make a lot of sense. However, as the world’s largest importer of commodities by far, especially industrial commodities, it turns out that China’s economic performance is correlated with commodity prices in the same way as that of commodity exporters, only with the direction of causality reversed.

When the Chinese economy is growing rapidly, its commodity consumption is likely to rise sharply, and given its disproportionate role in commodity markets, rising Chinese consumption will drive up the prices of commodities. When the Chinese economy is growing slowly, on the other hand, commodity prices are likely to drop. Commodity acquisition as a reserve strategy, in other words, would exacerbate economic volatility and leave China, like commodity exporters, with reserves that are most valuable when it least needs them and, presumably, least valuable when it most needs them.

For many of the countries most determined to escape from the U.S. dollar’s dominance, in other words, investing in reserves is likely to lock them into acquiring assets when prices are high and selling them when prices are low. Only smaller economies that are net importers of commodities are likely to benefit from investing a significant portion of their reserves in commodities, and even these economies have to worry about the positive correlation between global growth and commodity prices. The value of reserves should be either stable or inversely correlated with the performance of the underlying economy, and most global commodities are unlikely to satisfy that condition.

WILL THE UNITED STATES FORCE OTHER COUNTRIES TO STOP USING THE DOLLAR?

Much of the discussion about whether or not the U.S. dollar can maintain its global dominance assumes as a matter of course that it is foreigners who want to constrain the global use of the dollar and it is Americans who will fiercely resist this process. This only indicates, however, just how confused much of this discussion has been. As Matthew Klein and I discussed in our 2020 book, Trade Wars Are Class Wars, the structure of international trade and capital flows does not really pit nation against nation so much as it pits economic sector against economic sector.

Among other things, this means that it is not the United States as a whole that benefits from the global dominance of the U.S. dollar but rather certain constituencies within the United States that do, in contrast to other constituencies that pay the price for the dominance of the U.S. dollar. The beneficiaries include two major, politically powerful groups: Wall Street and the foreign affairs and defense establishments. By contrast, it is American workers, farmers, producers, and small businesses that pay what amounts to a significant economic cost.

This is because surplus-running countries benefit from their net absorption of foreign demand with a rising share of global manufacturing and the accumulation of foreign assets. But this rising share comes at the expense of the declining share of global manufacturing that deficit-running countries like the United States retain. What is more, by transferring part of its domestic demand abroad, the U.S. economy must make up for this loss either by encouraging more household debt or by increasing its fiscal deficit if it wants to avoid a rise in domestic unemployment.2

This is why the global dominance of the dollar now imposes an exorbitant burden on the U.S. economy, rather than the exorbitant privilege of old, and it is also why the United States likely will eventually have to refuse this role. For all the tremendous geopolitical power that control of the global currency system confers on Washington and Wall Street, it comes at a substantial economic cost to American producers, farmers, and businesses, and as the rest of the world grows relative to the United States, this cost can only increase.

But if the United States at some point refuses to run the permanently rising deficits that are needed to accommodate weak demand and excess savings in the rest of the world, deficits which underpin the global dominance of the dollar, how does this process ultimately resolve itself? Tariffs and other forms of direct trade intervention, as Klein and I explain, cannot work because they are largely ineffective in shifting the global savings imbalances that drive the U.S. trade deficit.

The only way for the United States, and other Anglophone economies, to be relieved of trade deficits is for an interruption in the global flow of capital that prevents savings imbalances from being exported. There are basically three ways in which this is most likely to happen. One way would be for the current system to be maintained until the United States is no longer able to carry the economic burden, in which case, amid a collapse in the credibility of the U.S. dollar, the world would abandon the currency. This would force the United States and other economies to adjust in a chaotic and disorderly way.

A second way would be for the United States unilaterally to opt out of the current system by constraining foreigners’ ability to dump excess savings into the U.S. economy, perhaps by taxing all financial inflows that do not lead directly to productive investment in the U.S. economy. There have already been such proposals in the U.S. Congress, and while as of yet they have been rejected, there are likely to be many more.

This would entail a substantial reduction in U.S. financial power abroad and in the power of Wall Street, and it would extremely painful and in some cases even destabilizing for countries—like China, Germany, Japan, Russia, and Saudi Arabia—that would likely prove unable to quickly resolve domestic demand and savings imbalances. This move would, however, boost U.S. manufacturing, raise domestic wages, and force U.S. businesses once again to rely on raising productivity rather than lowering wages to achieve international competitiveness.

Finally, the United States and the world’s other major economies could organize a new global trade and capital regime, based perhaps on ideas similar to those originally proposed by economist John Maynard Keynes at Bretton Woods, which, among other things, relied on a global synthetic currency (which he called the bancor) designed to absorb global imbalances and spread out their consequences across the major economies. Washington and its allies could do so by negotiating a new set of trade agreements that would force members to resolve their domestic demand imbalances at home, rather than force their trade partners to absorb them. By requiring countries with temporary surpluses to exchange these surpluses for bonds denominated in the new synthetic currency, it would also spread more widely the adverse consequences of those surpluses.

While either of the last two options would ultimately benefit the U.S. economy, the second of the two would be the least disruptive for the global economy and the one most likely to allow the United States and its allies to continue maintaining some degree of control over global trade and capital flows. But one way or another, Washington should take the lead in steering the global trade and capital regime away from its excessive reliance on the U.S. dollar. For all the uninformed and excited discussions about foreign antagonists forcing the U.S. dollar to lose its global dominance, this will never happen because no other country, including none of the country’s antagonists, is willing to take on the exorbitant burden that the U.S. dollar places on the U.S. economy. Washington itself must end the age of the U.S. dollar’s dominance for the benefit of the American economy.

HOW WOULD THE WORLD AND GLOBAL TRADE BE AFFECTED BY AN ABANDONMENT OF THE DOLLAR?

If the United States—and presumably the other Anglophone economies—were to take steps that eliminated the role of their domestic financial markets as the net absorbers of foreign savings, by definition they would also no longer run current account and trade deficits. But because these countries account for 70–75 percent of the world’s current account deficits (with the developing world accounting for most of the rest), this would also mean that, unless some other large economy proves willing to convert its surpluses into massive deficits, the world would have to reduce its collective trade surpluses by 70–75 percent.

