The Fall 2017 FX Report: Reading Between the Lines

With minimal fanfare last week, the U.S. Treasury issued its semi-annual Report to Congress on Foreign Exchange Policies of Major Trading Partners of the United States, better known as The FX Report. Below is a Q&A with former U.S. Treasury official Stephanie Segal, who offers context for the report and “reads between the lines” about how this Administration is approaching foreign currency policies and related trade policies.

Question: What is the FX Report and why does the Treasury Department issue it?

Answer: The FX Report satisfies two pieces of legislation – the Omnibus Trade and Competitiveness Act of 1988 and the Trade Facilitation and Trade Enforcement Act of 2015 – which require the Treasury Secretary to provide semiannual reports on the foreign exchange policies of major trading partners of the United States.

Under the 1988 legislation, Treasury must consider “whether countries manipulate the rate of exchange between their currency and the United States dollar for purposes of preventing effective balance of payments adjustment or gaining unfair competitive advantage in international trade.” The 2015 Act requires Treasury to assess major trading partners using three metrics: 1) bilateral trade balance with the United States, 2) current account surplus, and 3) intervention in the foreign exchange market. The Act also establishes a process to engage and impose penalties on economies that fail to adopt “appropriate policies.”

Question: What are the key take-aways from the Fall 2017 report – did it find that China is manipulating its currency?

Answer: Treasury’s findings in the Fall 2017 report did not change substantially from the Spring 2017 report, which was the first issued under the Trump Administration. Treasury found that no major trading partner met all three criteria during the four quarters ending June 2017, meaning no major U.S. trading partner exceeded the thresholds for its bilateral trade surplus with the United States ($20 billion); current account surplus (3 percent of GDP); and foreign exchange intervention (2 percent of an economy’s GDP). Treasury also concluded that no major trading partner met the standards for currency manipulation in the first half of 2017.

Treasury concluded that four major trading partners – Japan, Korea, Germany, and Switzerland – met two of the three criteria, placing them once again on the “Monitoring List”. Taiwan was removed from the List following Treasury’s estimate that it reduced foreign exchange intervention to below 2 percent of GDP over two consecutive reporting periods. With respect to China, Treasury kept China on the Monitoring List, even though it exceeded the threshold for only one of the three criteria (its bilateral trade surplus with the United States) citing China’s “disproportionate share of the overall U.S. trade deficit”.

Question: What does the Report signal about the Trump Administration’s approach to currency practice?

Answer: Taiwan’s removal from the Monitoring List is the main development in the Fall 2017 report, but you can read between the lines for additional insights on the Administration’s thinking:

First, and not surprisingly, Treasury maintained China on the Monitoring List despite its assessment that China met just one criterion, making clear that U.S. economic policy toward China is squarely focused on the bilateral trade deficit. This is not new, but the reference to “unfair trade barriers,” in addition to exchange rates and other macroeconomic policies as tools used to disadvantage U.S. exports, is new and consistent with recent US Government actions including the Section 301 investigation into China’s potentially discriminatory policies toward American technology transfer, intellectual property, and innovation. At the same time, the acknowledgement that global value chains likely overstate the U.S. trade deficit with China, and references to U.S. services surpluses in individual economy write-ups, offer a more nuanced view on trade than has been heard thus far from the Administration.

Second, neither Canada nor Mexico appear on the Monitoring List. The Report nonetheless highlights the NAFTA renegotiation and the Administration’s objectives of including “an appropriate currency mechanism that ensures that NAFTA countries avoid manipulating exchange rates to gain an unfair competitive advantage.” The Report signals possible negotiation of similar mechanisms in the context of other free trade agreements. The US-Korea Free Trade Agreement jumps to mind, considering the Report’s reference to “Korea’s years of substantial asymmetric foreign exchange intervention to limit won appreciation”.

Third, the inclusion of India in the Report’s Executive Summary, citing its “scale and persistence of foreign exchange purchases” is clearly intended to send a signal that India is close to a formal listing. It remains to be seen if India will adjust policy, particularly considering increased U.S. interest in India as a partner and counterweight to China in the Asia-Pacific region.

Finally, Treasury included language regarding its efforts to press for a stronger focus on exchange rate issues in key international venues, including the G-7, G-20, and the International Monetary Fund, which suggests that Treasury has not abandoned multilateral channels for advancing U.S. objectives.

Further reading: TradeVistas Essential “Currency Manipulation 101”

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