Critical Questions

Countervailing Currency Undervaluation

February 5, 2020

On Tuesday, the Commerce Department issued a final rule that will allow the use of tariffs to offset imports from countries whose governments take action to depress the value of their currency. The rule is controversial and raises a number of questions regarding U.S. economic and trade policy. Perhaps of most immediate relevance, the rule adds another arrow to the Trump administration’s trade policy quiver, once again placing currency front and center of an “America First” economic policy.

Q1: What specifically does the administration’s modified rule allow?

A1: The rule allows for currency undervaluation to be treated as a subsidy under U.S. trade remedy law and, as a result, permits the application of countervailing duties (CVD) on goods from countries the Commerce Department deems to have an undervalued currency.

The modified rule clarifies to which entities countervailing duties for undervalued currency can be applied. This is an essential element of the rule because subsidies can only be offset with countervailing duties if they meet a bar of specificity, one aspect of which is that they are provided to a certain “group of enterprises or industries.” The rule takes an extremely broad definition of “group” for this purpose, defining “group” as “enterprises that buy or sell goods internationally (i.e., enterprises in the traded goods sector of an economy),” which in practice should cover essentially all firms that export goods.

Additionally, the rule lays out how currency devaluation will be assessed. This aspect of the rule is discussed below.

Q2: What is the significance of including currency undervaluation for purposes of determining the scope for countervailing duties?

A2: As noted in our August 2019 commentary, the Trump administration has taken a number of steps to place currency front and center of an “America First” economic policy; Tuesday’s rule modification is the latest proof point, equating currency undervaluation with countervailable financial support.

Beyond expanding the basis and applicability of CVDs, the ruling is significant because of the role it gives Commerce in determining currency undervaluation, historically within the exclusive purview of Treasury, the agency responsible, in consultation with the Federal Reserve System, for U.S. exchange rate policy. While the modified rule commits Commerce to “seek and generally defer to Treasury’s expertise in currency matters,” the final assessment will come from Commerce, setting up the possibility that the two agencies might reach different conclusions. Internationally, Treasury’s main counterparts are other finance ministries, who, in turn, are empowered to make commitments, including “to refrain from competitive devaluation of currencies” and to “resist all forms of protectionist measures.” By contrast, the Commerce Department is appropriately focused on enhancing job creation domestically and increasing U.S. exports. The final rule effectively gives the agency in charge of U.S. export promotion an important voice on exchange rate assessments, a precedent that may well complicate international agreements down the road and confuse understanding of U.S. policy and objectives.

Q3: How will “currency undervaluation” be assessed? What are the differences between the Commerce and Treasury approaches?

A3 : Assessing currency misalignment (under or overvaluation) is notoriously tricky business; comments received in response to Commerce’s draft rules underscore that point. The Commerce Department’s final rule attempts to address some of the concerns: first, it clarifies that in determining whether a country’s currency is undervalued, it will “take into account the gap between a country’s real effective exchange rate (REER) and the REER that achieves an external balance over the medium-term,” an approach used by the International Monetary Fund (IMF) in making its own country-specific external sector assessments. Second, the final rule states that “Commerce normally will make an affirmative finding of currency undervaluation only if there has been government action on the exchange rate that contributes to an undervaluation of the currency.” The rule does not define “government action” but indicates that “Commerce will not normally include monetary and related credit policy of an independent central bank or monetary authority.”

The Commerce Department acknowledges the subjectivity of any assessment. As required by the Trade Facilitation and Trade Enforcement Act of 2015, Treasury attempted to address the subjectivity inherent in such assessments by developing objective criteria, including thresholds for an economy’s bilateral trade balance with the United States, overall current account balance, and foreign exchange intervention, to determine “whether an economy may be pursuing foreign exchange policies that could give it an unfair competitive advantage against the United States.” At the same time, Treasury maintained the authority to label an economy a “currency manipulator” under the Omnibus Trade and Competitiveness Act of 1988, which calls on Treasury to “consider whether countries manipulate the rate of exchange between their currency and the United States dollar for purposes of preventing effective balance of payments adjustments or gaining unfair competitive advantage in international trade.” It’s worth noting that Treasury relied on the 1988 Act to label China a currency manipulator last year.