To understand the implications, let’s assume a country that runs persistent trade surpluses is forced to adapt to a world of much lower trade deficits, and hence of much lower trade surpluses. As I have explained elsewhere (here, here, and here, for example), in countries that run persistent surpluses, domestic savings must exceed domestic investment. Domestic savings are high, in turn, mainly because ordinary households, who consume most of their income, receive a very low share of the GDP they produce—compared to shares of businesses, the government, and the very rich.

Countries that run persistent surpluses, in other words, do so because deficiencies in domestic demand caused by distortions in the distribution of income make them incapable of absorbing all they produce domestically. To put it in another way, these distortions force up their savings rates above their investment rates. This means that, if an external event were to force a sharp contraction in a country’s trade and current account surpluses, there are broadly speaking five ways (or some combination thereof) by which its economy could adjust to bring savings and investment back in line.

• A surge in unemployment: Such a country’s savings would decline if a collapse in its exports caused manufacturing unemployment to surge. Unemployed workers, of course, have negative savings.
• A boost in consumer lending to spur domestic demand: The country’s savings would decline if the central bank, in response to a collapse in exports, quickly forced banks to increase consumer lending dramatically so as to replace foreign demand with domestic demand. Even if it were possible to do this efficiently, rising household debt would eventually be unsustainable.
• A jump in government deficit spending to spur demand: Savings would decline if the country’s government, in response to a collapse in exports, quickly expanded the fiscal deficit so as to replace foreign demand with domestic demand. Even if it were possible to do this efficiently, rising fiscal deficits would eventually be unsustainable.
• Income redistribution: The country’s savings would decline if the government were able to engineer a substantial redistribution of income to ordinary households. This would be sustainable and by far the best long-term outcome for both the country and the world, but any substantial redistribution of income would be a slow and difficult process, and it would almost certainly be politically disruptive, as is clearly the case, for example, in China.
• A surge of investment: The country’s government could engineer a massive increase in investment. The private sector is unlikely to respond to a collapse in exports by increasing investment, and indeed private firms would probably reduce investment, so the increase in government investment would have to be enough to absorb both the contraction in the trade surplus and any reduction in business investment. This is what China did, for example, in 2009–2010.

There are only a limited number of ways in which a country that runs persistent surpluses can adjust to a global contraction in aggregate trade deficits, all of which are very difficult. This just reinforces how it is the willingness and ability of the United States to run large, persistent deficits that underpins the role of the dollar as the world’s dominant currency, and how it is these deficits that most benefit, directly or indirectly, the countries that claim to be most eager to dethrone the U.S. dollar. These are also the countries—especially China—who claim to be most keen to have their currencies replace the U.S. dollar even as their domestic economic policies make this impossible.

WHAT HAPPENS NEXT?

The world is stuck with the U.S. dollar, not because it creates an exorbitant privilege for the U.S. economy over which Washington will fight, but because it allows many of the world’s largest economies to use a portion of American demand to fuel domestic growth. These economies, in other words, can run large surpluses to balance their domestic demand deficiencies by exchanging excess production for real assets—such as American real estate, factories, stocks, bonds, farmland, mines, and real businesses—that other countries would be unwilling (and largely unable) to give up.

That is why, while the U.S. dollar may create an exorbitant privilege for certain American constituencies, this status creates an exorbitant burden for the U.S. economy overall, especially for the vast majority of Americans who must pay for the corresponding trade deficits either with higher unemployment, higher household debt, or greater fiscal deficits. This is also why the end of the U.S. dollar’s dominance has little to do with the political desires of countries like Russia, China, Venezuela, and Iran, and everything to do with the political decisions of Americans. Once Washington understands the cost of this exorbitant privilege—although this may unfortunately take many more years—U.S. leaders will take steps, either unilaterally or collectively, that force the world off its dependence on the U.S. dollar.

Michael Pettisan, an expert on China’s economy, is professor of finance at Peking University’s Guanghua School of Management, where he specializes in Chinese financial markets. Aside from this blog, he writes a monthly newsletter that focuses especially on global imbalances and the Chinese economy.

Carnegie does not take institutional positions on public policy issues; the views represented herein are those of the author(s) and do not necessarily reflect the views of Carnegie, its staff, or its trustees.

To read the full piece, please click here.

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Exceptional policy support prevented a global economic depression, even as the pandemic took a heavy toll on lives and livelihoods. The global reaction, as seen in major shifts in travel, consumption, and trade, also made the world a more economically imbalanced place as reflected in current account balances—a record of a country’s transactions with the rest of the world.

In our latest External Sector Report we found that the global reaction to the pandemic further widened global current account balances—the sum of absolute deficits and surpluses among all countries—from 2.8 percent of world GDP in 2019 to 3.2 percent of GDP in 2020. Those balances are set to widen further as the pandemic continues to rage in much of the world.

If not for the crisis, global current account balances would have continued to decline. While external deficits and surpluses are not necessarily a cause for concern, excessive imbalances—larger than warranted by the economy’s fundamentals and appropriate economic policies—can have destabilizing effects on economies by fueling trade tensions and increasing the likelihood of disruptive asset price adjustments.

A year like no other

The dramatic fluctuations in current account deficits and surpluses in 2020 were driven by four major pandemic-fueled trends:

• Travel declined: The pandemic led to a sharp decrease in tourism and travel. This had a significant negative impact on the account balances of countries that rely on tourism revenue, such as Spain, Thailand, Turkey, and even larger consequences for smaller tourism-dependent economies.
• Oil demand collapsed: The collapse in oil demand and energy prices was relatively short lived, with oil prices recovering in the second half of 2020. However, oil-exporting economies, such as Saudi Arabia and Russia, saw current account balances decline sharply in 2020. Oil-importing countries saw corresponding increases to their oil trade balances.
• Medical products trade boomed: Demand surged by about 30 percent for medical supplies critical for fighting the pandemic, such as personal protective equipment, as well as the inputs and materials to make them, with implications for importers and exporters of these items.
• Household consumption shifted: As people were forced to stay home, households shifted their consumption away from services toward consumer goods. This happened most in advanced economies where there was an increase in the purchase of durable goods like electrical appliances used to accommodate teleworking and virtual learning.

