Special OTN Update - Assessing the Global Currency War [Oct 14, 2010]

SPECIAL
OFFICE OF TRADE NEGOTIATIONS

… for trade matters
OTN Update
October 11, 2010

A s s e ssi n g th e G l o b a l
Cu rr e n c y W ar
Currency alignments have been a source of concern in effect of the yen’s devaluation.2
international economic relations on several occasions in the past.
Recently however, tensions have been so high in this regard that This type of exchange rate re-alignment has been the catalyst
there have been calls for major economic fora such as the G20 to for the escalation of tensions between the US and other
add it to their agenda. Additionally, in the view of at least one states such as China, in particular. Having declared that the
state, Brazil, the world is already in the midst of a currency war.1 official exchange rates of some currencies are artificially low,
the US Government is seeking to enact legislation that will
At first glance, it does appear that the exchange rates of the empower the Federal government to impose punitive tariffs on
currencies of the major economies such as the United States of US imports originating in countries whose currencies are
America, China, Europe and Japan are not only moving unusually deemed to be fundamentally undervalued. The Chinese
frequently but appear to be jockeying for specific positions – one authorities have dismissed the claim.
relative to another. Some observers have contended that these
depreciations reflect attempts at competitive devaluation on the
part of several of these economies. The intention of the states
participating in this exercise would be to lower their exchange
1
rates (and the prices of their exports denominated in foreign Brazilian Finance Minister Guido Mantega warned of an international
currencies) in order to boost those exports. Japan, South Korea currency war while addressing a gathering of Brazilian industrial leaders
on September 27 2010. See http://www.theglobeandmail.com/report-
and Taiwan as well as the USA recently took action consistent on-business/economy/world-is-in-currency-war-
with this claim. The Central Bank of Japan, for example, recently brazil/article1728151/print/
intervened on the currency market by way of a one trillion yen sale 2
See , Grey, B., US House Passes Anti-China Trade War Bill, Global
in order to force the exchange rate of the yen downward, i.e. to Research, October 1 2010 available at
‘cheapen the yen’. On the heels of this action, the USA http://www.globalresearch.ca/index.php?context=va&aid=21252
announced higher interest rates. The consequential and
predictable sale of U.S dollars completely or largely nullified the

OTN UPDATE is the flagship electronic trade newsletter of the Office of Trade Negotiations (OTN), formerly the Caribbean Regional Negotiating Machinery
(CRNM). Published in English, it is a rich source of probing research on and detailed analyses of international trade policy issues and developments
germane to the Caribbean. Prepared by the Information Unit of the OTN, the newsletter focuses on the OTN, trade negotiation issues within its mandate
and related activities. Its intention is to provide impetus for feedback by and awareness amongst a variety of stakeholders, as regards trade policy
developments of currency and importance to the Caribbean.
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2

