Foreign currency manipulation is a red herring

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Trade policy is finding its way back into the spotlight thanks to the 2024 election campaign. Both the Biden administration and GOP presidential candidates are ramping up protectionist rhetoric ahead of the primaries next year. Foreign currency manipulation has been a common justification for protectionism since former President Trump began accusing China of the practice during his 2016 campaign. The issue is much overblown.

Competitive currency devaluation occurs when a country devalues its currency to gain a supposed advantage in international trade. By devaluing the national currency, a country’s domestic products become cheaper to export, increasing exports and reducing trade deficits. Protectionists such as former Trump trade advisor Peter Navarro often accuse other countries of intentionally devaluing their currencies to the detriment of the U.S. economy. In his thinking, this justifies protective tariffs and other measures to combat these alleged unfair trading practices.

Contra Navarro and other protectionists, foreign monetary policies should not dictate our own trade policy. Devalued currencies in other countries often have nothing to do with trade. Countries routinely inflate to stimulate their economies or make debt repayment easier. Devaluations from inflationary monetary policy are baked into the cake, regardless of trade policy on either side. U.S. trade policy can do little to effectively counter foreign currency devaluation. Nor would it be desirable to try.

Trump’s tariffs failed to significantly reduce the U.S. trade deficit. A strong dollar relative to other currencies was likely one reason for this failure. A major reason for the dollar’s strength is that the U.S. typically has lower inflation than other countries. When foreign currencies fall in value compared to the dollar, it becomes more expensive for foreigners to buy U.S. exports, increasing the U.S. trade deficit.

Despite the attention given to the trade deficit, it is merely an accounting measure, so trade policy geared toward reducing the trade deficit is both ineffective and unnecessary.

Among others, former U.S. Trade Representative and Trump advisor Robert Lighthizer accuses other countries, especially China, of intentionally devaluing their currencies to run trade surpluses. In reality, evidence of widespread competitive currency devaluation is scant. There is no conspiracy here. American monetary policy, for all its flaws, tends to be less inflationary than China’s, Europe’s, and other trading partners.

While it may seem appealing, competitive currency devaluation is a counterproductive and costly policy. Monetary devaluation may not necessarily increase net exports past the short term. Export prices may fall at first due to the lower exchange rate, but inflation also increases the prices of domestic products, driving export prices back up. Inflation will likely negate the trade surplus-inducing effects of currency devaluation.

Currency devaluation also makes imports more expensive by lowering the exchange rate. That means domestic consumers must pay more for everyday necessities. Domestic producers also suffer as a result of higher input costs. Taking these costs into account, as one should, competitive currency devaluation fails on net to strengthen international competitiveness and harms domestic productivity.

If competitive currency devaluation is so ineffective and costly, why would foreign countries intentionally employ such a policy? And even if they do, it poses no threat to the U.S. economy that should concern policymakers. The U.S. government should not be concerned with foreign countries’ monetary policies. It should instead craft trade policy that benefits the American economy.

Some protectionists have argued that the U.S. should emulate the supposed unfair trading practices of foreign countries. Politicians and government officials from both sides of the aisle, including Sen. Josh Hawley, Sen. Tammy Baldwin, and Peter Navarro have proposed devaluing the dollar to gain an advantage in international trade.

Competitive currency devaluation would not prove any more successful for the U.S. than it would for any other country. Besides failing to strengthen competitiveness in pursuit of a misguided goal of a favorable trade balance, currency devaluation requires significant inflation. Which Americans have had quite enough of lately, thank you.

An April poll by Gallup found that inflation was “by far the top trouble mentioned when Americans are asked to name the most important financial problem facing their family.” The cost of rent or a mortgage were found to be “a distant second” concern.

Currency devaluation and exchange rate adjustments are primarily a matter of monetary policy, not trade policy. U.S. trade policy should aim to strengthen the American economy instead of getting hung up on foreign monetary policy.