All of these factors contributed to some countries seeing a wider current account deficit, meaning they bought more than they sold, or a larger current account surplus, meaning they sold more than they bought. Favorable global financial conditions, with the unprecedented monetary policy support from major central banks, made it easier for countries to finance wider current account deficits. In contrast, during past crises where financial conditions sharply tightened, running current account deficits was harder, pushing countries further into recession.

On top of these external factors, the pandemic led to massive government borrowing to finance health care and provide economic support to households and firms, creating large uneven effects on trade balances.

The outlook

Global current account balances are set to widen even further in 2021 but this trend is not expected to last. The latest IMF staff forecasts indicate that global current account balances will narrow in the coming years, as China’s surplus and the US’ deficit falls, reaching 2.5 percent of world GDP by 2026.

A reduction in balances could be delayed if large deficit economies like the US undertake additional fiscal expansions or there is a faster-than-expected fiscal adjustment in current account surplus countries, like Germany. A resurgence of the pandemic and a tightening of global financial conditions that disrupt the flow of capital to emerging markets and developing economies could also affect balances.

Despite the shock of the crisis and possibly due to its worldwide impact, excessive current account deficits and surpluses were broadly unchanged in 2020, representing about 1.2 percent of world GDP. Most of the drivers of excess external imbalances pre-date the pandemic and include fiscal imbalances as well as structural and competitiveness distortions.

Rebalancing the world economy

Ending the pandemic for everyone in the world is the only way to ensure a global economic recovery that prevents further divergence. This will require a global effort to help countries secure financing for vaccinations and maintain healthcare.

A synchronized global investment push or a synchronized health spending push to end the pandemic and support the recovery could have large effects on world growth without raising global balances.

Governments should step up efforts to resolve trade and technology tensions and modernize international taxation. A top priority should be the phasing out of tariff and non-tariff barriers, especially on medical products.

Countries with excess current account deficits should, where appropriate, seek to reduce budget deficits over the medium term and make competitiveness-raising reforms, including in education and innovation policies. In economies with excess current account surpluses and remaining fiscal space, policies should support the recovery and medium-term growth, including through greater public investment.

In the years to come, countries will need to simultaneously rebalance, while ensuring that the recovery is built on a solid and durable foundation.

To read the full commentary from IMF Blogs, please click here. 

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The press release from Treasury found three countries/territories to have problematic currency practices — Switzerland, Vietnam and Taiwan — but didn’t find any them to be currency manipulators. This constituted a change of position on Switzerland and Vietnam which had been found to be currency manipulators in the December 2020 report. All three countries are subject to increased scrutiny and interface with Treasury. A number of other countries remain on the monitoring list for currency practices with Mexico and Ireland being added to that list in this report. China was separately identified for transparency concerns. See U.S. Department of the Treasury Press Release, Treasury Releases Report on Macroeconomic and Foreign Exchange Policies of Major Trading Partners of the United States, April 16, 2021, https://home.treasury.gov/news/press-releases/jy0131. The press release is copied below and the April 2021 Report is embedded after that.

“WASHINGTON – The U.S. Department of the Treasury today delivered to Congress the semiannual Report on Macroeconomic and Foreign Exchange Policies of Major Trading Partners of the United States. In this Report, Treasury reviewed and assessed the policies of 20 major U.S. trading partners during the four quarters through December 2020.

“The Report concluded that both Vietnam and Switzerland continue to meet all three criteria under the Trade Facilitation and Trade Enforcement Act of 2015 (the 2015 Act) during the period under review.  Additionally, the report finds that Taiwan met all three of the 2015 Act criteria for the period under review.  Treasury has conducted enhanced analysis of Vietnam, Switzerland, and Taiwan’s macroeconomic and foreign exchange policies, as reflected in the Report.  Treasury will continue its enhanced engagement with Vietnam and Switzerland, and Treasury will commence enhanced engagement with Taiwan.  This engagement includes urging the development of a plan with specific actions to address the underlying causes of currency undervaluation and external imbalances.

“Under the Omnibus Trade and Competitiveness Act of 1988 (the 1988 Act), Treasury has determined that there is insufficient evidence to make a finding that Vietnam, Switzerland, or Taiwan manipulates its exchange rate for either of the purposes referenced in the 1988 Act.  Nevertheless, consistent with the 1988 Act, Treasury considers that its continued enhanced engagements with Switzerland and Vietnam, as well as a more thorough assessment of developments in the global economy as a result of the COVID-19 pandemic, will enable Treasury to better determine whether either of these economies intervened in currency markets in 2020 to prevent effective balance of payments adjustment or gain an unfair competitive advantage in trade.  For Taiwan, Treasury will initiate enhanced engagement in accordance with the 2015 Act and expects that engagement will help Treasury to make the determination required under the 1988 Act for the period of review. 

“No other major U.S. trading partner met the relevant 1988 or 2015 legislative criteria for currency manipulation or enhanced analysis during the review period.  Treasury urged China to improve transparency regarding its foreign exchange intervention activities, the policy objectives of its exchange rate management regime, the relationship between the central bank and foreign exchange activities of the state-owned banks, and its activities in the offshore RMB market. 

“’Treasury is working tirelessly to address efforts by foreign economies to artificially manipulate their currency values that put American workers at an unfair disadvantage,’ Secretary of the Treasury Janet L. Yellen said today.

“Treasury found that eleven economies warrant placement on Treasury’s ‘Monitoring List’ of major trading partners that merit close attention to their currency practices: China, Japan, Korea, Germany, Ireland, Italy, India, Malaysia, Singapore, Thailand, and Mexico.  All except Ireland and Mexico were included in the December 2020 Report.

“Today’s Report is submitted to Congress pursuant to the Omnibus Trade and Competitiveness Act of 1988, 22 U.S.C. § 5305, and Section 701 of the Trade Facilitation and Trade Enforcement Act of 2015, 19 U.S.C. § 4421.”

