Download Post-Hearing Submission of Metals Service Center Institute (“MSCI

Post-Hearing Submission of
Metals Service Center Institute (“MSCI”)
Concerning
Aluminum: Competitive Conditions Affecting the U.S. Industry
_________________
ITC Investigation No. 332–557
October 7, 2016
The Metals Service Center Institute (“MSCI”) respectfully submits the following
responses to questions posed by the International Trade Commission at the
September 29, 2016 hearing in the above-referenced proceeding.
Executive Summary
1.
Response to question posed by Commissioner Broadbent regarding
currency manipulation:
It is MSCI’s position that the Chinese currency is significantly undervalued and
that the Chinese currency policy has been in place for nearly two decades. We
demonstrate that the actual yuan-dollar exchange has persistently differed from the
equilibrium exchange rate. We document that the policy has led to the Chinese
accumulation of over $3 trillion in foreign exchange reserves, an amount that is 8-9
times the level that economists suggest is needed for financial stability. We show
that the Chinese reserves exceed those held by the next five largest countries
combined and that China’s mercantilist exchange rate policy has caused massive
current account surpluses for China and huge bilateral trade deficits for the U.S..
2. Response to question posed by Commissioner Pinkert: “[O]n the
question of currency manipulation, can one define currency manipulation
without looking at flows of capital between countries?”
The key issue is whether a country has a large current account surplus and is
actively buying foreign currencies to prevent appreciation and maintain that
surplus. There is little doubt that both are true for China, not just in the more
recent 12 months but consistently for nearly two decades. It is the long run,
persistent distortion of the exchange rate that has been particularly damaging for
U.S. import competing industries. The Chinese mercantilist approach toward the
exchange rate has caused serious damage to U.S. firms and workers.
Discussion
1.
Response to question posed by Commissioner Broadbent regarding
currency manipulation:
It is MSCI’s position that the Chinese currency is significantly undervalued. The
manipulation is not a new phenomenon. A weak currency has been the policy of the
Chinese government for nearly two decades. The magnitude of the undervaluation
and the duration of the policy mean that the yuan-dollar exchange rate must be
considered manipulated.
While the Chinese exchange rate policy distorts trade with all its trading partners,
it is particularly damaging to the U.S. because the yuan is explicitly pegged to the
U.S. dollar. The impact of the Chinese policy on other countries is tempered
because their currencies can adjust vis-à-vis the U.S. dollar. This adjustment
partially offsets the distortion created by China. By contrast, U.S. import
competing firms experience the full impact of the distorted exchange rate. U.S.
policymakers must hold our trading partners accountable and address the resulting
harm to U.S. workers and manufacturers.
Before documenting China’s long term exchange rate distortion, we want to
comment on our use of the term “manipulation”. The meaning of the word
“manipulation” is open to dispute. We understand the Treasury Department has its
own procedure for labeling a country a “currency manipulator,” and we also
recognize the great political pressure on Treasury to avoid using the term.
Treasury’s trepidation, however, does not change the reality that the yuan has long
been, and continues to be, significantly undervalued.
Even a cursory look at the long term exchange rate, capital flows, and current
account imbalance makes it clear that market forces are not in play and the heavy
hand of government control is being exerted. If the effects of the Chinese policy
were limited to within its borders, then one might accept such a massive
government intervention. But, that is not the case when we are talking about the
exchange rate. Purposeful and persistent undervaluation of the yuan amounts to a
government-created competitive advantage for Chinese exporters, puts U.S. firms
and workers on an uneven playing field, and is inconsistent with the principles of
free and fair trade.
In 1977 the IMF stated that members should “avoid manipulating exchange rates or
the international monetary system in order to prevent effective balance of payments
adjustment or to gain an unfair competitive advantage over other members.” 1
IMF, Surveillance Over Exchange Rate Policies, Dec. No. 5392-(77/63) (Apr. 29,
1977), in IMF, Annual Report 1977, pp. 107-108 (1977).
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Unfortunately, the IMF did not formally define how one would measure or define
what constitutes “manipulation”. We do not take issue with the three criteria used
by Treasury to identify manipulation: bilateral trade surplus, material current
account surplus, and persistent, one-sided intervention. We take issue, however,
with Treasury’s narrow measure of “persistent”. Under Treasury’s approach,
persistent is limited to the most recent 12 month period.
The following common sense definition of currency manipulation captures the
essence of the issue:
Currency manipulation occurs when a government buys or sells
foreign currency to push the exchange rate of its currency away from
its equilibrium value or to prevent the exchange rate from moving
toward its equilibrium value.
