Here in Brazil we have not thought very much about China over the years. It is far away and culturally alien to us. In the 21st century, China has not gotten any closer to Brazil, nor is it less foreign to us, but we are thinking about it a lot lately all the same, particularly those of us engaged in business and trade. Like many other countries, we discuss the actual value of China’s currency, the yuan. Some say the yuan is undervalued by 20 percent against the dollar and other major currencies; others claim that 40 percent is a more accurate estimate. But everyone agrees that Chinese currency manipulation has seriously damaged other economies, including ours.Its harmful consequences are multi-dimensional. On the one hand, currency manipulation produces effects similar to those of an import tariff, restricting access to the Chinese market. On the other, it functions as a kind of subsidy for Chinese exports, rendering them artificially competitive. The increased aggressiveness of Chinese exports damages both the industry of the importers and that of third countries whose imports are being displaced. The wider, long-term implications of Chinese currency manipulation include the de-industrialization of many economies. Chinese demand for commodity imports pushes the balance in developing economies like Brazil away from value-added manufacturing processes and back agriculture at the same time as it pulls the demand for manufactures toward itself. This is not the only problem that economies like Brazil have experienced in recent years. After the 2008 world economic crisis, both American and European policymakers focused on increasing exports as a major means of economic recovery. To gain advantage in doing so, many governments engaged in what is euphemistically called quantitative easing. Then the Chinese successfully “re-pegged” to the dollar, leaving Brazil worse off than before. Its currency has grown stronger, and its exports have been damaged even more. Brazil has nevertheless posted strong economic growth figures, based largely on commodity exports and more vibrant domestic demand. For this reason, most Brazilians are not particularly upset by the Chinese international economic policy, although the economic and political elite are now well aware of the challenge it poses for Brazil’s future. Times like these should lead us to reflect on history. When the 1944 Bretton Woods Agreement, which established the dollar standard, collapsed in 1971 as President Richard Nixon unilaterally cancelled the direct convertibility of the dollar to gold, U.S. Treasury Secretary John Connally was reputed to have said: “The dollar is our currency but your problem.” Setting aside the spirit in which he made this remark, Connally was essentially correct, and he has been correct ever since. The difference today, with the rise of China and the tactics the Chinese government has adopted toward the international economy, is that the “dollar standard” is now America’s problem too. While there is a broad consensus as to the nature of the problem, there is not yet any agreement on what to do about it. To some extent, we lack the proper instruments. The International Monetary Fund has clear rules against currency manipulation but lacks the power to enforce them. On the other hand, the World Trade Organization does have the power to enforce its agreements through the dispute settlement process, but it does not specifically regulate currency manipulation. While technically correct, this assessment of what the IMF and the WTO can and cannot do embodies an obsolete assumption that leads to a mistaken conclusion. The obsolete assumption is that the clear line that once divided international financial regulation from international trade regulation during the “gold standard” years has not changed despite the 1971 implementation of the “dollar standard.” But that line has obviously blurred. The current “currency war” has financial roots, but its consequences directly affect international trade, making currency manipulation rightfully the WTO’s business. The mistaken conclusion following from the obsolete assumption is that the problem of currency manipulation is insoluble because the regulation of the problem’s origin is separate from the regulation of its consequences. It doesn’t have to be separate, provided there is sufficient political will to join the two. We currently lack a single international organization with the power and mandate to regulate international trade and finance together. One day, perhaps, that deficiency will be remedied, but we are not helpless in the meantime. The IMF and the WTO have a dynamic relationship with each other that is expressed by the development of several common programs. Furthermore, a close look at the particulars of the WTO agreements and the IMF’s regulatory protocols reveals enough overlap to raise the spirits of creative policymakers. Even though the IMF focuses on monetary issues, one of its main goals and reasons for being is to balance international trade. Article I of the IMF Articles of Agreement says that one of the IMF’s purposes is to facilitate the expansion and balanced growth of international trade, and to contribute thereby to the promotion and maintenance of high levels of employment and real income and to the development of the productive resources of all members as primary objectives of economic policy . . . [to] assist in the establishment of a multilateral system of payments in respect to current transactions between members and in the elimination of foreign exchange restrictions which hamper the growth of the world trade.
It follows that any abnegation of the obligation to encourage the growth of trade would violate Article I of the IMF Articles of Agreement.There is more. The “Nixon Shock” led to the second amendment of Article IV of the IMF Articles of Agreement, implemented in 1978, which states that country members can use any exchange rate system they want as long as they follow some IMF rules, such as abolishing gold as the standard of their currencies. The amendment states: Recognizing that the essential purpose of the international monetary system is to provide a framework that facilitates the exchange of goods [trade] . . . each member undertakes to collaborate with the Fund . . . to avoid manipulating exchange rates . . . in order to . . . gain an unfair competitive advantage over other members.