In prior posts, I have reviewed how Vietnam’s currency practices had resulted in a 301 investigation initiated by USTR (one of two, the other dealing with using illegally harvested timber) with a report issued in mid-January 2021, in the Commerce Department preliminarily finding currency practices of Vietnam were countervailable and in the December 2020 Treasury finding that Vietnam was manipulating its currency. See October 12, 2020, U.S. commences two investigations into Vietnam under Sec. 301 of the Trade Act of 1974, as amended – on currency and on use of illegally harvested timber, https://currentthoughtsontrade.com/2020/10/12/u-s-commences-two-investigations-into-vietnam-under-sec-301-of-the-trade-act-of-1974-as-amended-on-currency-and-on-use-of-illegally-harvested-timber/; December 21, 2020, Vietnam and Switzerland found to be “currency manipulators” in latest U.S. Treasury semiannual report, https://currentthoughtsontrade.com/2020/12/21/vietnam-and-switzerland-found-to-be-currency-manipulators-in-latest-u-s-treasury-semiannual-report/; January 15, 2021, USTR releases report from Section 301 investigation on Vietnam’s currency valuation, https://currentthoughtsontrade.com/2021/01/15/ustr-releases-report-from-section-301-investigation-on-vietnams-currency-valuation/.

The current Treasury report (pages 3-4) flags the elements examined and what is different in this report versus the prior one for Switzerland and Vietnam.

“In this Report, Treasury has reviewed 20 major U.S. trading partners with bilateral goods trade with the United States of at least $40 billion annually against the thresholds Treasury has established for the three criteria in the 2015 Act:

“(1) Persistent, one-sided intervention in the foreign exchange market occurs when net purchases of foreign currency are conducted repeatedly, in at least 6 out of 12 months, and these net purchases total at least 2% of an economy’s gross domestic product (GDP) over a 12-month period.2

“(2) A material current account surplus is one that is at least 2% of GDP over a 12-month period.

“(3) A significant bilateral trade surplus with the United States is one that is at least $20 billion over a 12-month period.3

“In accordance with the 1988 Act, Treasury has also evaluated in this Report whether trading partners have manipulated the rate of exchange between their currency and the United States dollar for purposes of preventing effective balance of payments adjustments or gaining unfair competitive advantage in international trade.

“Because the standards and criteria in the 1988 Act and the 2015 Act are distinct, a trading partner could be found to meet the standards identified in one of the statutes without necessarily being found to meet the standards identified in the other. Section 2 provides further discussion of the distinctions between the 1988 Act and the 2015 Act.

“Treasury Conclusions Related to the 2015 Act

“Vietnam again exceeded the thresholds for all three criteria under the 2015 Act over the four quarters through December 2020. Treasury has updated its enhanced analysis of Vietnam in this Report. In early 2021, Treasury commenced enhanced bilateral engagement with Vietnam and is working with the Vietnamese authorities to develop a plan with specific actions to address the underlying causes of Vietnam’s currency undervaluation.
Switzerland again exceeded the thresholds for all three criteria under the 2015 Act over the four quarters through December 2020. Treasury has updated its enhanced analysis of Switzerland in this report. In early 2021, Treasury commenced enhanced bilateral engagement with Switzerland and is discussing with the Swiss authorities options to address the underlying causes of Switzerland’s external imbalances.

“Taiwan exceeded the thresholds for all three criteria under the 2015 Act over the four quarters through December 2020. Treasury has conducted enhanced analysis of Taiwan in this Report and will also commence enhanced bilateral engagement with Taiwan in accordance with the 2015 Act. The bilateral engagement will include urging the development of a plan with specific actions to address the underlying causes of Taiwan’s currency undervaluation.

“Taiwan has maintained a tightly managed floating exchange rate regime since the late 1970s. Although Taiwan has liberalized capital controls in recent decades, the central bank continues to actively intervene in the foreign exchange market. Over many years, these practices have resulted in a structurally undervalued exchange rate that has failed to adjust in the face of Taiwan’s persistently large current account surpluses. Although the New Taiwan Dollar (TWD) has appreciated modestly in nominal and real effective exchange rate terms over the past decade, the authorities’ foreign exchange purchases and other, less formal exchange rate management practices have slowed the pace and scale of external adjustment, preventing the TWD from fully reflecting macroeconomic fundamentals.

“Treasury Conclusions Related to the 1988 Act

“The 1988 Act requires Treasury to consider whether any economy manipulates the rate of exchange between its currency and the U.S. dollar for purposes of preventing effective balance of payments adjustments or gaining unfair competitive advantage in international trade. In the December 2020 Report, Treasury found that Switzerland and Vietnam each met the standards for currency manipulation for the four quarters through June 2020. For the four quarters ending in 2020, based on initial enhanced engagements with Vietnam and Switzerland under the 2015 Act, further analysis, and data, Treasury has determined that there is insufficient evidence to make a finding that either economy (or any other economy covered in the Report) manipulates its exchange rate for either of the purposes referenced in the 1988 Act. Nevertheless, consistent with the 1988 Act, Treasury considers that its continued enhanced engagements with Switzerland and Vietnam, as well as a more thorough assessment of developments in the global economy as a result of the COVID-19 pandemic, will enable Treasury to better determine whether either of these economies intervened in currency markets in 2020 to prevent effective balance of payments adjustment or gain an unfair competitive advantage in trade. For Taiwan, Treasury will initiate enhanced engagement in accordance with the 2015 Act and expects that engagement will help Treasury to make the determination required under the 1988 Act for the period of review. Meaningful actions to address policy distortions and increase data transparency will be critical for making progress under these engagements. Treasury will also continue to consider whether economies that do not trigger enhanced engagement manipulate their currencies for the purposes referenced in the 1988 Act

“2 The Report covers data from the 12-month period ending in December 2020. These quantitative thresholds for the scale and persistence of intervention are considered sufficient on their own to meet this criterion. Other patterns of intervention, with lesser amounts or less frequent interventions, might also meet this criterion depending on the circumstances of the intervention.

“3 Treasury focuses in this Report on trade in goods only, as it has done in past Reports. The United States has a surplus in services trade with many economies in this Report, including China, Japan, Korea, Singapore, and Switzerland, and to a lesser extent, Taiwan and Vietnam. Taking into account services trade would reduce the bilateral trade surplus of these economies with the United States.”

