It has been some time now since exchange rate became one of the touchiest trade issues. Practically speaking, few tools can be more tempting and effective than exchange rates in terms of artificially increasing export while suppressing import. Any gains from trade liberalization and market opening would evaporate instantly with an artificial adjustment of an exchange rate.
According to the International Monetary Fund’s World Economic Outlook in October 2015, a 10 percent depreciation in currency translates to a 1.5 percent increase of gross domestic product through a rise in exports. Against this backdrop, the Trans-Pacific Partnership (TPP) has also adopted a joint declaration denouncing exchange rate manipulation. The word “manipulation” is used here -- a rather strong term for describing the macroeconomic policy of other states.
The uncomfortable truth is that Korea is one of the countries whose names have been mentioned in such discussions of exchange rates.
There is no official list of countries who have engaged in such practices yet, but often when concerns are expressed about exchange rate manipulation, Korea’s name comes up in the conversation.
The IMF has raised questions from time to time. In reports issued by the U.S Treasury Department in October 2014 and April 2015, Korea, along with other countries, was described as a country that weakens the value of its currency. This topic was even included in the agenda of the bilateral summit meeting in October 2015.
In the past, the issue had mainly involved warnings made based on incomplete information and confrontational accusations.
However, recent changes will soon lend some bite to these warnings.
The United States has just adopted a new legislation that targets the unfair foreign currency practices of its major trading partners.
The Bennet-Hatch-Carper amendment, contained in the Trade Facilitation and Trade Enforcement Act of 2015, passed the U.S. Senate in early February and was signed into law by President Obama on February 24. Upon signing, President Obama referred to this act as a “new tool” for “smart trade policy in the 21st century.”
In short, this act aims to penalize trading partners that try to gain trade benefits through exchange rate manipulation. Countries are identified based on the following three conditions: a bilateral trade surplus with the United States; a material current account surplus; and persistent one-sided intervention in its foreign exchange market. Once they have been identified, the Treasury Department will carry out “enhanced engagement,” which involves “urging,” “expressing concern,” “advising” and “developing a plan,” based on the wording of the act. If the country fails to remedy the situation within a year then the U.S. government will “take into account” the currency undervaluation when negotiating with the country or when including the country in future U.S. trade agreements.
If implemented as worded, the legislation will indeed lend plenty of bite to taking action against countries who manipulate their exchange rates.
In many respects, this new legislation is reminiscent of the Exchange Rates and International Economic Policy Coordination Act of 1988. In response to the increasing appreciation of the U.S. dollar and trade deficits at that time, the 1988 act required the Treasury Department to look into the exchange rate policies of major trading partners, applying similar criteria to identify countries that have engaged in unfair foreign exchange practices. The Treasury Secretary was then supposed to negotiate with these countries to remedy the situation. At that time, three countries were identified under the 1988 act for negotiation: China, Taiwan, and Korea.
At this point, it is still debatable whether Korea will be identified under the criteria of the new legislation, however, both recent circumstances and past experiences imply that this new act will be an important foreign regulatory scheme that will test Korea’s foreign exchange policy through the prism of trade agreements.
The exchange rate has spiked to 1,240 won per dollar -- the highest point in almost 6 years, amid global financial volatility. Hence demand for the government to play a bigger role or to lend guidance in the market has also increased.
Whether this will translate into merely a “smoothing operation” as Korea has maintained or a “one-sided” market intervention, is a critical distinction.
By Lee Jae-min
Lee Jae-min is a professor of law at Seoul National University. — Ed.