U.S. President Donald Trump and his administration this week directed fresh criticism at countries that have long been the targets of currency manipulation charges. First, a chief White House trade adviser accused Germany of taking advantage of the weak euro to exploit the United States and its own European trade partners. The same day, Trump leveled a broadside at China and Japan's monetary policies, accusing them of pursuing devaluation strategies that have harmed U.S. trade. The increased focus on currencies may provide a window into U.S. tactics in coming discussions over global trade.
The Trump team's evaluations of the currency situation are rooted in fact. The dollar is overvalued by many measures, and its strength harms the competitiveness of U.S. goods and services exports, especially to those three nations. In 2015, the United States carried trade deficits of $386 billion with China, $77 billion with Germany and $71 billion with Japan. Germany's membership in the European Monetary Union gives it an advantage in global markets because weaker member economies pull the euro's value lower than it would be if it were Germany's alone. Japan has aggressively used unconventional monetary policy over the past two decades to try to restart its economy, and a byproduct of its campaign of quantitative easing is a weaker currency. China's clear intervention in its currency market between 2001 and 2014 kept the yuan weak, giving it a huge competitive advantage over trading partners, including the United States.
At the same time, the U.S trade deficit may be an unavoidable function of the dollar's role in the global economy. Economist Robert Triffin posited in the 1960s that any country whose currency is the global reserve (as the dollar is) must run trade deficits to get its currency into the hands of foreign countries. In other words, if countries spent their dollars buying U.S. exports, they wouldn't have any left to keep on reserve. Following this line of reasoning, the competitive disadvantage of U.S. goods and services in the global market is a natural consequence of the "exorbitant privilege" afforded to the holder of the world's reserve currency (the privilege being that you can print as much money as you want, and the world has to consume your inflation).
Despite U.S. protestations, each of the three countries can mount a defense against accusations of currency manipulation. In Germany's case, policymakers in Berlin do not make the decisions that directly guide its currency, the euro. Those are left to the governing board of the European Central Bank, which represents all 19 countries in the eurozone. So to attack Germany's currency is to attack the decision it made to join with its neighbors in a currency union — a politically difficult position for the United States to push. For Japan's part, its aggressive pursuit of quantitative easing policies is hardly unique — since the 2008 financial crisis, every major central bank, including the U.S. Federal Reserve, has undertaken similar programs. Finally, though China did keep its currency artificially weak for an extended time, since late 2014 that trend has reversed, and the Chinese are now trying to ease the fall of their naturally weakening currency to prevent an overly steep and economically disruptive depreciation. So while the label of currency manipulator was definitely applicable in previous years, it would be difficult to make it stick today.
Both sides of the currency debate appear to have valid arguments, but how the situation is resolved will depend on other factors, such as the leverage that countries hold over each other. Germany, Japan or China have the means to even their trade balances with the United States by reducing their competitiveness. In Germany's case, this could include stimulating consumption by boosting government spending — anathema to a German leadership that fastidiously follows a balanced budget policy. China could in theory push up the yuan's value by accelerating the spending of its $3 trillion pool of foreign exchange reserves, and Japan could tighten its monetary policy more quickly. But none of these countries wish to take these actions, deeming them harmful to their economic models and their own political stability.
The United States faced a parallel set of currency circumstances in the early 1980s. Then, as now, the dollar was strengthening rapidly, and many in the United States voiced concern about foreign competition, particularly from Japan. In 1985, the United States and the other four leading world economies (Japan, West Germany, France and the United Kingdom) reached the Plaza Accord, an agreement to coordinate their economic policies to weaken the dollar, especially against the yen and the deutsche mark. Then, as now, the global economic leaders did not want to cooperate, so the United States used the threat of protectionism as leverage. The United States could try to use a similar threat to bend arms today, but the less comprehensive trade rules in force 30 years ago under the General Agreement on Tariffs and Trade have morphed into the strictures imposed by the World Trade Organization (WTO). The heavy-handed strategy employed then by President Ronald Reagan would be more difficult to use successfully and likely would be seen as tantamount to threatening to unravel the WTO itself.
Trump has made no secret of his willingness to adopt protectionist trade policies. Whether he would follow Reagan's example to try to orchestrate an overarching currency deal with U.S. economic rivals or instead look to influence their policies on a bilateral basis remains to be seen. Another question is whether the United States has as much influence over its counterparts as it did in 1985. In that era, the United States' heftiest trading competitors, Japan and West Germany, each leaned heavily on the United States for military protection. By contrast, China today sees itself as more an equal than a subordinate and may be less easily pressured.
With the recent attention it has brought to currency issues, the United States appears to be firing the opening salvo in a negotiation aimed at bringing its counterparts to the table. Each of those countries will now face a decision about what it values more: Its relationship with the United States or its own economic model.
