TPP and Provisions to Stop Currency Management: Not That Hard
As discussions surrounding the proposed Trans-Pacific Partnership (TPP) heat up, there has been a new push to include provisions within the agreement to keep countries from managing the value of their currency for competitive gain vis-à-vis their trading partners. This push got an unexpected (by me, anyhow) boost recently when former U.S. Treasury Secretary and former Obama administration National Economic Council Director Larry Summers called for it (see page 22 in the link).
This currency management is a key cause of persistent U.S. trade deficits, and it is widespread. Given that our trade deficit drags on demand growth, and given that generating sufficient demand to reach full employment is likely to be a key economic problem in coming years, this is an important issue to address. Further, given that U.S. tariffs are extremely low, it’s hard to think of any other issue besides currency management that could possibly matter more for trade flows, so excluding it from the TPP seems odd. And yet many TPP proponents are extremely reluctant to include binding tools to stop currency management in the treaty. There have been many arguments for why the United States can’t or shouldn’t stop currency management, but the latest rationale is pretty novel: the claim is that including a currency chapter in the TPP would let other countries use the provisions of the treaty to stop the Federal Reserve from engaging in expansionary monetary policy. If such a provision had been in effect during the Great Recession, this argument continues, it would have kept the Fed from engaging in the quantitative easing (QE) that it undertook to blunt the recession and spur recovery.
Tying the Fed’s hands like this would indeed be a bad thing, but there’s no reason at all to think one couldn’t define currency management in way that did not constrain the Fed or any other central bank wanting to undertake similar maneuvers.
This gets mildly wonky, but here’s why: QE works through the Fed purchasing domestic assets in exchange for reserves it creates. That is, the Fed buys U.S. Treasury bonds and U.S. mortgage backed securities (MBS) and credits the sellers with reserves held at the Fed. This has a first-order effect of lowering interest rates on Treasury bonds and MBS. These lower rates in turn do provide some downward pressure on the value of the U.S. dollar, which makes our exports cheaper and imports more expensive, thereby reducing our trade deficit. But the primary channel and primary target is the domestic interest rate, and the asset being purchased is denominated in the same currency that the nation’s monetary authority controls.
Conversely, when people describe mercantilist currency management, they universally mean the purchase by a nation’s monetary authorities of foreign assets. So, the Chinese central bank buys not Chinese bonds, but U.S. Treasury bonds and MBS. This has the first-order effect of changing the relative demand for Chinese versus U.S. assets, which moves the U.S.-China exchange rate.
So, putting limits or rules or the extent of foreign asset purchases a nation’s monetary authorities can do in the TPP (or some other agreement) would do nothing at all to stop initiatives like the Fed’s QE program during and after the Great Recession.