What is the purpose of these re-alignments? In the case of China,
a growing trade and economic rival of the USA, the US has Can WTO rules influence the
argued that China is manipulating its exchange rate in order to management of exchange rate
obtain a trade advantage and to maintain an unfair advantage in
the international trade system. It is true that by undervaluing its policy?
currency, a country is making its exports cheaper on the
international market and imports relatively more expensive in
domestic currency terms. In normal circumstances, this would As defined by the International Monetary Fund (IMF),
enhance demand for exports and drive down imports. Viewed this
“an exchange rate policy involves a broad range of external
way, the action has the same effect as a tariff on imports, and an
policies that are specifically pursued for balance of payments
export subsidy. If it could be proven, both of these measures
purposes; e.g. the introduction of or substantial modification
would contravene current WTO rules.
for balance of payments purposes of restrictions on, or
Export subsidies are strictly prohibited under WTO rules. While incentives for, the inflow or outflow of capital. Moreover, to the
tariffs impede the access of imports, export subsidies artificially extent that certain domestic policies are also pursued for
stimulate export production. The financial benefits exporters balance of payments purposes, the indicators suggest that
derive from export performance may be considered as an these would also be included; specifically, the pursuit, for
intervention, and are frowned on by WTO rules. Both tariffs and balance of payments purposes, of monetary and other
export subsidies have the potential to distort patterns of trade in domestic financial policies that provide abnormal
directions different from those consistent with comparative encouragement or discouragement to capital flows. However,
advantage. In this sense, if the allegation is true, access to domestic policies pursued for these specific purposes should
China’s market negotiated by WTO members as part of the be distinguished from domestic policies that only have this
conditions for China’s accession to the WTO in 2001 may not effect. The latter category would not be considered exchange
materialize. The measures could frustrate the expectations of the rate policies within the meaning of the 1977 Decision.” 4
other WTO members as regards market access.
With respect to issues arising from the management of
There are several underlying issues of concept and application exchange rates policy and other monetary policy, Article
involved in the claims of undervaluation. Comparative advantage XV:2 of the WTO General Agreement on Tariffs and Trade
is not a static concept and all states take steps to enhance their (GATT) explains that
competitiveness in international markets. China, one of the
“In all cases in which the CONTRACTING PARTIES are
countries at the centre of the storm, has seen its comparative
called upon to consider or deal with problems concerning
advantage actually shift since the 1990s in just the same way that
monetary reserves, balances of payments or foreign
Japan’s shifted radically after the 1960s. Within agriculture, for
exchange arrangements, they shall consult fully with the
example, China has had to cede ground on cotton, grains and
International Monetary Fund. In such consultations, the
sugar in favour of Thailand. Its production and exports have been
CONTRACTING PARTIES shall accept all findings of
shifting to more labour intensive crops such as fruit and
vegetables, in which it appears to now have a comparative
advantage. 3 Given the imperfections in the currency market/s, the
correct or optimal value of a currency is a moot point.

However, does China’s exchange rate policy contravene the WTO
3
rules simply because it has similar effect as a tariff and subsidy? International Assessment of Agricultural Knowledge, Science and
Technology for Development (IAASTD), ‘Agriculture at a Crossroads’,
In order to answer this question, it is necessary to review WTO Volume II: East and South Asia and the Pacific (ESAP), 2009, pgs. 187-
rules concerning the management of exchange rate policies. 188.
4
See IMF, Article IV of the Fund’s Articles of Agreement: An Overview of
the Legal Framework, 2006

http://www.crnm.org

3

statistical and other facts presented by the Fund relating to have is a hammer, everything looks like a nail!’. 6
foreign exchange, monetary reserves and balances of
payments, and shall accept the determination of the Fund as to In these circumstances the IMF’s credibility as a judge would
whether action by a contracting party in exchange matters is in be on the line.
accordance with the Articles of Agreement of the International
So, the more important question that needs to be answered
Monetary Fund, or with the terms of a special exchange
would not be how the IMF would decide but rather the WTO’s
agreement between that contracting party and the
jurisdiction on this matter.
CONTRACTING PARTIES.”
Returning to the GATT, Article XV:4 further indicates that
It follows that, with respect to addressing complaints such as
notwithstanding the deference to the IMF,
those regarding alleged currency manipulation, the WTO has
deferred to the IMF as the body to decide on such matters. On “Contracting parties shall not, by exchange action, frustrate
matters of currency manipulation, Article IV, Section 1 (iii) of the the intent of the provisions of this Agreement, nor, by trade
Articles of Agreement of the International Monetary Fund (IMF) action, the intent of the provisions of the Articles of Agreement
does indicate that countries should avoid manipulating of the International Monetary Fund.”
exchange rates in order to gain an unfair advantage over other
members. For the purposes of this Article, the concept of The policies implemented with respect to exchange rates
manipulation to gain an unfair advantage has been defined to should not frustrate the objectives of the GATT. Basically, the
mean a fundamental exchange rate misalignment in the form of latter are to prevent the distortion of trade through the
an undervalued exchange rate and the purpose of the reduction of tariffs and the removal of other trade barriers to
misalignment is to increase net exports.5 the trade of goods amongst WTO members. On the other
hand, the Article also communicates that trade actions should
Whether the IMF would conclude that China’s exchange rate not frustrate the objectives of the IMF agreement. This
policy aims at exchange rate misalignment in order to increase suggests that even though an action by a government may
net exports is debatable. This is particularly the case because not be considered a contravention of the IMF rules, that action
the IMF itself has, over the years, been accused of providing should not frustrate WTO objectives. Therefore, WTO
advice to member states which relies inordinately on currency jurisdiction is relevant to matters relating to the effect of
devaluations to remedy external and internal imbalances. In this exchange rate policy in as far as they may frustrate the
sense at least, it has to be acknowledged that the exchange objectives of the rules of trade.
rate is a tool aimed at many goals. In a recent review of the
policies of the institution for example, Richard Fletcher formerly The U.S. case against China is that by having the effect of an
of the IDB has quoted Guyana’s former Minister of Finance as export subsidy, China’s exchange rate policy frustrates the
describing the IMF’s approach as being similar to that of a objectives of WTO rules. As discussed earlier, an
workman with only a hammer at his disposal - ‘when all you undervalued exchange rate can be deemed equivalent to a
combined set of policies – a tariff imposition and export
subsidization – that could represent an infringement of WTO
5
rules.
For guidance on the interpretation of Article IV, Section 1(iii) refer to
the Annex of NTERNATIONAL MONETARY FUND Bilateral Surveillance
However, it has long been acknowledged that the efficacy of
over Members' Policies Executive Board Decision, June 15, 2007
available at devaluation in enhancing export income would depend on
http://www.imf.org/external/np/sec/pn/2007/pn0769.htm#decision price and income elasticity of demand. Demand does not rise
6
Fletcher, R., ‘Undervaluation, Adjustment and Growth’ in Brawley, M
simply because a specific price falls. Additionally, the actual
Power, Money, and Trade: Decisions that Shape Global Economic
Relations, H.E Division, University of Toronto Press, 2005, p. 352. impact of this action on market shares would depend on price
7
See Staiger, R. and Sykes, A. , “Currency Manipulation and World flexibility. 7 In the long term, in the face of price flexibility, a
Trade”, May 2010 available at devaluation would have no permanent effect because prices
http://www.stanford.edu/~rstaiger/china.paper.052010.pdf
in the devaluing country will eventually adjust, leaving relative
prices ‘the same’ and import and export volumes unchanged.