The Trump Administration did not impose tariffs on Vietnam following the release of the Section 301 report in January leaving the decision on what action to take to the Biden Administration. President Biden’s U.S. Trade Representative, Ambassador Katherine Tai, met virtually with Vietnam Minister of Industry and Trade Tran Tuan Anh on April 1, 2021 and reviewed concerns re China’s currency practice as reviewed in the 301 investigation as well as illegal logging and other issues. See USTR Press Release, Readout of Ambassador Katherine Tai’s virtual meeting with Vietnam Minister of Industry and Trade Tran Tuan Anh. April 1, 2021, https://ustr.gov/about-us/policy-offices/press-office/press-releases/2021/april/readout-ambassador-katherine-tais-virtual-meeting-vietnam-minister-industry-and-trade-tran-tuan-anh (“Ambassador Tai highlighted the Biden Administration’s concerns about currency practices covered in the ongoing Section 301 investigation.  The ministers also discussed U.S. concerns on illegal timber practices, digital trade and agriculture.”). Thus, it is likely that the U.S. and Vietnam will work out bilaterally U.S. concerns on Vietnam’s currency versus imposing additional duties following the Section 301 report, at least at this time.

The first Department of Commerce investigation to look at currency as a countervailable subsidy for Vietnam made a preliminary affirmative determination. The final determination is not due until late May. See Department of Commerce, International Trade Administration, C–552–829, Passenger Vehicle and Light Truck Tires From the Socialist Republic of Vietnam: Preliminary Affirmative Countervailing Duty Determination and Alignment of Final Determination With Final Antidumping Duty Determination, 85 FR 71,607 (Nov. 10, 2020); Department of Commerce, International Trade Administration, A–552–828, Passenger Vehicle and Light Truck Tires From the Socialist Republic of Vietnam: Preliminary Affirmative Determination of Sales at Less Than Fair Value, Postponement of Final Determination, and Extension of Provisional Measures, 86 FR 504 (January 6, 2021)(final due within 135 days of the preliminary Federal Register). It is unclear what, if any, modification will be made to the countervailability of Vietnam’s currency in the context of the ongoing investigation based on the change in view of Vietnam by Treasury.

Conclusion

Currency misalignment whether intentional or not can have significant effects on trade flows. The U.S. has historically been quite concerned about misaligned currencies although Treasury historically preferred to work with other countries than label them currency manipulators. Early signals from the Biden Administration are that Treasury is reverting to a preference to work bilaterally with countries who actively intervene in currency markets and have an undervalued currency and large trade surplus in goods with the U.S. If so, Treasury will, as it did in the current report, find “insufficient evidence” for countries who satisfy the factual criteria under U.S. law to conclude such actions were for the purpose “of preventing effective balance of payments adjustments or gaining unfair competitive advantage in international trade.” While trading partners will undoubtedly prefer the Biden Administration’s apparent approach, the approach will be problematic for many U.S. industries and their workers and remove leverage to get correction of foreign government practices.

• Terence Stewart, former Managing Partner, Law Offices of Stewart and Stewart, and author of the blog, Current Thoughts on Trade.

To read the original blog post, please click here. 

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“At the direction of President Donald J. Trump, the Office of the U.S. Trade Representative (USTR) is initiating an investigation addressing two significant issues with respect to Vietnam. USTR will investigate Vietnam’s acts, policies, and practices related to the import and use of timber that is illegally harvested or traded, and will investigate Vietnam’s acts, policies, and practices that may contribute to the undervaluation of its currency and the resultant harm caused to U.S. commerce. USTR will conduct the investigation under Section 301 of the 1974 Trade Act. As part of its investigation on currency undervaluation, USTR will consult with the Department of the Treasury as to issues of currency valuation and exchange rate policy.

“United States Trade Representative Robert E. Lighthizer said, ‘President Trump is firmly committed to combatting unfair trade practices that harm America’s workers, businesses, farmers, and ranchers. Using illegal timber in wood products exported to the U.S. market harms the environment and is unfair to U.S. workers and businesses who follow the rules by using legally harvested timber. In addition, unfair currency practices can harm U.S. workers and businesses that compete with Vietnamese products that may be artificially lower-priced because of currency undervaluation. We will carefully review the results of the investigation and determine what, if any, actions it may be appropriate to take.’

“USTR will issue two separate Federal Register notices next week that will provide details of the investigation and information on how members of the public can provide their views through written submissions.”

https://ustr.gov/about-us/policy-offices/press-office/press-releases/2020/october/ustr-initiates-vietnam-section-301-investigation.

The two Federal Register notices were published on October 8. Initiation of Section 301 Investigation: Vietnam’s Acts, Policies, and Practices Related to Currency Valuation, 85 Fed. Reg. 63637-68 (Oct. 8, 2020); Initiation of Section 301 Investigation : Vietnam’s Acts, Policies, and Practices Related to the Import and Use of Illegal Timber, 85 Fed. Reg. 63,639-70 (Oct. 8, 2020).

In each notice of initiation, USTR reviews the concerns leading to the 301 investigation, indicates that consultations with Vietnam have been requested, provides a timeline for the public to submit written comments and indicates that because of uncertainties from COVID-19, USTR is not scheduling a public hearing but “will provide further information in a subsequent notice if it will hold a hearing”. Public comments in both investigations are due on November 12, 2020.

The currency investigation flows from the following concerns identified in the notice of initiation.

“The Government of Vietnam, through the State Bank of Vietnam (SBV), tightly manages the value of its currency—the dong. The SBV’s management of Vietnam’s currency is closely tied to the U.S. dollar. Available analysis indicates that Vietnam’s currency has been undervalued over the past three years. Specifically, analysis indicates that the dong was undervalued on a real effective basis by approximately 7 percent in 2017 and by approximately 8.4 percent in 2018. Furthermore, analysis indicates that the dong’s real effective exchange rate was undervalued in 2019 as well.

“Available evidence also indicates that the Government of Vietnam, through the SBV, actively intervened in the exchange market, which contributed to the dong’s undervaluation in 2019. Specifically, the evidence indicates that in 2019, the SBV undertook net purchases of foreign exchange totaling approximately $22 billion, which had the effect of undervaluing the dong’s exchange rate with the U.S. dollar during that year. Analysis suggests that Vietnam’s action on the exchange rate in 2019 caused the average nominal bilateral exchange rate against the dollar over the year, 23,224 dong per dollar, to be undervalued by approximately 1,090 dong per dollar relative to the level consistent the equilibrium real effective exchange rate.” 84 FR 63637-38.

The public is asked to provide written comments on six issues:

“• Whether Vietnam’s currency is undervalued, and the level of the
undervaluation.

“• Vietnam’s acts, policies, or practices that contribute to undervaluation of its currency.

