Policy Brief NUMBER PB14-17 JUNE 2014 experienced trade defi cits that were larger than they otherwise Alternatives to Currency would have been. Even in periods of full employment such as the mid-2000s, currency manipulation caused a misalloca- Manipulation: What tion of capital; in particular, it enabled unsustainable housing booms in many countries. Fred Bergsten and Joseph Gagnon (2012) identifi ed 22 Switzerland, Singapore, countries as currency manipulators over the 2001–11 period. Governments of these countries maintained trade (current and Hong Kong Can Do account) surpluses by holding down the values of their currencies through excessive purchases of foreign assets. Table Joseph E. Gagnon 1 updates some of the data Bergsten and Gagnon analyzed for these countries through December 2013. Th e table shows that many of them still buy large quantities of offi cial foreign Joseph E. Gagnon is a senior fellow at the Peterson Institute for International Economics and the author of Flexible Exchange Rates assets, suggesting that the issue of currency manipulation is for a Stable World Economy (2011) and Th e Global Outlook for not going away. For the subset of the 22 countries for which Government Debt over the Next 25 Years: Implications for the historical data are available, fi gure 1 shows that net purchases Economy and Public Policy (2011). of offi cial foreign assets have declined a bit from their previous peak, but they remain much higher than before 2003.2 Author’s Note: Th anks to Kent Troutman for expert research assistance and A recent paper (Gagnon 2013) shows that net offi cial to Fred Bergsten, Jacob Kirkegaard, Marcus Noland, Adam Posen, Kent Troutman, Edwin Truman, Angel Ubide, and Steve Weisman for helpful fi nancial fl ows (which are dominated by offi cial purchases comments. of foreign assets) strongly aff ect a country’s current account balance, with each $1.00 of offi cial fl ows raising the current © Peterson Institute for International Economics. All rights reserved. account by $0.60 to $1.00. Th is is a much larger eff ect than is generally believed. For this group of countries with large net For the major advanced economies and the world as a whole, offi cial fl ows, fi gure 1 shows that movements in the current insuffi cient aggregate demand—that is, too little spending— account balance are closely related to movements in net offi cial impeded recovery from the Great Recession of 2008–09. By fl ows. Th is research strongly supports the important distinc- manipulating their currencies to boost their net exports, many tion between domestic and external policies that is written countries made a bad situation worse for their trading partners, into international economic rules. External policies, such as which saw demand shifted away. Th e world needs policies that offi cial purchases of foreign assets, operate almost exclusively increase total demand rather than policies that fi ght over the through their eff ects on other countries. Domestic policies allocation of the existing amount of demand. operate primarily internally, with spillovers to other countries Th e costs of currency manipulation are high. Such poli- being only a secondary and smaller eff ect. For this reason, cies prolonged excess unemployment in the United States, international rules place greater restrictions on external than peripheral European countries, and other countries that are on domestic policies. not intervening to keep their currencies weak.1 Th ese countries 1. In principle, fi scal and monetary policy should have acted more force- fully to restore full employment. In practice, the nature and depth of the 2. Th ere are three related concepts: changes in stocks, fi nancial fl ows, and recession, combined with the novelty of hitting the zero bound on interest actual purchases (or intervention). Flows equal purchases plus accrued earn- rates, prevented a fully adequate macroeconomic policy response. In those ings. Changes in stocks equal fl ows plus changes in valuation, including from circumstances, currency manipulation by trading partners worsened an already exchange rate movements. Th e balance of payments accounting identity says unsatisfactory outcome. that the current account equals net fi nancial fl ows. 1750 Massachusetts Avenue, NW Washington, DC 20036 Tel 202.328.9000 Fax 202.659.3225 www.piie.com NUMBER PB14-17 JUNE 2014 Table 1 Official foreign assets of selected countries Gagnon’s strategy seeks to bring more pressure to bear against (billions of US dollars at year end) currency manipulators to get them to stop. However, as Average Bergsten and Gagnon (2012, 2) note, “An important compo- change, nent of this strategy is to develop new sources of sustainable 2012–13 2013 2012 2013 (percent domestic-demand-led growth in surplus countries as endorsed Country Level Change Change of GDP) by the leaders of the Group of Twenty (G-20).” Algeria 195 8 6 3 Th is policy