http://www.crnm.org

4

Furthermore, there are conceptual and operational problems acting, explicitly limits access to the subsidy to an enterprise
with the U.S. approach which seeks to employ, through or industry or group of enterprises or industries. Even when
legislation, the isolation and remedy of only the export specificity is not obvious on the face of it, other factors can be
subsidization effect of the alleged undervalued currency. used to judge whether the subsidy is de facto specific.

At the same time estimating the short term impacts when However, in order for an action deemed as a subsidy to
prices are not flexible would be complex. Even in this regard, qualify as a prohibited export subsidy, the latter would have to
however, the objective assessment of the real trade impact be contingent upon export performance.
would depend on the way goods (and services) are priced.8
An undervalued exchange rate has a systemic macro-
All of the foregoing suggests that whether prices are flexible economic effect which cannot be isolated or limited to a
or not, standard trade models do not impel us to the specific group of enterprises. The burden of proof required to
conclusion that exchange rate misalignment undermines make a convincing case that an undervalued exchange rate
WTO commitments. The translation of the impacts of a constitutes a financial contribution which benefits a specific
devaluation into an equivalent set of trade policy actions is enterprise or industry or group of enterprises or industries
complex and fraught with challenges. And, we have not yet would therefore be challenging to discharge. Though the U.S.
considered injury. Looking at the debate to date, there is little legislation purports to use trade remedies on the grounds of
basis for assuming that trading partners have been materially export subsidization, the U.S. would need to objectively show
injured by the Chinese exchange rate policy. how an undervalued currency meets the above criteria.