“• The extent to which Vietnam’s acts, policies, or practices contribute to the
undervaluation.

“• Whether Vietnam’s acts, policies and practices are unreasonable or discriminatory.

“• The nature and level of burden or restriction on U.S. commerce caused by the undervaluation of Vietnam’s currency.

“• The determinations required under section 304 of the Trade Act, including what action, if any, should be taken.” 85 FR at 63638.

In the timber investigation, the background information which led to the initiation of the investigation is described as follows:

“Vietnam is one of the world’s largest exporters of wood products, including to the United States. In 2019, Vietnam exported to the United States more than $3.7 billion of wooden furniture. To supply the timber inputs needed for its wood products manufacturing sector, Vietnam relies on imports of timber harvested in other countries. Available evidence suggests that a significant portion of that imported timber was illegally harvested or traded (illegal timber). Some of that timber may be from species listed under the Convention on International Trade in Endangered Species of Wild Fauna and Flora (CITES).

“Evidence indicates that much of the timber imported by Vietnam was harvested against the laws of the source country. Reports indicate that a significant amount of the timber exported from Cambodia to Vietnam was harvested on protected lands, such as wildlife sanctuaries, or outside of and therefore in violation of legal timber concessions. Cambodia nevertheless remains a significant source of Vietnam’s timber imports. Similarly, timber sourced from other countries, such as Cameroon and the Democratic Republic of the Congo (DRC), may have been harvested against those countries’ laws.

“In addition, Vietnamese timber imports may be traded illegally. For example, it appears that most timber exported from Cambodia to Vietnam crosses the border in violation of Cambodia’s log export ban. In addition, aspects of the importation and processing of this timber also may violate Vietnam’s domestic law and be inconsistent with CITES.” 85 FR 63639.

Public comments are sought on the following six issues:

“• The extent to which Vietnamese producers, including producers of
wooden furniture, use illegal timber.

“• The extent to which products of Vietnam made from illegal timber,
including wooden furniture, are imported into the United States.

“• Vietnam’s acts, policies, or practices relating to the import and use
of illegal timber.

“• The nature and level of the burden or restriction on U.S. commerce caused by Vietnam’s import and use of illegal timber.

“• The determinations required under section 304 of the Trade Act, including what action, if any, should be taken.” 85 FR 63639.

USTR must make a determination within twelve months of the initiation of the two investigations. USTR can seek agreement with Vietnam to address the U.S. concerns.

The investigations are being started roughly one month before the November 3 U.S. elections. Obviously, if President Trump is reelected, the investigations will continue. If former Vice President Biden is elected, it is unclear what his Administration would do with the pending investigations (if USTR has not completed them by January 20, 2021)., although presumably the investigations would be continued and completed.

The two Federal Register notices are embedded below.

Terence Stewart, former Managing Partner, Law Offices of Stewart and Stewart, and author of the blog, Current Thoughts on Trade.

To read the original blog post, click here. 

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Last year, the U.S. exported $106 billion worth of goods to China. About $68 billion worth of those exports are covered in the Phase One deal, and China has agreed to purchase more than double that over the next two years.

Those include soybeans, cotton, lobsters, cars, crude oil, semiconductors, and more.

But what about the goods China won’t be buying more of? What about the other $38 billion worth of goods U.S. exporters normally sell to China?

The biggest items that were left out of the deal were civilian aircraft, engines, and parts, which the U.S. exported more than $10 billion worth of to China last year.

Other items—which may not grab headlines like soybean and corn sales—include optical equipment, motor vehicle parts, chemicals and plastics, platinum, scrap (paper, copper, aluminum), and other miscellaneous goods.

Nonetheless, those are goods Americans work hard to create and sell when and where they can.

The administration has given no indication of whether more purchases will be included in the second—Phase Two—deal with China. It has indicated that Phase Two is to include more structural issues, like dealing with China’s government support for its industries.

But even then, Phase Two negotiations are a long way off.

In fact, the administration isn’t even thinking about Phase Two right now.

That makes sense, given that Phase One was just signed in January. Negotiations will likely have to wait until 2021, and progress on Phase One is measurable. But it also means Americans will have to continuing paying high tariffs on imports from China.

The administration has said tariffs on $370 billion worth of imports from China will remain until Phase Two is finished.

But even then, the administration’s lead negotiator is no longer sure what the goal of the past three years of the U.S.-China trade war has become.

“I don’t know what the end goal is,” U.S. Trade Representative Robert Lighthizer said. “Right now, we need to stop an aggressive force.”

At one time, the administration’s goal was closing the trade deficit with China, which is a dubious objective, given the value that both exports and imports bring to the U.S. economy.

It’s also a goal that hasn’t been met. After actually increasing in 2017-2018, the goods trade deficit with China in 2019 is about the same as it was in 2016. 

Nevertheless, if the administration wanted the Chinese to buy more U.S. goods, why not ask them to buy more of all U.S. exports, instead of picking winners and losers?

Better yet, why not focus on the sort of structural trade liberalization in both the U.S. and China that would raise overall volumes of trade, a measure that has declined since 2016? 

Now that would be a Phase Two worth having.  

To view the original blog post at the Heritage Foundation, please click here 

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According to the agreement, China has committed to purchase no less than an additional $63.9 billion of covered goods from the United States by the end of 2020 relative to these 2017 baselines. Defining the 2017 baseline using Chinese import statistics implies a 2020 purchase target of $172.7 billion (red in panel a). Defining the 2017 baseline using US export statistics implies a 2020 target of $142.7 billion (blue in panel a).

Through March 2020, China’s year-to-date total imports of covered products from the United States were $19.8 billion, compared with a prorated year-to-date target of $43.2 billion. Over the same period, US exports to China of covered products were $14.4 billion, compared with a year-to-date target of $35.7 billion. Through the first three months of 2020, China’s purchases of all covered products were thus only at 40 percent (US exports) or 46 percent (Chinese imports) of their year-to-date targets.

For covered agricultural products, China committed to an additional $12.5 billion of purchases in 2020 above 2017 levels, implying an annual target of $36.6 billion (Chinese imports, panel b) and $33.4 billion (US exports, panel c). Through March 2020, China’s imports of covered agricultural products were $5.1 billion, compared with a year-to-date target of $9.1 billion. Over the same period, US exports of covered agricultural products were $3.1 billion, compared with a year-to-date target of $8.4 billion. Through the first three months of 2020, China’s purchases were thus only at 37 percent (US exports) or 56 percent (Chinese imports) of their year-to-date targets.

