Currency and Subsidies

September 14, 2020

Fair warning: today’s column is for trade wonks. If you’re looking for trenchant commentary on trade in the election or the two candidates’ trade policies, you can stop reading right here. I’ve attempted that before and will do so again, but today is for us wonks. The topic is currency manipulation as a subsidy. It is timely because the Commerce Department recently launched its first investigation into that possibility—against imports of Vietnamese tires—and the Treasury Department has provided Commerce with its verdict: that Vietnam is indeed manipulating its currency. This has important implications.

First, we begin with a short history. U.S. law on subsidies is not new. It dates back to the 1890s, and basic principles are embedded in World Trade Organization (WTO) rules; namely, that it is acceptable to impose a duty on subsidized imports (called a countervailing duty, or CVD) if they are determined to have injured a U.S. party. The amount of the duty is to be no more than the amount of the subsidy, so it is intended to offset the “crime” but not to be punitive. In the United States, the Commerce Department determines whether a subsidy exists, and the International Trade Commission decides whether injury has occurred.

In the good old days, this was not complicated. The classic example is the government that offered to pay a manufacturer for each item it exported. Now, of course, things are more complex, and subsidies include not only direct payments but below market rate loans, delayed repayment schedules, cheap electric power, free land for the factory, exemption from regulatory standards, and thousands of other ways to distort the market.

One bedrock principle in both U.S. law and WTO rules is that a subsidy must be specific; that is, it must be a benefit paid or made available to a particular entity or entities. So, for example, if a government set electricity rates at an artificially low level for the entire country, that would not be a countervailable subsidy. Similarly, maintaining a country’s exchange rate at an artificially low level has not been considered a subsidy because it applies to the country’s entire economy—it is not specific.

Last February, the Commerce Department ignored that principle and issued regulations that would allow it to find a subsidy if it determines that a currency is undervalued in relation to the U.S. dollar, that government action contributed to the undervaluation, and that the subsidy is being predominantly or disproportionately used by the industry being investigated. The regulations also indicated that, while Commerce would have the last word, it will “generally defer” to Treasury’s expertise. (I’m guessing there was a huge internal bureaucratic struggle over that wording and Treasury’s role.)

The Vietnamese tire case is the first time this new authority has been road-tested, pun intended. On August 24, the Treasury Department released its findings that Vietnam’s currency was undervalued by 4.7 percent and that the government had contributed to that by buying $22 billion in foreign exchange reserves. The Commerce Department will now presumably fold that into its investigation and add that percentage to any additional subsidies it finds to produce a final number.

This is going to cause problems for several reasons. First, there is no widely agreed-upon methodology for making a judgment of undervaluation. Most economists will tell you that if the currency floats, its value is what the market says it is and that under or over valuation is an artificial construct. Former Treasury official Mark Sobel said, “There is no precise, agreed method to measure currency undervaluation, let alone of a bilateral exchange rate pair. The estimates clearly run afoul of the fallacy of false precision. If other countries follow suit or react, it could be quite damaging to the international monetary system.” In other words, we’re making it up as we go along, and if other countries decide to do the same thing, it could come back to bite us.

Second, precisely because the “subsidy” is not specific, it can be applied to all of a country’s exports. So, if the tire industry prevails, expect a wave of copycat petitions to be filed by other industries facing competition from Vietnam. A bonanza for the Washington trade bar but not for U.S. consumers.

Third, the measure clearly contravenes WTO rules, so we should expect Vietnam to lodge a complaint there, which we will likely lose. Of course, with the Appellate Body not functioning, that may not matter in the short run except that it is one more thing the administration is doing to undermine international trade rules. Eventually, if the Appellate Body is restored, as could well happen with a new U.S. administration, we will likely lose at that level as well and be forced to remove the regulation, pay compensation, or suffer retaliation.

In short, this new Commerce regulation is overinflated and punctures long-standing trade rules. It should be retired.

William Reinsch holds the Scholl Chair in International Business at the Center for Strategic and International Studies in Washington, D.C.

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