Since the USA’s contention is that China’s policy undermines There is an additional legal element which is beyond the
or even contravenes WTO rules, it would be useful to scope of the above examination. Are there other trade rules
examine the U.S. complaint against China from a legal that can be used to curb the practice of competitive
perspective. devaluation? A Non-violation complaint has been cited as an
alternative legal recourse.
The U.S. legislation seeks to facilitate action against exports
from countries whose interventions in currency markets can Article XXIII:1(b) of the GATT states that
be defined as an export subsidy in accordance with WTO
rules. 9 As alluded to previously, the GATT rules establish
criteria for defining subsidies. The WTO Subsidies and
Countervailing Duties (SCM) Agreement identifies two
discrete criteria that should be used to determine if a
government action can be deemed as a subsidy. 8
Ibid.
9 As indicated by the one-page summary of H.R. 2378 , the U.S.
The first criterion is that there must be a financial contribution countervailing duty law facilitates the imposition of remedial tariffs on
by the government in question. This financial contribution can imports benefiting from foreign government subsidies for export, if it is
shown that imports benefiting from such subsidies cause or threaten
take the form of the direct transfer of funds or the potential injury to a U.S. industry producing the same or similar products.
(direct) transfer of such funds; government revenue, However, the U.S. Department of Commerce has, to date, declined to
otherwise due, forgone or not collected; the provision of investigate foreign government currency practices as a countervailable
subsidy. The new U.S legislation - The Currency Reform for Fair Trade
goods and services or purchases of goods by the Act – now requires the Department of Commerce not to ‘dismiss a
government; and payments to a funding mechanism made by claim based on the single fact that a subsidy is available in
the government. circumstances in addition to export’ and further requires Commerce to
‘consider all the facts in making its determination of export
contingency.'
In addition, a benefit must be conferred on a recipient as a To view the one page summary see
result of the financial contribution. The SCM Agreement also http://faircurrency.org/legislation/HR2378_one-pager.pdf
requires that the subsidy be specific to an enterprise or The Currency Reform for Fair Trade Act is available at
http://faircurrency.org/legislation/HR2378%20Bill%20Text%20%20Refe
groups of enterprises. Specificity in this context is determined r%20in%20Senate.pdf
if the government or legislation under which the government is

http://www.crnm.org

5

“If any contracting party should consider that any benefit how the WTO system can be used to compel nations to
accruing to it directly or indirectly under this Agreement is amend their exchange rate policies.
being nullified or impaired or that the attainment of any
objective of the Agreement is being impeded as the result
of…(b) the application by another contracting party of any
measure, whether or not it conflicts with the provisions of this The consequences of unchecked
Agreement, …the contracting party may, with a view to the
satisfactory adjustment of the matter, make written systemic competitive devaluation
representations or proposals to the other contracting party or
parties which it considers to be concerned. Any contracting
party thus approached shall give sympathetic consideration to Competitive devaluation in one country tends to prompt
devaluation responses in other countries. In terms of trade
the representations or proposals made to it.”
gains, although specific states may gain a temporary
The case law indicates that in order to prove non-violation, the advantage, this exercise is a zero-sum game in global terms.
complaining party must identify the benefit accruing under the Consequently, competitive devaluation is typically regarded
agreement and show the nullification or impairment of the as a beggar-thy-neighbour policy. In addition, whereas the
benefit as the result of the application of the measure. effects may be benign when implemented only by one country
or a small cluster of countries which are not major economies
While on the face of it, this Article may appear to be a ‘catch in the global system, competitive devaluation involving several
all’ for any perceived nullification or impairment of benefits, major trading states can trigger unstable trade flows, inflation
the WTO case law also makes it quite clear that the Article is and chronic global disturbances which can also affect, inter
intended to be used with caution and treated as an alia, investment and the global distribution of resources.
exceptional concept because “Members negotiate the rules CARICOM states, like many developing countries, are
that they agree to follow and only exceptionally would expect particularly vulnerable to such global systemic imbalances
to be challenged for actions not in contravention of those and would presumably have no interest in a global currency
rules.” 10 war.

This notwithstanding, establishing a case that China’s
exchange rate policy nullifies an anticipated benefit
(presumably a market access benefit) would be challenging. A
market access package was arranged during the negotiations
of China’s WTO accession to the WTO in 2001. During that
time, China’s current exchange rate policy was in place. It is
doubtful therefore that a credible objection to that policy could
now be used in a non-violation complaint.

The extent to which the WTO rules can be used to mitigate
what the Brazilian Finance Minister perceives as a currency
war therefore seems limited. Furthermore, it is not obvious

10
See Japan - Measures Affecting Consumer Photographic Film and
Paper, Report of the Panel, WT/DS44/R

US Treasury Secretary, Timy Geithner
Photograph: Reuters

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6

adjustment in CARICOM?

