U.S. President Barack Obama’s signature international economic initiative, and the centerpiece of his pivot to Asia, is the Trans-Pacific Partnership (TPP), a trade agreement of a dozen Asia-Pacific countries. But the partnership faces a major hurdle. Bipartisan majorities of both houses of Congress insist that the TPP forcefully address the manipulation of exchange rates, the practice through which some countries keep their currencies artificially weak and thus unfairly make their exports more competitive. The U.S. auto industry, likewise, has indicated that it will oppose the TPP unless the issue is effectively addressed, and it has politically important supporters in the labor unions and the steel industry. At the same time, however, many observers believe that a U.S. effort to raise currency concerns would torpedo the agreement. There is a way to resolve this dilemma, but it will require new initiatives by the Obama administration, Congress, and TPP partner countries.
The critics of the TPP are correct to link currency and trade. Changes in exchange rates can affect trade flows and trade balances far more than any of the border, or even behind-the-border, barriers that are the usual focus of trade agreements. Indeed, it is just as economically distorting to artificially depress currency values—as China and a number of other countries have done over the past decade—as it is to impose high import tariffs and subsidize exports directly. As a result of this behavior, in some periods the United States has suffered much larger trade deficits and sizable job losses than it otherwise would have.
The international economic system has been totally ineffective at responding to such manipulation. The International Monetary Fund (IMF) has clear rules against competitive devaluations. But it has no enforcement mechanism and its decision-making process is highly politicized and easy for the manipulators to block. The World Trade Organization (WTO) can levy tough sanctions, but its rules on exchange rates are vague and have never been tested. Further, despite earlier congressional efforts,