Q4: Does the rule violate World Trade Organization (WTO) rules?

A4: The question of whether using countervailing duties to offset currency undervaluation is a violation of WTO rules has been debated for years. Critics of the approach claim that currency undervaluation does not meet the characteristics of a subsidy necessary for a response of countervailing duties set out by the WTO. Proponents claim the opposite. There are two major points of contention in the debate: whether currency undervaluation meets the definition of a “financial contribution” by a government or public body, and whether currency undervaluation subsidizes a “specific . . . enterprise or industry or group of enterprises or industries.” For currency undervaluation to be legitimately considered countervailable under WTO rules, it would have to meet the definitions of both “financial contribution” and “specific . . . enterprise or industry or group of enterprises or industries.”

These issues are addressed under the Agreement on Subsidies and Countervailing Measures (ASCM). As per the ASCM, a subsidy is deemed to exist if there is a financial contribution by a government or a public body within the territory of a member, or if there is any form of income or price support and a benefit is thereby conferred. Critics claim currency undervaluation meets neither of those definitions. The Commerce Department in its final rule pushed back against this argument with two arguments of its own. First, the department pointed out that determinations regarding this question are made on a case-by-case basis and not in rulemaking. Second, the department simply asserted that the exchange of domestic currency to U.S. currency could constitute a financial contribution.

Regarding the specificity question, the ASCM requires that a subsidy be specific to an enterprise or industry or group of enterprises or industries within the jurisdiction of the granting authority. Decisions in WTO disputes have previously defined the concept of industry or a group of industries as related to producers of certain products (see, for example, U.S. – Upland Cotton) while conceding that the specificity question should be assessed on a case-by-case basis. The Commerce Department’s modified rule defines “group” as enterprises that buy or sell internationally. It does not limit the enterprises on the criteria of producers of certain products or a group of products, which critics of the rule claim does not fulfill the specificity criterion and therefore breaches WTO rules. The administration argues that the definition of “group” provided in the modified rules refers to an identifiable group of enterprises and, therefore, it is specific.

The Commerce Department also claims that prohibited subsidies—those contingent on exports or the use of domestic goods over imports—are deemed “specific” under WTO rules and are outright prohibited. The department argues that currency undervaluation could be considered a prohibited subsidy because it “underprices exports and overprices imports,” creating the effect of an export and import-substitution subsidy. Critics of the rule claim that it does not suffice to demonstrate solely that the government granting the subsidy anticipated exports or import substitution. Instead, a member must establish that the subsidy is contingent on export performance or on import substitution (see: Canada – Aircraft and other disputes). Critics argue that currency undervaluation is tied to the exchange of currency and not to exportation or import substitution, and therefore cannot be classified as a prohibited subsidy that is specific. Additionally, currency undervaluation has not been mentioned in the illustrative list of export subsidies (see Annex I, ASCM).

With each side of the debate armed to the brim with arguments dressed in legalese, the United States is almost certain to face a formal complaint at the WTO.

Q5: Does the rule violate U.S. law?

A5: Regarding U.S. law, there has been some question over whether Commerce has the statutory authority to take currency undervaluation into account, particularly without Congress modifying the current CVD law. A foreign company or government could use this legal argument in U.S. litigation in response to a CVD order justified on grounds of currency undervaluation. The Commerce Department claims that it has the authority to administer the CVD law, including in instances where currency undervaluation should be countervailable, and has the authority to promulgate regulations to do so. The Commerce Department also argues that it does not have a history of finding that currency undervaluation is not countervailable, and even if it did it is always able to change its practices.

Stephanie Segal is a senior fellow with the Simon Chair in Political Economy at the Center for Strategic and International Studies in Washington, D.C. William Reinsch holds the Scholl Chair in International Business at CSIS, Jack Caporal is an associate fellow with the CSIS Scholl Chair. Sanvid Tuljapurkar is in intern with the CSIS Scholl Chair.

Critical Questions is produced by the Center for Strategic and International Studies (CSIS), a private, tax-exempt institution focusing on international public policy issues. Its research is nonpartisan and nonproprietary. CSIS does not take specific policy positions. Accordingly, all views, positions, and conclusions expressed in this publication should be understood to be solely those of the author(s).

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