The equilibrium value of a currency is that which is sustainable over
the long run. An exchange rate is sustainable if the current account
balance is not generating an explosive path for net foreign assets
relative to both domestic and foreign wealth. Sustainability
generally implies a small value of the current account balance. 2
Under this definition it is clear that China has engaged in currency manipulation
for many years. First, the yuan is not near its “equilibrium value,” nor has it been
for at least two decades. Second, the yuan-dollar exchange rate is not sustainable,
as Chinese reserves have exploded – growing from less than $1 trillion to over $4
trillion in a ten-year period. And third, China’s trade balance vis-à-vis the U.S. is
enormous, averaging well over a $300 billion surplus annually.
We now elaborate on these three key elements of currency manipulation.
The Yuan is Massively Undervalued
What is the “equilibrium value” of the yuan-dollar exchange rate? Economists most
commonly use the concept of Purchasing Power Parity (“PPP”) as the benchmark
exchange rate. The PPP captures the long-run tendency for the exchange rate to
imply that a market-basket of goods is priced equivalently in the two currencies. 3
Said differently, the PPP exchange rate means that, on average, Chinese goods
would not be systematically underpriced relative to U.S. prices.
Joseph E. Gagnon, Combating Widespread Currency Manipulation, Peterson
Institute for International Economic Policy Brief, PB12-19, July 2012, pp. 1-2.
3 Robert C Feenstra and Alan M. Taylor, International Economics, Worth
Publishers, 2008, Chapter 14.
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Discrepancies from the PPP are common in the short run. However, in the longer
run market based exchange rates move to the PPP exchange rate. How quickly the
convergence occurs is one sign of a market-based exchange rate system. The
common view is that the “half-life” of a misalignment is three to five years. 4 As we
will show, the yuan has been massively undervalued relative to PPP for a long time,
and the conventional 3-5 year half-life adjustment finds no support in China’s
exchange rate history.
Figure 1 below depicts the persistent and substantial difference between the actual
yuan-dollar exchange rate (solid line) and the PPP benchmark (dashed line). The
enormous deviation of the actual exchange rate from the PPP benchmark is evident
in the chart. The data make it clear that the deviation is not just large but
persistent. There is little evidence that the deviation will be resolved in any
reasonable time frame (i.e., the half-life of the yuan misalignment is measured in
decades, not years).
Figure 1: Yuan-Dollar Exchange Rate (Actual vs. PPP)5
9
8
Yuan-Dollar Exchange Rate
7
6
44% appreciation
in Yuan still needed
5
4
3
2
Actual Exch. Rate (Yuan to US$)
PPP Exch. Rate
1
0
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
The figure shows the yuan-dollar exchange rate was fixed at 8.27 yuan to the dollar
Kenneth Rogoff, “The Purchasing Power Parity Puzzle,” Journal of Economic
Literature, 34(2), (1996), pp. 647-668.
5 International Monetary Fund, World Economic Outlook Database, October 2016.
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through the end of 2004. Whether 8.27 is undervalued or overvalued depends on
what the equilibrium or benchmark value is. As shown, at that time the PPP
benchmark was 2.9. This means the yuan was undervalued by 67%.
Due to pressure from the United States and other trading partners, the Chinese
began to adjust their exchange rate beginning in 2005. By the end of 2015 the
exchange rate was 6.28 yuan to the U.S. dollar. While the Chinese have moved in
the right direction, they are far from equilibrium, and the progress is glacial. As of
the end of 2015 the benchmark PPP was 3.5. This means the yuan is still
undervalued by 44%.
We have several comments on the extent of the distortion. First, the modest
adjustment that has occurred over the past decade hardly exonerates the Chinese
from being considered currency manipulators. If anything, it confirms the Chinese
government’s orchestrated intervention. The exchange rate movement was not a
result of market forces but rather purposeful political decision by the Chinese
government. Second, the yuan remains substantially undervalued. The Chinese
exchange rate policy gives its firms an immense pricing advantage. Even if all else
were equal (i.e., no other Chinese government subsidies to its producers, no other
distortions to input prices, etc.), Chinese firms would, on average, be able to
undercut U.S. prices by 44% simply because of the exchange rate. This is
unsustainable and harmful to U.S. firms. The U.S. aluminum industry is the best
in the world and can successfully compete in the global marketplace given a fair and
even playing field. The Chinese government’s persistent intervention to create a
systemic pricing advantage has demonstrably and materially harmed U.S. firms
and workers. Third, the additional adjustment required to bring the yuan exchange
close to a market benchmark is huge. Assuming no change in Chinese government
policy, the current rate of adjustment implies the yuan will not approach PPP for
another 20 years. This forecast is unsustainable and will devastate the U.S.
aluminum industry and all U.S. manufacturing.
