Congress Continues to Attack Currency Manipulation as China Defuses G-20 Pressure For Now: the International Law Issues

Introduction

On Saturday, June 19, 2010, one week before the G-20 Toronto Summit, China’s central bank announced that it would increase the exchange rate flexibility of the renminbi (“RMB”),[1] but emphasized that it did not see the economic basis for a large-scale appreciation of the RMB.[2] Policymakers around the world welcomed China’s announcement as a constructive step but stressed that, as put by United States (“U.S.”) Treasury Secretary Timothy Geithner, “the test will be how far and how fast [the Chinese] let the currency appreciate.”[3] Skeptics were confirmed in their view when China’s central bank stated that there would be no one-off adjustment of the RMB exchange rate, that the RMB’s daily 0.5 % trading band against the U.S. dollar (“USD”) would not change, and that the rate would be flexible “in both directions” (i.e. could move up or down).[4] A week later, the RMB had risen by only 0.5 percent against the USD.[5]

At the G-20 Toronto Summit (June 26-27, 2010), an explicit statement welcoming China’s announced policy shift was dropped from the final version of the Summit Declaration upon Chinese request. This demonstrated once again China’s sensitivity over its exchange rate policy, which it insists is a purely domestic issue.[6] Whereas a week before the summit, the Chinese exchange rate had promised to overshadow everything else,[7] the Summit Declaration now merely states that emerging surplus economies “will undertake reforms tailored to country circumstances” in order to, among other things, “[e]nhance exchange rate flexibility to reflect underlying economic fundamentals."[8] U.S. President Barack Obama told reporters at the G-20 Summit that the U.S. “didn’t expect 20% revaluation in a week,” but that it will be watching over the next “several months,” expecting to see the RMB/USD rate appreciate.[9]

The policy shift announced by China comes at a time when political pressure on the U.S. Administration for a tougher approach against China is once again rising.[10] China has long been criticized for maintaining a significantly undervalued exchange rate peg to the USD as part of a strategy of export-led growth.[11] Following the Chinese announcements of June 19-20, New York Senator Charles Schumer (D) stressed that this merely “vindicated [his] initial skepticism,” reiterating his determination to press ahead with his bipartisan legislation on the issue.[12] With the G-20 summit past, Congress may continue its saber-rattling to encourage China to let the RMB appreciate faster – and U.S. industry will continue to seek trade remedies against the RMB exchange rate.

This Insight discusses the international law rules regarding exchange rate manipulation and the U.S. domestic actions proposed to respond to it. It does not take a position on whether China’s exchange rate policy violates these rules, because that would require an economic assessment too complex for a brief treatment such as this.

I. Existing International and Domestic Law on Exchange Rate Manipulation

In international law, exchange rates are governed by the Articles of Agreement of the International Monetary Fund (“IMF” or “Fund”) (“IMF Agreement”). Article IV:1 of the IMF Agreement requires each member of the Fund to collaborate with the Fund and other members to assure orderly exchange arrangements, and, in particular, to “avoid manipulating exchange rates . . . in order to prevent effective balance of payments adjustment or to gain an unfair competitive advantage over other members” (Article IV:1(iii)). In its 2007 Decision on Bilateral Surveillance (“2007 Decision”), the Fund clarified that this could mean either causing the exchange rate to move or preventing it from moving “for the purpose of securing fundamental exchange rate misalignment in the form of an undervalued exchange rate in order to increase net exports.”[13] The intent requirement enshrined in Article IV:1(iii) of the IMF Agreement makes it politically very delicate for the IMF to officially find one of its members in breach of that provision.

Recognizing this dilemma, the Fund’s 2007 Decision introduced a new non-binding “principle D,” recommending that IMF members avoid exchange rate policies that result in external instability, regardless of their purpose. This was intended to flesh out the Article IV obligation for IMF members to collaborate with the Fund and other members, without directly affecting the intent element in Article IV:1(iii). However, if the IMF Executive Board, by providing a binding interpretation of principle D, were to recommend that all members avoid massive accumulations of foreign exchange reserves, then non-respect of principle D could ultimately lead to a finding of breach of the general obligation to collaborate.

Arguably, tying exchange rate policies to the concept of external stability has enhanced the Fund’s surveillance of international monetary conduct under IMF Article IV. However, with respect to China’s exchange rate peg, the 2007 Decision has not led to any measurable results.

U.S. law also includes provisions on exchange rates: Title III of the U.S. Omnibus Trade and Competitiveness Act of 1988, inspired by USD misalignment in the 1980s.[14] Title III, too, focuses on intentional exchange rate manipulation. It requires the Treasury Department, in consultation with the IMF, to analyze the exchange rate policies of the major U.S. trading partners and to issue reports each year and updates six months thereafter. These reports examine whether countries are manipulating their USD exchange rates “for purposes of preventing effective balance of payments adjustments or gaining unfair competitive advantage in international trade.” If Treasury finds such manipulation, the issue should be resolved via negotiations, except “where this would have a serious detrimental impact on vital national and economic and security interests.” However, since 1994, no such Treasury report has labeled any country as an exchange rate manipulator.

It is against this background that numerous bills on exchange rate manipulation have been introduced in recent sessions of Congress.

II. Recent Congressional Proposals to Tackle Exchange Rate Manipulation

The leading current proposal is the Currency Exchange Rate Oversight Reform Act of 2010, introduced on March 17, 2010 by a bipartisan group of senators led by Charles Schumer (D-NY), Debbie Stabenow (D-MI), and Lindsey Graham (R-SC) (“Schumer-Stabenow-Graham Bill”).[15] This bill bridges between the two main competing legislative approaches since 2007.[16] It would replace Title III of the 1988 Act and would require semiannual reports by Treasury (1) identifying “fundamentally misaligned currencies,”[17] and (2) designate such currencies “for priority action” where the country that issues the currency is engaging in actions such as protracted large-scale intervention in the currency exchange market, or excessive and prolonged official or quasi-official accumulation of foreign exchange reserves. For either category, whether the country concerned is acting with the intent to gain unfair competitive advantage would be irrelevant for the assessments undertaken by Treasury.