The availability of cheaper imports for the Region would be
Policy responses to the welcome if the goods and services in question are not
‘Currency War’ produced domestically. The consequence would be higher
real incomes for consumers and or the availability of less
expensive inputs for domestic producers and exporters. There
Some countries such as Brazil and South Africa have would be benefits for employment, output and national
considered imposing higher taxes on capital inflows in order income.
to stem the appreciation of their currencies – the corollary of
the devaluation strategies employed by other states. However, it is reasonable to surmise that the practitioners of
competitive devaluation are not unaware of the limitations of
However, as with the imposition of tariffs and the the practice and that they contemplate an end game which
establishment of other barriers to trade, the restriction of necessitates a different longer term trade strategy.
capital inflows could be counterproductive. In any case this is
not an option which would commend itself to all states, U.S. President Barack Obama has suggested the orientation
particularly those dependent on foreign direct investment and of U.S. trade and industrial policy should be guided by a more
the movements of hot money. tangible strategy.

The debate on currency wars can at times appear to be “History should be our guide. The United States led the
bizarre if one recalls the lengths to which many states go to world’s economies in the 20th century because we led the
avoid formal devaluations of their currencies. This reticence world in innovation. Today, the competition is keener; the
arises from the fact that the exercise is not costless. There challenge is tougher; and that is why innovation is more
are consequences for the cost structures of domestic and important than ever.” 11
export industries with implications for the competitiveness of
the export sector and the share of wages in national income.
Devaluation of a currency per se is not a viable long term
strategy. To be viable it needs to be implemented in tandem
with measures to improve factor, including labour,
productivity.

Recognizing (i) the limits of WTO rules to mitigate competitive
devaluation, (ii) the short term or rather short lived benefits of
competitive devaluation, and (iii) the short term impact of
policy responses such as those being undertaken by Brazil,
what then are the sustainable substantive options for policy

L-R: World Bank president Robert Zoellick, and IMF managing
director Dominique Strauss-Kahn at the annual IMF-World
Bank meeting in Washington on Thursday.
Photograph: Yuri Gripas/Reuters
11
See ‘A Strategy For American Innovation: Driving Towards
Sustainable Growth and Quality Jobs’, Executive Office of the President
of the United States, September 2009 available at
http://www.whitehouse.gov/sites/default/files/microsites/ostp/innova
tion-whitepaper.pdf

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7

The same obtains for other countries including those in the human resource management. This will be necessary to
Caribbean. ensure that the right kind of work force is being cultivated to
operate functionally in productive sectors that are
While unwary and ‘unalert’ policy makers are distracted by the appropriately oriented towards knowledge-based
tit-for-tat exchange of a currency war, China as well as the competitiveness.
United States are pursuing strategies to ensure their
dominance of the new global knowledge economy.

Whether or not this ‘war’ persists beyond the short term ***************
therefore, the Caribbean requires, a strategy which
recognizes the competitive strengths in the Region as well as
the changes in global trading patterns.

Those patterns favour products and services based on
innovation and the knowledge industry. Therefore, what is
required are government policies and producers, which are
responsive enough to foster and nourish innovation-based
outputs and industries, and are capable of responding
increasingly in sync with the speeds which characterize the
communication and technological revolution.

This holds true for the USA and China as well as for the
Caribbean. The Region can have no interest in being a victim
of competitive devaluation nor does its interest lie in being a
spectator while the rest of the world retools. The Region shall
have to effect the necessary adjustments. This will not always
be easy but it is urgent.

The generation and exploitation of knowledge will be essential
in maintaining rapid rates of future economic growth and
competitiveness. The good news is that the knowledge
economy is still a relatively new area in trade and as such,
entry barriers and costs of learning are still manageable as
are strategic alliances with other trading partners.
Furthermore, competitiveness in this arena is, thankfully, not
reliant to the same degree on the existence of economies of
scale as is the case in the production and export of goods.

CARICOM countries should therefore intensify their efforts to
improve productivity, diversify their productive sectors through
innovation in processes and products and, to foster the
development of national and regional intellectual capital.
These are necessary in order to drive their own long term
competitiveness within the new knowledge economy.
Success in this regard requires a high degree of coordination
and harmonization between national and regional
development policies, industrial policy, industrial relations and

http://www.crnm.org

Special OTN Update - Assessing the Global Currency War [Oct 14, 2010]

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