For covered manufactured products, China committed to an additional $32.9 billion of purchases in 2020 above 2017 levels, implying an annual target of $110.8 billion (Chinese imports) and $83.1 billion (US exports). Through March 2020, China’s imports of covered manufactured products were $14.6 billion, compared with a year-to-date target of $27.7 billion. Over the same period, US exports of covered manufactured products were $10.9 billion, compared with a year-to-date target of $20.8 billion. Through the first three months of 2020, China’s purchases were thus only at 52 percent (US exports) or 53 percent (Chinese

To view the original article, please click here

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For the first time in almost 50 years, the UK is now developing its own trading relationships. This article reviews options for UK trade deals post Brexit and the potential impacts they may have on the UK’s trade balance.

The EU and UK trade policy objectives did not necessarily coincide

Since 1973, UK trade policy has been made by the European Union. The UK’s national interest has, therefore, been subordinated to that of the collective group of nations that make up the European Union. This has had important ramifications given the different structure of the UK economy compared with the EU bloc of which it was a part.

For example, as a collective, the EU is a net exporter of food, while the UK is a net importer. The UK produces about 50% of the food that it consumes, yet most EU agricultural policy has been aimed at curtailing production of food to limit the Union’s excess production. This fact alone means that in trade negotiations the importance of agricultural protection for “domestic” producers differs dramatically between say, France and the UK.

The UK’s interest lies in being able to purchase food from abroad at the best possible price, irrespective of whether it comes from the EU or not. In contrast, many EU countries see their national interest in protecting domestic producers from more efficient and lower cost global producers at the expense of European consumers.

The importance of manufacturing exports to the German economy is much greater than it is to the UK. Conversely, the UK’s largest exports are in the service sector, which made it unique among the major members of the EU. Where the UK’s national interest diverges from the collective interest of the EU, the UK’s departure from the EU should provide the opportunity for a more bespoke and therefore potentially more favorable trade regime.

Quite apart from the differing trade priorities, membership of the EU has impacted the pattern of UK trade further through the indirect impact of the development of the Eurozone. The consequence of an economically diverse group of European countries sharing a common currency has been a growing misalignment of exchange rates between some of the UK’s largest or potentially largest trading partners.

The single European currency has distorted trade patterns and stifled growth

The southern European countries have in general suffered from structurally high levels of unemployment and stagnant growth at least in part as a consequence of sharing an exchange rate with the more dynamic northern nations. The lack of economic growth in Italy, Spain, Greece and Portugal has dampened their demand for imports.

Conversely, the northern countries, in particular Germany, have benefited from undervalued exchange rates. They have broadly speaking enjoyed high levels of employment and income growth driven by their exporting success. This income growth has not translated into import demand in the same quantity and their current account surpluses have therefore ballooned to gargantuan proportions.

About 90% of the growth in world imports was outside the EU in the past decade

A dysfunctional Eurozone has not provided a good external economic environment for UK exporters. While global imports grew USD 5.25 trillion between 2008 (the pre-GFC peak) and 2018, imports of Eurozone countries grew by just USD 468bn accounting for a mere 9% of the global total, with the broader EU (excluding the UK) accounting for about 11%. In other words, 90% or so of the growth in the potential UK export market took place outside of the EU.

Half of the growth in world imports has come from Asia since the GFC

The second major global trend shaping the UK’s trade environment has been the economic rise of Asia generally and China in particular. In 1999, prior to China’s accession to the WTO, China accounted for just 0.8% of UK exports and 1.6% of UK imports. The rapid rise of a mercantilist China as a global trading power means that the PRC now accounts for about 7% of UK imports and 3.5% of UK exports. Asia in total accounts for about 20% of UK trade.

While the UK’s future economic relationship with China is intrinsically bound up with security and geopolitical issues, the rest of Asia still proffers a tremendous trading opportunity, particularly if the newly industrialized and emerging Asian countries begin to diversify away from China and abandon their neo-mercantilist approach to trade.

In contrast to the 9% share in global import growth of the Eurozone in the decade through to 2018, East Asia and the Pacific has accounted for 50% of the total growth, split roughly 50:50 between China and the rest. In addition, South Asia and the Arab world has accounted for about another 11%.

The UK has moved from being a net exporter to a net importer of energy

Finally, the UK’s trade pattern has been heavily impacted by the deterioration in North Sea oil production which has turned the UK from a net exporter of oil and petroleum products to a net importer. Having spent most of the period from 1980 onwards as a net exporter of energy, the UK turned a net importer in 2004. Since then, energy dependence has risen and imports now account for about one-third of primary energy supply.

This resulted in an energy trade deficit of GBP18 bn in 2017 or about 0.7% of GDP being almost entirely composed of imports of oil and gas. The UK is a relatively efficient user of energy (2.8 tons of Oil Equivalent per capita versus the US at 6.8 tons, for example) and therefore security of supply will have to come from diversification of source, geopolitical considerations and in the medium term an increasing proportion of domestically sourced renewable energy. In the UK there is a confluence of interest between the green agenda, national security concerns, trade and industrial policy when it comes to energy policy.

The UK has run persistent trade deficits in recent decades

If the above factors have been the major drivers of trade patterns in the UK, what has the result been? The UK has been a perennial current account deficit country running a deficit in every year since 1985 despite being an energy net exporter through till 2004. The trade balance in goods and services has been positive in just 18 out of the last 62 years and most of those years were pre-1985. The UK recorded a very modest trade surplus in the three-year period 1995-1997.

Very substantial goods deficits have been somewhat offset by large services surpluses

Underlying the consistent deficits, however, has been a bifurcation of performance between trade in goods on the one hand, and trade in services on the other. Since the early 1980s the UK’s trade in goods has been consistently in deficit while the services sector has been producing consistent and growing surpluses – albeit not large enough to pay for the goods deficit.

These imbalances are among the largest in the world. For example, the UK’s deficit in goods trade in 2017 and 2019 averaged in excess of 6.5% of GDP, while the surpluses in services were over 5% of GDP.