“Unfair competitive advantage” is not further defined, allowing members who manipulate their currencies to claim that they seek no competitive advantage but wish only to stabilize the value of their currencies and correct distortions in order to stabilize their domestic economic system. However, Section 3 of Article IV states that the IMF “shall oversee the international monetary system in order to ensure its effective operation and shall oversee the compliance of each member with its obligations.” By any reasonable reading, this gives the IMF the power to enforce its rules. The IMF can compel a country to change its exchange rate if the political will exists to allow it to do so.Other tools arise because of the fact that the WTO agreements refer to IMF regulation. GATT Article XV, which is part of the umbrella of agreements that comprise the WTO system, establishes that “[t]he Contracting Parties shall seek co-operation with the International Monetary Fund to the end that the . . . Fund may pursue a co-ordinated policy with regard to exchange questions within the jurisdiction of the Fund.” This language establishes that the WTO agreements and IMF regulations are linked, and that there is no clear line dividing financial and trade regulation. Additionally, Section 4 of GATT Article XV states: “Contracting parties shall not, by exchange action, frustrate* the intent of the provisions of this Agreement, nor, by trade action, the intent of the provisions of the Articles of Agreement of the International Monetary Fund.” The explicative note of this article states that the meaning of the word “frustrate” here “is intended to indicate that infringements of the letter of any Article of [the GATT] shall not be regarded as a violation if there is no “appreciable departure from the intent of the Article.” Since currency manipulation can frustrate the application of both the GATT and the IMF Articles of Agreement, GATT Article XV alone is sufficient as a legal basis to challenge Chinese currency manipulation under the WTO dispute settlement process. It is clear, after all, that Chinese manipulation is frustrating the provisions of either IMF Articles of Agreement (Articles I and IV) or WTO agreements via GATT Article XV. Yet another way to challenge Chinese currency manipulation under the WTO dispute settlement process is through GATT Article XXIII. The article establishes that if a member has a benefit that is directly or indirectly nullified or impaired under GATT, it can be brought to the WTO dispute settlement process. Obviously, having a strong legal basis on which to challenge Chinese currency manipulation cannot by itself affect the “currency war.” Challenging Chinese tactics is a political decision that is enmeshed with the entirety of the bilateral relationships between China and its major trading partners, especially the United States. From our perspective in Brazil, it is clear that the U.S. government must play a major role in backing down aggressive Chinese tactics. Not only is the United States the world’s largest economy, but it above all other countries is responsible for having created and guarded the open international trading system of the post-World War II world. It was instrumental in the founding institutions of that order, including the IMF and the WTO. Unfortunately, the U.S. government has yet to face up to its responsibilities or to recognize the tools at its disposal. For example, a 2006 Justice Department report prepared in consultation with the IMF’s Policy Development and Review Department concluded that “it was not clear what type of activity was intended to be covered by the phrase ‘manipulating the international monetary system’ as distinguished from the other prohibited activity, that of manipulating ‘exchange rates.’” Another conclusion was that “the determination as to whether the competitive advantage obtained by a member through manipulation is ‘unfair’ would require the exercise of considerable judgment.”1 Perhaps in 2006, when the “currency war” could be said to have been in its skirmish stage, we could not have expected a stronger position. But things have since changed in the “war”; the U.S. interpretation of the IMF and WTO mandates has not. Even today American policy remains on balance weak, as demonstrated by its preference for private attempts to cajole Chinese economic policymakers into doing the right thing. Thus in one of its latest reports about currency practices issued this past July, the Treasury Department avoided declaring China a currency manipulator. This appears to have been a response to the announcement a few weeks earlier by the People’s Bank of China suggesting that China favored the return of the yuan to a managed floating system. China did allow a very limited float, resulting in a very modest appreciation of the yuan (on average about half a percent per month) that has had no appreciable effect on the balance of trade. On January 12, 2011, just a week before President Hu Jintao’s visit to the White House, Treasury Secretary Tim Geithner said China must “move more aggressively to reform the handling of its currency.” But since that announcement there has been no Chinese policy response, only the gradual emergence of a new debate in China over the consequences of its currency manipulation on domestic inflation. With the hidden crisis of the world economy attending the Asian “golden age” no longer so well hidden, one hopes that the United States will reinterpret the IMF and WTO mandates in tandem with a new and tougher policy. This new interpretation and new policy must follow eventually because of the deterioration of the U.S. capacity for indebtedness, which, aside from having become a major political issue in the United States, challenges the dollar itself as the world’s monetary axis. The American political class knows the numbers, and they are staggering. The U.S. bilateral trade deficit with China for 2010 surpassed $227 billion, the largest bilateral imbalance in the history of world trade. Since 2001, the United States has lost approximately 42,400 factories and about 5.5 million jobs, with much of the damage coming in the U.S. export sector (although it is true that U.S. businesses have been complicit in this by shifting their manufacturing operations to Asian countries that offer a combination of low labor costs and large scales of production). There are signs of new energy in the face of this challenge. Internal pressures are increasing significantly in the United States to the point that President Obama has threatened to take domestic measures against the Chinese currency. The most concrete sign of change is the recent approval of a bill in the House of Representatives designed to counteract damages caused by foreign subsidies. But as the American political system gropes for a policy, the “currency war” crisis is already a reality for the many countries in the developed and developing world that have to face unfair Chinese competition and are now being actively de-industrialized. While many Americans know something of the magnitude of the U.S. problem in this regard, they are generally less informed about what has been going on in the developing world, including Brazil. In 2010, Brazil registered record imports, thanks to China’s massive contribution. The deficit in the bilateral balance of manufactures is approximately $70 billion, of which almost 40 percent concerns trade with China. Brazil has also lost market share to China and other Asian competitors in traditional markets like those of the United States, the European Union and Argentina, amounting to about $12.6 billion between 2004 and 2009. Moreover, Brazilian manufacturing exports to China tend to remain stable at quite low levels, with little likelihood of extensive growth. The situation, moreover, is quickly growing worse. China’s bilateral trade with Brazil exceeded $50 billion in the first 11 months of 2010, representing a 62 percent annualized increase in exports to $23.42 billion, while China’s (mainly commodity) imports from Brazil grew 41.6 percent to $28.16 billion. In 2010, China became Brazil’s largest trading partner, the largest export destination of Brazilian goods and the second-largest importing country-of-origin next to the United States. Along with the weakness of U.S. policy with regard to Chinese currency manipulation, we ought to acknowledge that the United States has had very little company in pressing its case. But now that the U.S. government appears to have bestirred itself to act, it may finally get some help from its friends. Japan has recently intervened to prevent the strengthening of the yen, as has South Korea with the won. In Brazil, Minister of Finance Guido Mantega has called attention to the “currency war”, and Brazil increased its IOF (Tax on Financial Transactions) by 4 percent to discourage short-term currency speculation. Moreover, in order to avoid what he called a “trade war”, Mantega announced that Brazil’s Central Bank would start buying dollars in the futures market, a strategy designed to create demand for dollars and so curb the value of the real. The Brazilian government is preparing other new measures to prevent further appreciation of its currency, and it might raise the topic of exchange-rate manipulation at the WTO and other global bodies. It is good that countries other than the United States are now prepared to act in the face of Chinese currency manipulation; it is not necessarily good that each country is doing so separately. That has the potential to create beggar-thy-neighbor consequences, such as when Brazil tries to solve its problems by increasing pressures on the dollar. It would be much better for all concerned to focus efforts through the WTO dispute settlement process. Several remedies are available. Trade remedies, in the strict sense of the term, include countervailing duties and anti-dumping and safeguard measures. The regulation of trade remedies under the WTO constitutes a different obligation. In the case of trade remedies, the WTO rules only give legal guidance for the national application of these remedies for the country of the imported goods. However, trade remedies in the broad sense of the term constitute formidable armaments against Chinese currency manipulation. First there is the specific safeguard against China written into China’s WTO accession agreement. This safeguard can be triggered when imports from China steadily increase and cause market disruption in importing countries. Implementation can make the establishment of quotas possible, as well as increase import tariffs. It is worth noting that the deadline for applying this safeguard expires in December 2013. It has been used so far only four times, twice by India and once each by Turkey and the United States. Perhaps it is time to use it again, this time in a more coordinated manner. Other trade remedies in a broad sense include administrative procedures to inform customs authorities of subsidized and illegal prices and administrative procedures of customs valuation regulated under the WTO. The WTO Agreement on Customs Valuation established rules for valuation of products based upon the value of transaction, which includes commissions, packing, assists, royalties, cost of transport and other costs according to Articles 1 and 8. If the customs valuation cannot be made according to the transaction value, other methods apply. The point is that, if it is proved to the customs authority that a specific good imported from China is undervalued, the customs authority can block its transmittal. Note, too, that such practices can be directly applied by the importer and be implemented even while a decision under the WTO dispute settlement process is being considered. In this way, victims of currency manipulation need not wait for the often protracted resolution of disputes and can at the same time gain leverage over that resolution. China is not the first country to manipulate its currency to the advantage of its exports. Decades ago, Japan and Germany did very much the same thing as they tried to recover from the devastation of World War II. But the Japanese and German economies at the time were very small compared to the size of the Chinese economy today, and the Japanese and German authorities undertook these policies with at least the tacit approval of the United States and at a time of vibrant and well distributed growth. And while China has indeed been manipulating its currency for many years, the current phase of its policy, dating from the 2008 re-pegging to the dollar, is far more damaging and aggressive than past phases. Before 2008, it was possible to interpret Chinese policy as self-interested but not necessarily or primarily designed to harm others. That is a far more difficult argument to make today. Political leaders in Brazil have not wished to turn China into an enemy; it is not in the nature of Brazilian policy to seek enemies anywhere. But Brazil has been harmed more seriously than most other countries by China’s policy, and its business leaders have finally managed to get the attention of the political class. It is therefore likely that Brazil would support an appropriate coordinated international mobilization of affected governments to curb China’s present exchange-rate vandalism. Indeed, Brazil may be prepared to lead such an effort alongside United States and other countries. The next G-20 meeting may provide a suitable framework to reform international exchange rate policy in accordance with the instruments at hand in the IMF and WTO mandates and, in particular, to force China’s strict compliance with international rules.