China’s Mammoth Foreign Exchange Reserves
To push down the value of its currency, the Chinese government has sold yuan to
buy dollars. Consequently, the Chinese government must hold the foreign currency
acquired in the form of a foreign financial asset, typically a bond or a bank deposit.
Currency manipulation can be measured in terms of the net cross-border flow of
financial assets held by the official sector. Official purchases of foreign assets, or
net outflows, push down the value of a currency.
Figure 2 below depicts China’s massive foreign exchange reserves. In 2003 China
was adding about $10 billion a month to its reserves; by 2010 China was adding
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more than $30 billion a month. This massive intervention led New York Times
columnist and Nobel Prize winner Paul Krugman to state that China’s policy “is the
most distortionary exchange rate policy any major nation has ever followed”. 6
Figure 2: China Foreign Exchange Reserves (excluding gold) 7
4,500
4,000
US Dollars (Billions)
3,500
3,000
2,500
2,000
1,500
1,000
500
Jan-00
Jul-00
Jan-01
Jul-01
Jan-02
Jul-02
Jan-03
Jul-03
Jan-04
Jul-04
Jan-05
Jul-05
Jan-06
Jul-06
Jan-07
Jul-07
Jan-08
Jul-08
Jan-09
Jul-09
Jan-10
Jul-10
Jan-11
Jul-11
Jan-12
Jul-12
Jan-13
Jul-13
Jan-14
Jul-14
Jan-15
Jul-15
Jan-16
Jul-16
0
While the Chinese reserves have fallen recently, the fall hardly exonerates China,
nor does it disprove that it is manipulating its exchange rate. To begin with, the
decline must be kept in perspective. Even after the recent fall, China’s current
reserve level is larger than when Krugman declared it the most distortionary
exchange policy in history.
While some level of foreign exchange reserves are responsible and facilitate
financial stability, China’s current levels vastly exceed what experts suggest are
necessary. The Greenspan-Guidotti rule recommends that countries hold foreign
Paul Krugman, “Taking on China”, New York Times, March 14, 2010, at
http://www.nytimes.com/2010/03/15/opinion/15krugman.html?_r=0, October 5, 2016.
7 International Monetary Fund, Total Reserves excluding Gold for China, retrieved
from FRED, Federal Reserve Bank of St. Louis;
https://fred.stlouisfed.org/series/TRESEGCNM052N, October 5, 2016.
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exchange reserves (i) equal to 100 percent of their short term external debt 8 and (ii)
equal to three months of imports (or exports). 9 China’s foreign exchange reserves
are at least 8 to 9 times larger than either of these benchmarks. 10 In other words,
the level of China’s foreign exchange reserves cannot be explained by conventional
economic rationale.
More perspective on China’s outsized foreign exchange reserves is found in the
following chart (Figure 3). As of mid-2016 China still has nearly three times the
foreign reserves as the second largest country, Japan (a country that is also often
considered a currency manipulator). In fact, as of mid-2016 China has more
reserves than the next five countries (Japan, EU, Switzerland, Saudi Arabia,
Taiwan) combined.
Olivier Jeanne and Romain Ranciere, The Optimal Level of International Reserves
For Emerging Market Countries: A New Formula and Some Applications, IMF
Working Paper 06/98, 2006.
9 International Monetary Fund, Assessing Reserve Adequacy, Paper prepared by the
Monetary and Capital Markets, Research, and Strategy, Policy, and Review
Departments, February 14, 2011.
10 Joseph E. Gagnon, Combating Widespread Currency Manipulation, Peterson
Institute for International Economic Policy Brief, PB12-19, July 2012.
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Figure 3: Comparing Foreign Exchange Reserves (mid 2016) 11
3,500,000
3,000,000
US Dollars (Millions)
2,500,000
2,000,000
1,500,000
1,000,000
500,000
0
The only way China could have accumulated such a large stock of foreign reserves –
nearly all of which is held by the government – is through large and persistent
intervention in the exchange market. But for the Chinese government’s massive
purchase of U.S. dollars (thereby keeping the yuan value low), the yuan would have
strengthened long ago, and the foreign exchange reserves would have never reached
their current level.
Current Account Balances
The third metric of a currency manipulator is a large current account balance. As
seen in the following figure (Figure 4), China’s current account surplus has swelled
over the past 15 years, growing from near zero to its 2015 level of over $330 billion.