Although goods exports as a percentage of GDP are well off their high of 20% reached in 1977, they still stand at 16% of GDP, roughly in line with their long run average. The decline in the UK trade position in goods has therefore more to do with the increased imports of goods as a percentage of GDP, than a decline in goods exports. Service exports as a percentage of GDP have risen from about 5% in the late 1980s to 14% of GDP in 2018 making them almost the same size as goods exports.

There has been a stark difference between the balance of trade with the EU and the balance with the rest of the World

If there is a stark contrast between the trade performance of the UK in goods versus services, there is an equally stark contrast between the balance of UK trade with the European Union and with the rest of the world.

UK trade with the rest of the world has oscillated between surplus and deficit regularly in a cyclical fashion with the current position being a sizable but not outrageous surplus. In contrast, the UK has run consistent, very sizable and growing deficits with the EU. These have grown dramatically since the turn of the century.

In 2018 the UK ran a deficit with the EU of 4.5% of GDP

In 2018, for example, The UK ran a goods deficit with the EU of GBP94 bn (4.5% of GDP). This was modestly reduced by a services surplus of GBP 28bn giving an overall trade deficit with the EU of GBP66 bn. In contrast, the UK ran a trade surplus with the rest of the world of GBP29 bn leaving an overall deficit of GBP37 bn.

The single currency has prevented the natural adjustments from taking place

On the eve of the introduction of the single currency in 1999, the UK’s deficit with the EU was just a modest GBP13 bn. It grew steadily but controllably through to GBP22 bn in 2011 when the Eurozone crisis broke and has tripled in size since then. The key driver has been growing currency mis-alignment – the deficit with Germany has grown much faster than say that with Italy – and a complete lack of growth in the Euro Area.

Poor growth in the Euro Area has limited the scope for export growth

In 2008, Euro Area GDP was USD14.1 trillion; the Euro Area ran a current account deficit of USD250 bn meaning final domestic demand was about USD 14.3 trillion. A decade later and final domestic demand in the Euro Area has fallen by 8% or more than USD1 trillion – with no growth in nominal GDP and a big swing in net exports. UK final demand has been flat on this measure while world final demand, the UK’s opportunity set, has risen USD22 trillion.

To view the full blog, click here.

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The commitment to market-determined exchange rates was long the policy of the Obama administration and China had accepted this goal through its participation in communiques of G-20 finance ministers and central bank governors, who endorsed it. China has not engaged in substantial intervention in the foreign exchange market since 2016, and its current account (trade) surplus has been less than 2 percent of GDP in recent years.

In August 2019, the US Treasury designated China as a currency manipulator. At that time, Treasury claimed that “China has taken concrete steps to devalue its currency,” but no evidence has emerged to support that claim. Rather, most economists and market analysts agree that China’s currency depreciated organically, without official manipulation, in a market response to rising expectations of US tariffs on Chinese exports, a textbook economic relationship that is supported by a recent PIIE working paper. It is undoubtedly true that China could have intervened to prevent or reverse the depreciation of August 2019, but that would be contrary to the goal of maintaining a market-determined exchange rate. The phase one currency chapter does not call for China to take any steps to resist future market developments.

To view the full blog, click here.

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In recognizing this trend, while employing somewhat misguided criteria, the US Treasury Department again did not name any country a manipulator in its semiannual report to Congress on Foreign Exchange Policies of Major Trading Partners of the United States on May 28. This post updates the status of manipulation by 19 countries using the Bergsten-Gagnon criteria (listed below).

According to Bergsten and Gagnon (2017), a country must meet all of the following criteria to be considered a currency manipulator in a given calendar year:

• the current account surplus exceeds 3 percent of GDP;
• net acquisitions of official foreign-currency assets (net official flows) exceed 2 percent of GDP;
• foreign exchange reserves and other official foreign assets exceed three months of imports;
• foreign exchange reserves and other official foreign assets exceed 100 percent of short-term external debt, public and private;
• net official flows exceed 65 percent of oil exports minus production cost;
• classification by the World Bank as a high-income or upper-middle-income country.

Some oil exporters increased purchases, but only Norway manipulated

One notable change in 2018 was an increase in foreign asset purchases by a few major oil exporters. Oil prices fell sharply in 2014 and 2015, prompting many oil exporters to draw down their foreign assets in 2016 and 2017. Prices have recovered partially since then. Only Algeria and Trinidad and Tobago continued to draw down foreign assets in 2018, while Oman and the United Arab Emirates (UAE) returned to balance. The remaining oil exporters—Norway, Kuwait, and Russia—either resumed or increased purchases of foreign assets. Only Norway’s purchases, however, exceed 65 percent of oil exports minus production cost. For most oil producers, the optimal saving rate out of net oil revenues is less than 75 percent, some of which should be invested at home Gagnon (2018).

Some financial centers had lower private capital inflows in 2018

Financial centers have been the largest manipulators in recent years. In dollar terms, Switzerland and Singapore had the world’s largest net official flows in 2016 and 2017, and Singapore continued to do so in 2018. Manipulation in these economies typically responds to private capital inflows, which can be volatile. In 2018, private capital inflows slowed, reducing the amount of net official flows needed to stabilize their exchange rates. However, net official flows continued to exceed the 2 percent of GDP criterion in Singapore and Macao.

Each financial center’s manipulation is a response to different circumstances. Switzerland’s central bank conducts its manipulation to prevent further appreciation of the Swiss franc and maintain a large current account surplus. Singapore’s manipulation derives primarily from its public pension system, which collects high payroll taxes from workers and invests them entirely overseas through a sovereign wealth fund to back future pension obligations. Hong Kong and Macao have fixed exchange rates and high rates of domestic saving, which create current account surpluses that the monetary authority buys up to prevent appreciation. Macao also has a separate fiscal reserve account that invests fiscal surpluses overseas.

China is not manipulating

China was by far the largest currency manipulator in 2003–13. It reversed that practice in 2015–16, when it sold large amounts of foreign assets to prevent its currency from depreciating when private investors became net sellers. The private net outflow ended in 2017, and China was the third largest net official purchaser in dollar terms that year. But these flows were less than 1 percent of GDP. Based on incomplete data, China made essentially no net purchases or sales in 2018, but maintained its enormous stock of official assets, the bulk of which are reserves.

To view the full blog, click here.

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