brief fl eshes out the growth component of this Angola1 38 10 0 4 strategy. For large economies such as China, Japan, and Korea, Azerbaijan 50 5 5 7 most observers agree that standard macroeconomic policy tools are suffi cient to achieve sustainable growth in domestic China2 4,065 159 566 4 demand. In addition, structural reforms can also be helpful Denmark 86 4 4 1 in creating a climate for increased domestic investment (or Hong Kong 311 32 –6 5 consumption, in the case of China). However, many believe Israel 82 1 8 2 that smaller, highly open economies lack the ability to conduct 3 Japan 1,239 –28 45 0 independent macroeconomic policy and that they may face a Kazakhstan2 142 16 69 20 stark choice between currency manipulation or recession. Korea3 349 20 26 2 Th is brief takes up the cases of Switzerland, Singapore, and Kuwait 442 3 120 33 Hong Kong in the wake of the Great Recession. All are medium- Libya1 119 14 3 11 sized economies that are highly open to trade and capital fl ows. Malaysia3 138 6 –1 1 In each of these countries, as in the major advanced economies, Norway3 880 128 144 27 short-term interest rates dropped to zero in 2008–09 and have Qatar 212 46 65 28 remained near zero since. Use of fi scal policy has been modest. Russia 471 32 –2 1 None has undertaken large-scale, unconventional monetary policies comparable to those taken in the euro area, Japan, the Saudi Arabia 726 115 85 14 United Kingdom, or the United States. Singapore3,4 543 11 57 12 All three have purchased very large amounts of offi cial Switzerland 498 197 30 18 foreign assets since 2009, but the circumstances diff ered. In Taiwan 417 18 14 3 Switzerland, the policy refl ected a break from past behavior, Thailand 162 6 –10 –1 driven by concern about a sharp appreciation of the currency United Arab Emirates1 1,044 57 181 31 at a time of below-target infl ation. In Singapore, the policy Total 12,207 860 1,410 refl ected a continuation of historical patterns amid a relatively 1. 2013 reserves data based on latest available: September (UAE), November stable macroeconomic environment. In Hong Kong, the (Angola, Libya). policy refl ected the automatic response of the central bank to 2. I include only the share of sovereign wealth fund assets that are invested in foreign assets as estimated by Bagnall and Truman (2013). currency pressure in the context of a currency board. None of 3. I include only the share of sovereign wealth fund assets that are invested in these countries received any signifi cant international oppro- foreign assets, as reported by the respective authorities. 4. I assume that 50 percent of the foreign exchange reserves of the Monetary brium for policies that helped to sustain large current account Authority of Singapore are managed by the Government Investment Corporation surpluses at a time of defi cient global demand. and make an adjustment to avoid double counting. Each of these countries could have used monetary and Note: This table reports the sum of foreign exchange reserves and foreign assets in sovereign wealth funds. fi scal policies to deliver sustainable domestic-demand-led Sources: Foreign exchange reserves data were obtained from the IMF’s growth. In each case, greater fi scal and especially monetary ease International Financial Statistics database. Assets of sovereign wealth funds (SWFs) would have allowed countries to achieve a similar macroeco- for the following countries were obtained from national sources: Azerbaijan, Korea, and Norway. All other countries’ SWF data were obtained from the nomic outcome with less currency intervention and a declining Sovereign Wealth Fund Institute. GDP is from IMF’s World Economic Outlook. current account surplus.3 A faster global recovery would have resulted. Th e aggregate consequences of currency intervention Th e International Monetary Fund’s (IMF) Articles of across all the currency manipulators are substantial, as can be Agreement state that member countries “shall avoid manipu- lating exchange rates or the international monetary system in 3. It is always diffi cult to know the counterfactual eff ect of alternative policies. order to prevent eff ective balance of payments adjustment or Yet Gagnon (2011) presents several case studies in which small and medium- sized economies were able to use independent monetary policy eff ectively to to gain an unfair competitive advantage over other members.” stabilize employment and infl ation without resorting to currency intervention Clearly, this injunction is not being enforced. Bergsten and and large external imbalances. 2 NUMBER PB14-17 JUNE 2014 Figure 1 External accounts of selected countries, 1990−2013 percent of world GDP 2.0 Net official flows Current account 1.5 1.0 0.5 0 1990 1995 2000 2005 2010 Note: Countries are Algeria, Angola, Azerbaijan, China, Denmark, Hong Kong, Israel, Japan, Kazakhstan, Korea, Libya, Malaysia, Norway, Russia, Singapore, Switzerland, and Thailand.