U.S. Trade Disputes Escalate over Currency

The trade dispute between the U.S. and China, two of the biggest protectionist powers, is reaching a new level. All participants in international trade, including Brazil, are closely monitoring this escalation. The U.S. government may levy higher taxes on goods from countries with currencies considered artificially undervalued, such as China.

This change will take place if a bill currently in the House of Representatives becomes law. The proposal passed in the Ways and Means Committee, and Speaker of the House, Democrat Nancy Pelosi, intends to pass the bill on to the full House. The proposal has yet to reach the Senate, but the political message is quite clear: Washington soon may have another powerful tool to limit foreign competition.

For years, the major powers have pressed China to let the yuan appreciate. The Chinese currency has remained undervalued for a long time, despite external account surpluses and the accumulation of vast reserves. This process occurs because the currency exchange is controlled, and currency fluctuates only within a very narrow margin.

The Chinese government has slightly expanded the margin of fluctuation and promises to liberalize trade, but gradually. The result so far has been negligible. The undervaluation of the yuan makes it almost impossible to compete with Chinese producers, and this affects not only developed economies, such as the American and European ones, but also emerging economies like Brazil.

Diplomatic pressure on the Chinese government is routine but ineffective, and even more ineffective at the international level. The rules of the World Trade Organization do not govern exchange policies. Many cases have been filed against China, but they were based on allegations other than exchange policies.

The bill pending before the U.S. House of Representatives opens a new chapter in the conflict. If the proposal becomes law, the world’s largest economic power will apply a unilateral rule to combat competition labeled as unfair.

This would not be the first U.S. unilateral action within the international trade arena. American authorities have tried to impose other standards made in Washington on their partners, while maintaining billions of dollars for agribusiness subsidies. Some of these subsidies have already resulted in convictions for certain types of aid granted to the cotton sector. It remains to be seen whether a law against exchange policies labeled as unfair will be compatible with other WTO rules.

Competition based on undervalued exchange rates is an old practice, dating back to the 1930s, when it was very common for industries within highly developed economies to dispute turf during a depressed market. Many countries engaged in war currency battles, and the result was bad for everyone, delaying trade recovery. With the creation of the International Monetary Fund in 1944, it seemed possible to establish some order within the exchange system. However, this limited discipline was dismantled in the 1970s, after the official devaluation of the dollar.

The system of international standards for trade regulates other aspects of competition, but governments remain free to adopt the currency exchange model of their choice. With the Uruguay Round, ended in 1994, and the creation of the WTO, the system improved in important respects, but the exchange went out of control.

A bill in Congress will give U.S. President Barack Obama one more reason for argument with the Chinese authorities during the upcoming G-20 Summit in November. However, the American initiative will contribute a more lasting and long-range effect by including currency exchange tariffs as part of the agenda for trade negotiations. Unilateral laws, even when in principle compatible with WTO rules, are dangerous. Creation of international rules can be very complicated, but it is the best alternative.