The Trade Facilitation and Trade Enforcement Act
In February, President Obama signed the Trade Facilitation and Trade Enforcement Act, a broad refresh of U.S. trade laws. Title VII of this law concerns exchange rate and economic policies. The earlier law, passed in 1988, required the Treasury Department to determine if a nation was “manipulating” its exchange rate. If a country was found to be doing so, the Treasury could engage in consultations to change the policies of the manipulator. In practice, the Treasury found few nations in violation of the earlier law. China was tagged with this designation five times from 1992 to 1995, Taiwan twice, in 1988 and 1992, and South Korea in 1988. In reality, being designated a manipulator didn’t trigger significant penalties.
In this report, we will discuss the history of exchange rate issues in trade, the new legislation and its potential impact on U.S. trading partners. We will review the reserve currency role and explain why this role almost precludes any effective trade policy designed to punish foreign trade practices. We will reflect on the new law in light of the current political situation in the U.S. and, as always, conclude with the impact on financial and commodity markets.
Currencies and Trade: A Background
The earlier law, passed in 1988, acknowledged that foreign nations could use exchange rates to enhance the value of their exports and effectively “steal” aggregate demand from the U.S. economy. It is important to note that the earlier law was enacted near the end of a major dollar market cycle that triggered two major currency agreements, the Plaza Accord in 1985 and the Louvre Accord in 1987.
This chart shows the JP Morgan dollar index, which adjusts for trade flows and inflation. Note that the dollar rose by nearly 50% from 1978 to 1985. The combination of deregulation, loose fiscal policy and tight monetary policy made the dollar very attractive to foreign buyers as it led to falling inflation and very high real interest rates.
However, the strong dollar undermined U.S. competitiveness, taking the current account from near-balance in 1981 to a 3.3% deficit (as a percentage of GDP) by 1987. In 1985, at the Plaza Hotel in New York, the G-5 (U.S., U.K., Germany, Japan and France) agreed that the dollar’s strength had become a danger to the global economic system and all agreed to push the dollar lower through direct intervention and “jawboning.” These measures, even in the absence of other policy changes, were effective in lowering the dollar. In 1987, the same group agreed to arrest the dollar’s decline by creating a set of “reference rates.”
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