The subject of currency wars and trade wars is gradually gathering interest among scholars and public opinion. In the face of the magnitude of present misalignments and their clear impacts on trade, one may wonder why and how this issue is absent from trade rules and multilateral trade negotiations at the WTO in Geneva.
Brazil has presented two submissions to the Working Group on Trade, Debt and Finance of the WTO, in April and September 2011. In the first, a work programme was proposed, including academic research on the relationship between exchange rates and international trade (WT/WGTDF/W/53). In the second, further analysis of trade instruments available in the multilateral trading system allowing members to redress eventual distortions caused by exchange-rate misalignments was requested (WT/WGTDF/W/56).
The WTO Secretariat, at the request of the Working Group, presented a review of literature on the relationship between exchange rates and international trade (Auboin and Ruta 2011 ). The work brings together extensive research on the effects of exchange-rate volatility on trade flows, but it presents no specific study about the impacts exchange-rate misalignments have on WTO principles, rules and instruments. In short, the WTO analyses the subject from the perspective of the IMF, not of the WTO.
The genesis of the GATT, IMF, and the World Bank in the 1940s created a clear red line between the GATT and IMF. One was to be responsible for trade liberalisation, and the other for exchange-rate and balance-of-payment stability. It is important to remember that, at the time, the multilateral trade rules were conceived under the dollar-gold standard. Even after the adoption of flexible exchange rates, during the 1970s the exchange rate subject was not incorporated either at the GATT nor, later, at the WTO.
This artificial construction creates an illusion – that trade can be separated from exchange rates. While the world’s big economies – the US and the EU – dominated the trade scenario, whenever exchange-rate misalignments considerably affected trade, the issue was discussed between a few countries only. This practice has been put into question since the beginning of the 2000s, when emerging countries started to become more prominent actors in the international arena.
At present, the Doha Round faces a serious impasse and one can question how the WTO can solve the exchange rate issue. The only reference to the question in the trading system is found in Article XV of the GATT that establishes that countries shall not frustrate the objectives of the trade agreement through exchange-rate measures, nor the objectives of the exchange agreement through trade. This article, however, has never been tested by GATT or WTO panels. Some experts suggest the use of trade defence instruments such as antidumping and countervailing measures as potential remedies, but their compatibility with WTO rules has also been questioned. The main problem is that exchange-rate issues were never incorporated into WTO rules because they were always considered as matters managed by – and under the jurisdiction of – the IMF. With the intensification of the discussions on trade and exchange rate, the subject was considered at the G20 but, until now, the participating countries could not agree to a solution.
The issue of exchange-rate misalignments and their impact on trade is not new, but it has recently gained increased attention from economists, and a number of estimates of misalignments are available for all currencies in the world. It is relevant to note that misalignments are estimated against an equilibrium rate and not against some arbitrarily fixed point in the past. There are several models used to estimate the equilibrium exchange rate, such as purchasing power parity, the current-account equilibrium, the equilibrium of a country’s net external position of assets and liabilities, or the exchange rate based at the unit cost of the workforce. From the analysis of the different studies, it becomes clear that the magnitude of the exchange-rate misalignments can no longer be ignored. The Centro de Macroeconomia Aplicada (CEMAP), in São Paulo, is currently assessing the value of misalignments for the G20 currencies. Calculations for the end of 2010 show that the Brazilian real was overvalued by 30%, the dollar was undervalued by 10%, and the renminbi was undervalued by 20%. Undervaluation of some Asian currencies varies from 15 to 20%.
The next question to be raised is how such misalignments affect international trade policy instruments negotiated at the GATT/WTO over the last 60 years. The impacts of these misalignments on tariffs can be calculated in three steps:
- Creation of a graphical tariff profile for a country, i.e. its simple-average bound and applied tariffs by category (foodstuff, minerals, textile, machinery and electronics).
- “Tariffication” of the exchange-rate misalignment.
- Identification of its impact on import tariffs.
Details of this methodology are presented in Thorstensen et al. (2011). In the case of Brazil, the outcome is surprising. With a 30% overvaluation, Brazil is virtually nullifying its bound tariffs and transforming its applied tariffs into import incentives of around 25%. In other words, the exchange-rate misalignment has the effect of nullifying the market protection negotiated at the WTO and, even worse, of working as an incentive to imports.
Again for Brazil, considering the accumulated impact of some undervalued exchange rates, such as those in the US, China and other Asian countries in 2010, the effects on Brazilian tariffs are also alarming. For example, a 20% undervaluation of China’s exchange rate (or other similarly undervalued currency), when “tariffied” in conjunction with the Brazilian overvaluation of 30%, will represent not only the nullification of Brazil’s bound and applied tariffs, but also incentives to import (see Figure 1).
Figure 1. Brazil’s tariff and exchange-rate adjusted tariffs
There are other important consequences regarding undervalued currencies. Following the methodology of tariffication for exchange-rate misalignments, the results will be an extra tariff to be added over the negotiated tariffs of countries with undervalued currencies, representing a new barrier against imports. There are two consequences here. First, the bound tariffs negotiated at the WTO by these countries are being increased, in violation of Article II of the GATT that establishes that tariffs shall remain under the level bound at the respective schedules of each country (Figure 2). Second, these countries are benefiting from a wider market access in other countries than they had negotiated for in the WTO.
Figure 2. US tariffs and exchange-rate adjusted tariffs
Another serious issue related to the effects of misalignments on tariffs is the creation of different degrees of openness faced by a given country in other markets. Calculating the combined effect of several exchange-rate misalignments (overvaluation and undervaluation) to a given tariff profile (applied tariffs), each country will present a different set of tariffs against exports of exporting countries. In other words, considering the new “adjusted tariffs”, each exporter will face a different market-access situation in a specific market, depending on which country he exports his products to (Figure 3).
Figure 3. US tariffs and exchange-rate adjusted tariffs
This reality brings into question the effectiveness of the MFN principle established by GATT Article I, that “any advantage, favour, privilege or immunity granted by any contracting party to any product originating in or destined for any other country shall be accorded immediately and unconditionally to the like product originating in or destined for the territories of all other contracting parties.” Persistent exchange-rate misalignments cannot but create potentially infinite variations of market-access conditions among WTO members. This situation is directly the opposite of what the multilateral system sought with the establishment of the MFN principle.
The effects of misalignments are also distorting many other rules and instruments negotiated under the WTO, such as antidumping, subsidies, safeguards, rules of origin, GATT articles I, II, III, and XXIV.
The WTO can no longer ignore what is happening behind its magnificent structure of complex trade rules. The persistence of opposite exchange-rate misalignments, of countries with overvalued currencies and others with undervalued ones, for long periods is eroding the multilateral trading system. The WTO cannot remain silent to such reality. The core principles of its construction – transparency, predictability and confidence – are under question. The strengthening of trade rules, with the negotiation of instruments to neutralise the effects of exchange rates, is fundamental to the existence of the WTO. Otherwise, the WTO might become a diplomatic-juridical fiction – void of economic reality.
Auboin, Marc, and Michele Ruta (2011), “Currencies and trade: Looking at the recent literature ”, VoxEU.org, 13 November.
Thorstensen, Vera, Emerson Marçal and Lucas Ferraz (2011), “Impacts of Exchange Rates on International Trade Policy Instruments: The Case of Tariffs ”, São Paulo School of Economics (EESP), FGV, September.