Upon designation of a currency as “fundamentally misaligned,” Treasury would have to consult bilaterally with the country that issues such currency in order to facilitate the adoption of appropriate policies to address the fundamental misalignment. If a currency is designated “for priority action,” however, the Schumer-Stabenow-Graham Bill provides for several steps of increasing severeness:

     Immediately, the Administration would be required to consult with the IMF and recruit allies to persuade the country to eliminate the fundamental misalignment; also, to oppose any IMF governance changes benefiting a country thus designated (for instance, an increase in China’s IMF voting shares). Designation for the priority action list would also affect decisions on a country’s nonmarket economy status for anti-dumping investigations.[18]

     After ninety days, the Commerce Department would be required to reflect exchange rate undervaluation in calculation of dumping margins; federal procurement of the country’s goods and services would be banned (unless it is a party to the World Trade Organization (“WTO”) Government Procurement Agreement (“GPA”)[19]); the U.S. must request special IMF Article IV consultations with that country and vote against any new multilateral development bank financing to it; and the Overseas Private Investment Corporation (“OPIC”) must deny financing for any investments there.

     After 360 days, the U.S. Trade Representative (“USTR”) would be required to request WTO consultations with the country concerned regarding the WTO-consistency of its actions.[20] Treasury would be required to consult with the Federal Reserve regarding remedial intervention in currency markets, to be coordinated with the IMF and other central banks.

     The President could waive any action required under the bill, but would have to publish an explanation of the reasons why. However, such a presidential waiver would cease effect upon enactment of a joint resolution of disapproval. And while the President can veto the joint declaration, the Congress’ authority to override the veto would allow Congress for the first time ever to have the last word on exchange rate policy and its application.

III. Exchange Rate Misalignment and Anti-dumping Duties: A Major Conceptual Inconsistency

The Schumer-Stabenow-Graham Bill requires exchange rate undervaluation to be taken into account when calculating the margin of dumping in anti-dumping investigations. The bill requires the Commerce Department, which administers the U.S. anti-dumping laws, to “ensure a fair comparison between the export price and the normal value by adjusting the price used to establish export price or constructed export price to reflect the fundamental misalignment of the currency of the exporting country.” This adjustment would take place only when a “priority action” country fails to eliminate “fundamental misalignment.” The punitive and automatic nature of the price adjustment thus undertaken undercuts any argument that it provides for a “fair comparison . . . between the export price and the normal value” for the products concerned as required by Article 2.4.2 of the WTO Anti-dumping Agreement (“ADA”).

It is conceptually misguided to adjust dumping margins for exchange rate misalignment. Dumping is a matter of companies’ product pricing decisions, which have nothing to do with the macro-level governmental measures that lead to exchange rate misalignment. If exchange rate undervaluation were to be taken into account in anti-dumping calculations, a product that is not dumped (under normal rules) will suddenly have a dumping margin, which would amount to a violation of the ADA.[21]

The Schumer-Stabenow-Graham Bill also requires Commerce to investigate whether currency undervaluation is providing a countervailable subsidy, but only in response to a countervailing duties (“CVD”)[22] petition; the standing requirement for petitions and the material injury test would mean that such petitions could only be brought on a product-by-product basis. Moreover, the petitioner would still need to prove the existence of a financial contribution, and that the subsidy is specific. Both requirements constitute high hurdles. In two ongoing CVD investigations of Chinese products, Commerce is currently investigating allegations that undervalued exchange rates are a subsidy. A final ruling in one is due by July 12 – it still remains to be seen what Commerce makes of these allegations under existing U.S. law.[23]

Conclusion

In recent years, Congress has threatened to legislate on exchange rate manipulation in a way that very much recalls the saber-rattling that preceded the Plaza Agreement of 1985.[24] If China lets the RMB/USD exchange rate appreciate substantially over the months to come, this legislation will fade away. But from an international law perspective, two points should be stressed with respect to the current main legislative proposals.

First, changing trade remedy rules to take exchange rate undervaluation into account in calculating dumping margins is likely to run afoul of the WTO Agreements. And to the extent that the legislation is mandatory, it can (and likely will) be challenged “as such” in the WTO even before it is ever applied.

Second, where existing U.S. law requires Treasury to determine whether there is intentional exchange rate manipulation, thereby echoing the multilateral key provision in Article IV:1(iii) of the IMF Agreement, the Schumer-Stabenow-Graham Bill and similar proposals shift to objective factors. But this does not resolve the core problem that IMF Article IV:1(iii) still requires a showing of intent, although the Fund’s 2007 Decision has introduced at least some flexibility by tying exchange rate policies to the concept of external stability as discussed in this Insight. Thus, the actions proposed in the Schumer-Stabenow-Graham Bill could push the U.S. into violating the IMF Agreement. For instance, if the U.S. government were to impose unilateral penalties on China for exchange rate misalignment where the IMF has not established a breach of the IMF Agreement, the U.S. might itself be found in breach of the general obligation to cooperate with the Fund and other IMF members as set forth in the chapeau of Article IV of the IMF Agreement.

About the Author

Claus D. Zimmermann, LL.M. (Yale), an ASIL member, is a Doctoral Candidate at the University of Oxford.

About the ASIL International Economic Law Interest Group

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Endnotes