The contrast between China’s massive surplus and the U.S.’ large and persistent
International Monetary Fund, Total Reserves, retrieved from Wikipedia,
https://en.wikipedia.org/wiki/List_of_countries_by_foreignexchange_reserves#endnote_a, October 5, 2016.
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current account deficit is quite remarkable. The chart makes it clear that, as
China’s surplus has soared, so too has the U.S.’ deficit.
Figure 4: Current Account Balance, U.S. and China (annual) 12
The following chart (Figure 5) makes it clear that the U.S. has suffered from
China’s currency policy. Over the past 15 years China has pursued a weak currency
policy to promote its exports. This has directly impacted U.S. producers, who have
struggled to compete against low priced imports facilitated by China’s exchange
rate policy. The bilateral merchandise trade deficit with China has quadrupled
since 2000.
World Bank, World Development Indicators, retrieved from World Bank,
http://data.worldbank.org/indicator/BN.CAB.XOKA.CD, October 5, 2016.
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Figure 5: Bilateral Trade Deficit, U.S.-China 13
Summing Up
There is no debate that China has controlled its exchange rate in such a way to
artificially lower its export prices. As the above discussion has documented, the
yuan-dollar has long been significantly undervalued compared to its PPP
benchmark. As troubling, there is little reason to think this policy will change in
the near future. The consequences of the distorted exchange rate include a soaring
U.S. trade deficit with China, lost jobs, and factory closings.
U.S. Census Bureau, Trade in Goods with China, retrieved from Census,
http://www.census.gov/foreign-trade/balance/c5700.html, October 5, 2016.
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2. Response to question posed by Commissioner Pinkert: “[O]n the
question of currency manipulation, can one define currency manipulation
without looking at flows of capital between countries?”
What matters is whether a country has a large current account surplus and is
actively buying foreign currencies to prevent appreciation and maintain that
surplus. There is little doubt that China has done both. In the above response to
the first question, MSCI documented China’s massive and sustained current
account surplus and its equally massive reserve of foreign exchange (see Figures 2,
3, and 4).
On the specific issue of capital flow, government purchases of foreign assets are a
type of capital flow. The IMF definition places a lot of weight on such purchases,
but does not absolutely require them. There are scenarios where a government
imposes very asymmetric capital restrictions (e.g., different rules for private
outflows than for private inflow), so in general the IMF is cautious. We note,
however, that in the case of China, the large capital flow is observed.
Further, the Treasury Department’s decision not to declare China a currency
manipulator warrants discussion. The Trade Facilitation and Trade Enforcement
Act of 2015 (P.L. 114–125) (the “Act”) set forth three criteria that must be met in
order to declare a country a currency manipulator under that Act: (1) a significant
bilateral trade surplus with the United States, (2) a material current account
surplus, and (3) engaged in persistent one-sided intervention in the foreign
exchange market. Importantly, the enforcement tools provided in that Act are in
addition to, and do not supplant, Treasury’s other tools to combat currency
manipulation.
MSCI documented in its pre-hearing submission and in the above response to the
prior question how all three criteria in the Act were clearly satisfied. Treasury
found that criteria (1) and (2) were both satisfied. Treasury’s determination that
that criterion (3) was not satisfied is puzzling, given the massive stockpile of foreign
exchange reserves China has compiled over the past 15 years. What is the
disconnect? The answer lies in the very short time window Treasury chose to use to
assess persistent. In its report, Treasury limited its analysis to net purchases of
foreign currency over a period of 12 months. With all due respect, MSCI strongly
disagrees that 12 months is an appropriate period of time to measure “persistent”.
MSCI’s position is that the longer time period discussed above in our prior answer
more accurately captures the persistent nature of China’s intervention.
MSCI has two additional comments regarding Treasury’s decision to not call
China’s mercantilist control of its exchange rate “manipulation”. First, had the Act
been in effect in 2000, Treasury would have identified China as a country engaged
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in illegal exchange rate controls for most of the past 15 years. 14 The fact that it did
not do so in its 2016 study reflects only the peculiarities of recent trends. It should
not be viewed as an exoneration of China’s longer run policy.
Second, we understand that for many policy-makers “currency manipulator” is a
politically loaded term full of policy implications that could complicate many aspects
of the U.S. relationship with China. We do not believe the ITC needs to explicitly
use that term in order to acknowledge the fact that China has controlled its
exchange rate in a highly mercantilist fashion for more than 15 years. The
consequences of that policy have been felt across the entire U.S. manufacturing
sector, and most particularly in the aluminum industry.
C. Fred Bergsten and Joseph E. Gagnon, The New U.S. Currency Policy, April 29,
2016, at https://piie.com/blogs/realtime-economic-issues-watch/new-us-currencypolicy.
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